Political Dogma Limits US Economic Recovery
Recent data shows that the recovery of the US economy after the international financial crisis is much slower than in previous post-war business cycles and has decelerated. As Gavyn Davies, previously head of economics at Goldman Sachs, now a Financial Times commentator and formerly an optimist on US recovery, noted on June 3:
“The US employment numbers… confirmed what we already knew from a string of earlier data releases, which is that the [US] economy has slowed very markedly in recent months.”
This data settles an international debate on the speed of US recovery. The first position in this argued that while a double dip recession was unlikely, US recovery would continue to be slower than in previous business cycles. Economists holding this view included Paul Krugman, Nobel Prize winner and New York Times columnist, and Dean Baker, who predicted the US housing bubble, which ignited the financial crisis. On the opposite side, believing US recovery would be more rapid, were Davies, leading US hedge fund manager John Paulson, and others.
Now that the data clearly proves the first assessment to have been accurate, it is important to examine why US recovery has been weak and why it has slowed further. This is not due to necessary economic causes but rather to self-inflicted wounds imposed by political dogma. Nevertheless, as these dogmas are deeply embedded in US politics, it is unlikely that it will be overcome rapidly - therefore US economic growth will continue to be slow. Other countries, including China, have to take into account the consequences of this.
The reasons for the slow US growth are simply diagnosed. As Professor Dale Jorgenson, the world’s foremost statistical authority on economic growth, and others have repeatedly shown, the biggest contributor to US economic growth is capital accumulation. However, during the latest recession, US investment fell to its lowest level since World War II - 15.1% of GDP. Furthermore, while other major components of US GDP have regained pre-crisis levels, US private fixed investment in the first quarter of 2011 remained at 20 percent below pre-crisis levels.
What at first glance appears paradoxical about this US situation is that there is no shortage of investable funds. US corporate profits are at record levels - due to job cuts and wage reductions during the financial crisis. Consequently, US companies are sitting on cash mountains - as the Wall Street Journal noted on June 7 under the self-explanatory headline “Companies with 11-Figure Cash Balances.” Taking the technology sector alone, it noted: “Microsoft and fellow tech cash titans Google, Apple and Cisco together hold more than $131 billion in net cash.”
The US is thus suffering from a classic case of what John Keynes termed a “liquidity trap.” Adequate investable funds are available, but they are not being used and instead are lying idle as cash.
The economic solution is evident. The available funds should be used to launch investment. The problem is that there is no direct mechanism to ensure this occurs in the US, and political dogma prevents one from being created.
A comparison to China is clarifying. At the beginning of the international financial crisis, the US suffered a drastic investment decline. China in contrast was able to use its large state sector, including state banks, to launch a large-scale investment program - the 4 trillion RMB ($586 billion) stimulus package initiated in 2008. During the crucial crisis year of 2009, US investment fell by $500 billion, while China’s investment, under the direct and indirect effect of the stimulus package, rose by 5.3 trillion RMB ($776 billion) - helping propel China’s GDP to a $1.2 trillion increase that year.
Consequently it took the US three years, 4th quarter 2007 to 4th quarter 2010, for its GDP to regain pre-crisis levels. In the same period, China’s economy expanded by 30 percent.
Claims that the financial crisis showed the superiority of China’s economic structure were therefore not mere rhetoric. China’s “socialist market economy” proved more capable of dealing with the financial crisis than the US’ “free market economy.”
Naturally there are US economists who understand the deadly flaw in the US economy of the lack of any automatic mechanism to turn finance into investment. Krugman has pointed to crumbling US infrastructure. Richard Duncan calls for “a national industrial-restructuring program in which the government would invest in 21st Century technologies with the goal of establishing an unassailable American lead in the industries of the future.”
But even the most minimal of such programs cannot be delivered given US economic structure. Large-scale government intervention in investment would alter the balance between the state and private sectors in the US, increasing the former’s weight. This would require a sharp shift in the structure of the US economy and would be strongly resisted on ideological grounds.
Keynes, who diagnosed the problem, naturally knew how to deal with liquidity traps. While he opposed the state administering the economy, the Soviet system that China followed before 1978, Keynes said the state would have to intervene to set the overall level of investment - “the duty of ordering the current volume of investment cannot safely be left in private hands.” Keynes said that low interest rates policies alone, of the type currently pursued by the US Federal Reserve, would not overcome the liquidity trap: “It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.”
The system described by Keynes for dealing with liquidity strikingly resembles China’s present economic structure. While Keynes believed that a “somewhat comprehensive socialization of investment” was necessary, with the state determining “the current volume of investment,” he said: “This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative.”
As in China’s present system, Keynes therefore saw the state and the private sector as two elements of the same system - not, as in current US ideology, that the state and the private sector are counterposed.
The test of these two contrasting approaches in the present international economic situation has been decisive and clear. The US economy has been weak in its recovery and has been slowing further. China’s economy has expanded by almost a third. US political dogmas are limiting its economic recovery.
John Ross is Visiting Professor at Antai College of Economics and Management, Shanghai Jiao Tong University. From 2000 to 2008, he was then London mayor Ken Livingstone’s Policy Director of Economic and Business Policy. This article appeared in China Daily today. Republished with the kind permission of the author. Image courtesy of Truthout.org.
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