In my last post I argued that the study of economics should inform but not eliminate our individual moral judgments as citizens in a democracy. Economics shifts our attention from the virtues and vices of individuals to the strengths and weaknesses of fundamental economic policies. But that doesn’t mean we have to attribute economic events like the recent financial crisis just to impersonal economic forces. Policies are made by people, and some people have more influence on them than others.
To illustrate how a macroeconomic perspective can inform our moral stance, consider the distinction between personal saving and national saving.
Saving: the more the better?
Recently, I posted a series of investment guidelines called “Principles of Sound Investing.” The very first principle I discussed was “Live within your means,” dealing essentially with the virtues of saving. A household’s savings rate is a crucial determinant of its ability to sustain its income into the retirement years. This is partly just a matter of mathematics. By making assumptions about rates of return, longevity, and so forth, financial planners can calculate recommended savings rates, which usually come out in the range of 10-15%. But the issue also gets entangled with our ideas about how people should live. We tend to think of people who can save for tomorrow as frugal and responsible, while people who run up debt by spending beyond their means as self-indulgent and irresponsible.
Macroeconomics provides a different perspective on saving, one that focuses on national savings rates, not just household savings rates. From this perspective, saving is also a good thing, but only up to a point. Saving provides capital for investment in economic enterprises, which sustains economic production and supports future consumption. National production and national income depend in part on national saving. However, they also depend on national consumption, since producers can’t sustain or increase production if consumers aren’t buying. Too much consumption and too little saving can be a problem, but so can too much saving and too little consumption. That’s why the messages from advertisers seem at odds with our ethic of frugality: Go ahead, live it up; buy that sports car; you deserve it! Already in the 1950s, William H. Whyte was describing how the mass-consumption economy was undermining our traditional ethic of thrift.
Economists like Michael Pettis argue that underconsumption can be just as big an economic problem as overconsumption. He warns us against applying our individualistic conceptions of virtue to entire countries, seeing countries with a high ratio of savings-to-consumption like China and Germany as good, and those with a low ratio of savings-to-consumption like the United States and Greece as bad. In the global economy, the two kinds of countries are complementary, and together they have created the global imbalances that resulted in the financial crisis.
One country’s underconsumption enables and even forces another country’s overconsumption, through its export of goods and capital. A country whose citizens spend too little to absorb its productive capacity can rely on exports to keep the economy booming. But for that country to be a net exporter, generating trade surpluses, some other country must be a net importer, running up debt.
Underconsumption as a growth strategy
In addition to seeing underconsumption as a possible problem and exports as a solution, global macroeconomics can see underconsumption and exports as two sides of a conscious strategy for growing an economy. The idea is to hold consumption down, limit the production of consumer goods for the domestic market, and invest heavily in infrastructure and export industries. That’s been a common model for developing countries in Asia recently, as well as in countries like Brazil and the Soviet Union somewhat earlier.
The prime example of an underconsumption growth strategy today is the Chinese economy. Several key policies support that strategy. Employers raise wages at a slower rate than worker productivity. The central bank sets the value of the national currency low in relation to other currencies, reducing the buying power of Chinese consumers while making Chinese goods cheap on world markets. The central bank also sets interest rates very low, hurting ordinary depositors but helping producers borrow to expand production. The low interest rates are more helpful to producers than consumers, since China provides less financing for consumer expenditures.
This is one way to grow an economy, but it is not without costs. It limits the ability of the domestic population to benefit from the results of their own increasing productivity. In addition, it leads some other country to compensate by spending beyond its means, which it can’t do forever.
US debt in global perspective
What do the Chinese (and other net exporters) do with all the dollars they make by selling things to Americans? One thing they don’t do very much is buy our goods. If they did, the trade imbalance wouldn’t be so large. What they do a lot is lend those dollars back to us by purchasing US securities. They are net exporters of capital as well as net exporters of trade goods.
Here I’ll repeat what I said in an earlier post about international capital flows, quoting at some points from Pettis: Under some conditions, a capital or trade imbalance can be useful for the deficit country as well as the surplus country. For much of the nineteenth century, the United States depended on foreign capital–especially British and Dutch–because investment opportunities in its growing economy were actually greater than domestic savings could fund. But that didn’t hurt the country because “the wealth generated by foreign-funded investment was more than enough to repay the foreign debt and equity obligations.” Poor countries can also benefit by relying on foreign capital for a time. “For countries that lack technology, that have weak business and management institutions, or that suffer from low levels of social capital, foreign investment can bring with it the technology and management skills that allow the economy to grow faster than its foreign debt and equity obligations.”
Today, of course, the United States is no longer a poor country, nor a developing economy with more investment opportunities than we can fund ourselves. The large infusion of foreign capital into the US economy before the crash appears to have hurt the economy more in the long run than it helped it. With our manufacturing sector in decline and our net exports falling, there wasn’t much demand for new capital to expand production, at least not enough to absorb what Ben Bernanke has called a “global savings glut.” Instead, the capital went heavily to finance consumer and government spending. Economic activity was sustained, for a time, by running up government and personal debt. Foreigners bought a lot of Treasury bonds and–more relevant to the financial crisis–mortgage backed securities. The glut of capital pushed interest rates down, encouraging investors to “reach for yield” by considering untraditional but potentially high-return investments, such as the complicated pools of mortgages assembled by Wall Street firms.
So the housing bubble was driven by much more than irresponsible buyers borrowing beyond their means. A housing boom was one way to sustain a high level of economic activity in an increasingly uncompetitive US economy. It gave investors one place to invest and households one way to get ahead. We no longer seemed as capable of making products the world wanted to buy or expanding the middle class by raising wages. But we could finance an increase in home ownership anyway by making shakier loans and packaging them so they appealed to investors.
The financial crisis resulted from unsustainable imbalances in the global economy, especially the imbalance between net importers and net exporters, debtors and creditors, high-consuming and low-consuming nations. The economies involved had their own internal imbalances. China grew its export industries at the expense of domestic consumption. In the United States, the financial services industry boomed while manufacturing languished. We financed consumption more creatively than we developed the products and workforce required for success in the twenty-first century.
Economic imbalances also developed in Europe. Germany became a net exporter and creditor, while poorer countries like Greece became net importers and debtors. The use of a strong common currency, the euro, enabled the debtor countries to buy more than they should have, just as the strong dollar enabled Americans to import so much. One difference is that in Europe, the poorer countries are usually the debtors, while in the US-China relationship, it’s the richer country that is the debtor.
One lesson to learn from all this is that it takes both creditors and debtors to create a debt crisis. Those who heap moral blame on the debtors alone are not seeing the larger picture. Furthermore, the solution cannot just be that the debtors change their behavior to emulate that of the creditors. Since the roles are complementary, changes on one side require changes on the other side. The polices and practices of creditor economies depend on those of debtor economies. If Greeks and Americans suddenly adopted the frugality of Germans and Chinese, without complementary changes on the other side, the decline of consumption would produce global economic contraction and higher unemployment.
As the United States tries to solve its problems as a debtor nation, we don’t want to undermine the high output of our own economy either. Four things drive economic activity: household consumption, government spending, investment and net exports. (Since the US is a net importer, the last part of the equation drives foreign economies instead of our own.) Living beyond our means has been a way of sustaining aggregate demand for economic goods and services, both domestically and globally. Telling households and government to spend less may sound wise and responsible, but it fails to address the larger question of how to rebuild our economy on a stronger foundation. How can we grow the economy in a more sustainable way, without relying on consumers and government to spend beyond their means and run up debt? That is the subject of my next post.