Sunday, August 28, 2011

Our Economic Problem: Demand Deficiency

Every once in a while it helps to dig into the numbers. In the political arena, we hear all sorts of reasons given for our prolonged recession: runaway government spending; badly misconstrued government housing policy via Fannie and Freddie; runaway government debt; too much regulatory and government uncertainty, and the like. The one thing you won't hear much about is demand: the problem is deep and continuing government deficits, not demand.

Recall the basic equation: GDP = C + I + G + (X - M)

GDP equals Consumption plus Private Investment plus Government Spending plus Net Exports (Exports minus Imports). Google NIPA (National Income and Product Accounts), click on your top hit, and you are taken to a host of charts and tables put out by BEA (Bureau of Economic Analysis) where you can look up and keep track of the numbers. When any one of the four numbers above go up, other things being equal, GDP goes up. When one or more of the numbers goes down, GDP goes down.

Robert Gordon, an economics professor at Northwestern has put together a great series of charts, which I will include below. He takes the NIPA numbers from 2007 Q1, our last business peak, as the baseline: in the charts, when a category number is up or down a certain percent, this is in comparison to what the same category number was in 2007 Q1.

The first chart shows the 10 year GDP trend in total, and by its four component categories, with 2007 Q1 as the baseline:

And here are the elements that make up the four GDP components: Consumption; Investment; Government; and Net Exports:

Some of these numbers are hard to read. Here is a detailed chart:

What do thee charts tell us? They tell us that consumer demand, business investment, and state/local government spending have all taken big hits. Federal spending is up a bit, and the Net Export position has improved a good bit. Businesses aren't investing and consumers are buried under a mountain of debt (chart from Calculated Risk blog):

  More on this in coming days; but the economy has a demand problem and a debt problem, but contrary to everything you have heard, the problem is a private debt problem. Consumers are not going to begin spending until their balance sheets improve and the unemployed start coming back into the employed workforce. And residential investment/homebuilding cannot recover until the foreclosure mess is cleared up. Together consumption and private residential investment accounts for about 75% of the economy. Other business investment (equipment, nonresidential building) accounts for 10%. Government accounts for about 20%, and Net Exports comes in at -5%.

I don't happen to think business is not investing because they lack confidence. I think they are not investing because they don't have any orders for equipment or new office space. But even if confidence were the problem, this is just 10% of the economy. There is nowhere near as much bang for the buck here as there is finding ways to get the consumer to spend.

Politics has shut down government spending. The consumer is retrenching. If we can't shake out some action in one or both of these sectors, we are in for a long, Japan-like economic slog. Some thoughts on new directions tomorrow.

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