09 01 2011

Why is the US economy faltering?

Two years after the onset of the financial crisis, the US economy still looks very bad. The reason is that the US crisis is not only the result of a real estate bubble and the resulting crisis in the financial sector, but also of a more fundamental lack of competitiveness. The US economy needs a profound restructuring, and there is no simple way to achieve that.

More than two years have now passed since the outbreak of the international financial crisis with the US as its epicentre. The financial crisis signalled the beginning of a process of a necessary and painful adjustment in the US economy, where it basically will have to start to consume and import less and export more to the outside world. The US has for years consumed much more than it produces, both by the way of private consumption and by the way of astronomic military expenditures and expensive adventures all over the world. Now the moment has arrived to start paying the costs.

This is a long and painful process. Some adjustment has already taken place, as can be seen from the following figure, which shows the US export and import the last 4 years (2010 is a projection based on the data for the period January to September), but there is still a long way to go.

What we can see here, is that both exports and imports fell as a result of the financial crisis in 2009, bringing somewhat down the trade deficit. As the US and the world economy picked up in 2010, both exports and imports have started grow again, but the imports are growing faster than the exports, so the trade deficit is expected to reach more than half a trillion (500 billion) dollars again in 2010.

This was not what was supposed to be happening. The dollar has devalued strongly during the last decade, from being at one-to-one with the Euro in 2002 to reaching an extremely low level of 1.6 USD to the Euro at the end of 2007 (and around 1.3 today). This heavy devaluation should have made the US production more competitive, and should have balanced the trade. Why is this not happening?

Perhaps it is worth pointing out that the trade deficit is not alarmingly big, running at 3-4 percent of GDP. However, what makes it peculiar is the persistence as the trade deficit has been there for decades. Some economists tend to think that the trade (and current account) deficit is not very interesting, but unless the deficit is the result of a productive investment boom (which it is not in this case) it implies that somebody is living on borrowed money that may be difficult to pay back. In this case it is principally the US Government, which is running an enormous budget deficit of around 1.3 trillion USD or around 9 percent of GDP. So evidently, something is wrong with the US economy.

Apart from the problem with the build-up of debt in the economy, private and public, and the crisis in the housing sector and resulting crisis in the financial sector, the main problem is a lack of competitiveness.This is the result of many factors and can not be redressed quickly simply by a devaluation of the currency – or as some conservatives in the US seem to think – by cutting down public expenditures.

This is not to say that there are not sectors in the US economy that are competitive. There definitely are. There are industries that quite competitive because of their advanced technology or their branding - or because they enjoy world-wide monopoly (just look at Microsoft,which is posting record profits again). But these sectors are too small to redress the economy. To get the economy into balance, some sectors will have to shrink and others will have to expand. That implies productive restructuring and is a much more complex process than simply regulating overall demand by increasing or decreasing taxes or public expenditure.

Some adjustment is already happening. The fall in demand in the US has put a pressure on US producers to seek other markets for their products instead of comfortably relying on the home market, and in this a cheap dollar has also been helpful. This effect has no doubt been there the last couple of years, as exports actually have increased. But this restructuring will take time for several reasons.

One reason is that investment decisions made in the past will not be undone just because the dollar has become cheaper. This is the case for the outsourcing of much of the industrial production to countries with lower costs that has taken place during the last decade – there is no way the cheaper dollar will bring that production back home. And in general, it is much easier to close down industries than to open new ones.

Another reason is that the US economy has is strengths in some of the sectors that are not high growth sectors. Some of the more competitive sectors that have experienced high growth in the past, as for example financial services, are faced with a global fall in demand for their services – there is no easy way of repeating the past success of repackaging junk loans and sell them to naïve customers world-wide. Other competitive sectors, as for example tourism or tuition, are suffering under the more restrictive visa practices, which are a result of the “war on terror” and the recent general anti-migrant sentiment. And for the more traditional consumer goods, few US made products are internationally competitive, and most of those that are, are manufactured outside the US. Furthermore, as energy is still relative cheap in the US, many of the products manufactured for the home marked are not up to standard regarding energy efficiency.

None of these hurdles are impossible to overcome. But it will take time, particularly if the public policy is not addressing them adequately. The only successful industrial policy that the US has been promoting during the last decades is within the military-industrial complex. Based on bountiful government contracts the R&D in the sector is vigorous and has given the US an impressive (and scaring) technological lead, which has also resulted in spin-offs for civil use (just take the example of the GPS). But the military bias also means that scarce resources are drained away from more useful civilian purposes and that does not increase the competitiveness of the US economy.

So the judgement for the moment is that the US economy is on its way to redress some of the more fundamental imbalances, but it has only just started and it will be a long and painful process. The process will be longer and more painful unless a more helpful industrial policy is put in place, but that is not likely to happen, as the main priority for the US establishment continues to be to maintain the costly global military supremacy rather than investing in solving its domestic problems.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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