The Global Jigsaw
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By Paul Krugman - December 16, 2008, 3:02PM
Bob Reich raises an important question that's been worrying me: what does the end game look like? When, if ever, can the economy throw away its crutches and do without big stimulus? I'm not sure I agree with his answer, but my own answer raises some awkward issues, as I'll explain in a minute.
Basically, what's happening now is that the things that supported our economy in the middle years of this decade -- high consumer spending relative to income and a housing boom -- are gone, and won't come back for the foreseeable future. So what will take their place?
Bob argues that nothing will, unless the government does it. This is a modern version of the "secular stagnation" view popular in the 1940s (and visible in Keynes himself), which argued that there would be a persistent shortfall of private demand, and that we'd basically need a permanent WPA to support the economy. This view turned out to be wrong for the postwar decades, and was subject to a lot of ridicule from later economists -- but it actually looked pretty good for Japan in the 90s and after. I'm not ready to believe it for the United States, at least not yet; we don't have Japan's shrinking population, we still have a lot of technological vigor supporting business investment, it shouldn't be that hard to keep the economy growing without permanent fiscal support.
That said, where will the demand come from? I find it useful to compare U.S. spending in recent years with spending in the mid-90s, when things seemed much more sustainable. What changed? Well, we had bloated housing investment and bloated consumer spending. Meanwhile, nonresidental investment as a percentage of GDP was about the same in 2007 as it was in 1996.
So what offset the consumer/housing boom? A vastly increased trade deficit. And that suggests that a return to normalcy would involve getting savings up, housing spending down, and a combination of more exports and less imports.
That's where things get complicated: a lower US trade deficit means lower surpluses and/or higher deficits elsewhere. Who's the counterpart to our adjustment? OK, the Middle East, which no longer has its oil windfall. But China is having its own slowdown, as is Japan.
In other words, trying to figure out where we go from here is a sort of global jigsaw puzzle -- and I haven't managed to solve it yet.
In the end I think we will work it out; as I said, I'm not ready to be a secular stagnationist just yet. But Bob is definitely raising the right issue.
