Economy

Political dogma limits US economic recovery

By John Ross (chinadaily.com.cn)
Updated: 2011-06-13 09:20

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.