There are many dimensions to the world’s imbalances. We tend to focus on the financing side of the equation, stressing mounting disparities in saving rates, current account balances, and debt. But at a different level, there is even a more glaring imbalance – extraordinary disparities in the mix of global consumption.
The United States has taken consumerism to excess while other major nations have done the opposite. Global rebalancing cannot occur without a dramatic shift in the mix of world consumption – away from the over-extended American consumer and into the major pent-up demand economies such as Japan, China, and Europe. The coming wave of consumer rebalancing is likely to be of profound importance for investors, businesses, and citizens of the global village.
It’s no big secret that the American consumer has long been the major engine on the demand side of the global economy. What is surprising, however, is how the rest of the world has gone the other way – failing to garner support from private consumption and relying, instead, largely on investment and exports as the sustenance of economic growth.
This has resulted in extraordinary disparities in the consumption shares of major economies around the world. The US stands alone in the excesses of consumerism, with personal consumption averaging fully 71% of GDP since early 2002 – well above the 67% norm that prevailed over the 25-year period, 1975 to 2000. That’s a record for America, and undoubtedly a record for any leading economy in modern history. By comparison, other major economies are clear laggards: Europe’s consumption share is only 58%, Japan’s 55%, and China is at the bottom, with private consumption amounting to just 42% of its GDP.
One of the most paradoxical aspects of this unbalanced mix of global consumption shows up in the form of equally striking disparities in personal saving behavior around the world. America’s personal saving rate is now in negative territory. Not since 1933 – hardly a comforting comparison – have US consumers spent this far beyond their means, as those means are delineated by current incomes. By contrast, personal saving rates are considerably higher elsewhere in a consumption-short world – 8% in Japan, 14% in Europe, and a staggering 35% in China.
Along with America’s culture of excess consumerism comes an equally extraordinary aversion toward saving the old-fashioned way – setting aside funds from labour incomes. The rest of the world is of a very different mindset – more than willing to defer current consumption by setting aside saving for the future. That’s not to say this is a static picture. In particular, there has been a meaningful decline of the personal saving rate in Japan over the past decade – it has been cut in half from the mid-teens prevailing in the early 1990s. Even so, no other country or economy comes close to matching the American model of excess consumption and negative saving.
There are obvious and important complications to these comparisons. The US has led the charge in having migrated from income- to asset-based saving over the past decade. That has given rise to a widespread critique of the saving data. That criticism is overblown, in my view. By definition, income-based saving rates do not capture what many believe is a “rational” response of the wealth-dependent American consumer.
At the same time, unfunded public and private sector safety nets probably bias personal saving rates to the upside in Japan, Europe, and China; lacking in institutionalised saving plans, households can be expected to take on greater responsibility of their own. A similar pattern results from reforms and restructuring. To the extent workers are plagued by fears of job and income insecurity that arise from such developments, precautionary saving motives should be considerably stronger as a result.
Notwithstanding explanations for the history of these differences, my guess is that the future is likely to look very different insofar as the mix of global consumption is concerned. I have long been of the view that the US has taken its asset-dependent consumption model to excess. It’s not just the absence of income-based saving that concerns me. Equity extraction from overvalued homes, record levels of household sector indebtedness, persistently anaemic growth in real wages, and the life-cycle saving imperatives of an ageing generation of baby boomers all speak of an over-extended US consumer that is increasingly ripe for mean reversion. Over the next several years, I look for both spending and saving to move back into historical alignment with disposable personal income.
By contrast, consumer cultures should begin to flourish elsewhere in the world. That won’t come immediately. Restructuring – and the headcount reductions it entails – is always a short-term negative for incomes and consumption. But the competitive revival that follows then allows newly efficient companies to start expanding again – ultimately boosting employment and worker compensation and providing support for a renewal of personal consumption.
That was the case following the wrenching restructuring of Smokestack America in the first half of the 1980s, as well as in the aftermath of America’s jobless recoveries in the early 1990s and again in 2002-03. In all of those instances, there came a pivotal point in the downsizing when the bulk of the US workforce woke up to the reality that they were likely to be spared. Confidence and consumption, which had been lagging, then picked up as a result.
Japan could well be at that point right now, whereas in Europe and China that realisation could still lie in the more distant future. In restructuring circles, the mantra of “no pain without gain” has long been emblematic of the endgame of downsizing – underscoring the purging of inefficiencies that is necessary for a sustainable revival in domestic demand. Today, that evolution is well under way in Japan, Europe, and China.
China bears special mention in this context – not just because of its vast consumer market, but also because the current pressures on domestic consumption are so acute. Under the guise of state-owned enterprise (SOE) reform, China continues to eliminate at least five million jobs each year. Job losses in those cases amount to far more than just an income shortfall; they also entail the loss of shelter, medical care, family support and food allowances, and a wide array of other benefits. Largely in response, China is moving aggressively in setting up a social safety net – developing the support structure of national social security, private pensions, unemployment insurance, and worker retraining programs. But these efforts are all in their embryonic stages.
In the meantime, the Chinese leadership is acutely focused on uncovering new sources of job creation to fill the void left by SOE reform. Services are at the top of the agenda. The services share of Chinese GDP is only about 32% today – about half the US share, well below India’s 52% share, and, by far, the smallest services share of any major economy in the world today. There is nothing but upside to the emergence of a Chinese services sector – a development that should be aided significantly by the entry of foreign multinationals into Chinese service markets in the next 3-5 years as agreed under China’s WTO accession. If China succeeds in uncovering new sources of job creation at the same time it provides transitional assistance to displaced workers that would be a huge plus for an emerging consumer culture – a critical precondition for sustainable growth in the Chinese economy.
The coming rebalancing of global consumption is not a zero-sum game. Yes, the American consumer has taken its newfound asset-dependent saving and spending model to excess. As interest rates and property markets normalise, it seems reasonable to expect a migration back to income-driven models of consumer behavior in the United States. That could well take the consumption share of US GDP from its current share of 71% back down toward the longer-term trend of 67%.
The path of that transition, of course, is of critical importance for the global economy and world financial markets. A gradual mean reversion – everyone’s preferred outcome – would entail a US growth slowdown. An abrupt mean reversion – driven by a current-account funding crisis and/or an outright bursting of the property bubble – would probably tip the US and the global economy into recession. The longer the American consumer puts off the inevitable adjustment, the greater the imbalances and the higher the odds of a more disruptive outcome.
As I look at the timeframe of likely consumption adjustments that loom for the broader global economy, I would place the American consumer at the front of the queue. That underscores the cyclical risks looming in an unbalanced world. For the time being, prospects in the non-US world remain heavily dependent on the trajectory of the coming US consumption adjustment. With the world still a very US-centric place, an abrupt consolidation by the American consumer would spell serious problems for an externally-led Chinese economy that ships about one-third of all its exports to the US.
Should China falter, the rest of Asia’s China-centric supply chain could quickly be in trouble. NAFTA-related linkages pose comparable vulnerabilities for Mexico. This underscores what I believe remains one of the biggest risks in world financial markets – ever-frothy emerging-market equity and debt. In my view, the developing world remains a levered play on the American consumer – still the most vulnerable link in the global growth chain.
But such cyclical risks need not detract from a more promising outlook over the medium- to longer-term. In my view, the potential upside to consumption elsewhere in the global economy dwarfs the downside that looms in the US. On a purchasing power parity basis – the appropriate metric to use in this aspect of the rebalancing equation – the subpar consumption economies of Japan, Europe, and China collectively account for 35% of world GDP, well in excess of America’s 21% share.
That means every one-percentage point increase in the combined consumption share of these economies would be worth 1.7 times a comparable one-percentage point decline in the US consumption share. That could translate the asymmetries of global consumption disparities into an important plus. Inasmuch as under-consumption in economies such as Japan, Europe, and China appears to be much more of an outlier than over-consumption in the US, the coming rebalancing of global consumption is likely to be a positive-sum outcome for the world economy.
The world needs a new consumer. The American consumer is tired, over-extended, and so dependent on wealth-based saving that the US now faces a serious current-account problem. This, too, will pass – it’s “just” a question of how and when. Yet as the excesses of US consumption are purged, there is good reason to believe that consumers elsewhere in the world will more than fill the void. That implies a major expansion in global consumer markets in the years ahead – not only of critical importance for multinational companies but also essential for a narrowing of global income disparities. In the end, that could be the ultimate silver lining for the coming rebalancing of an unbalanced world.
By Stephen Roach, Morgan Stanley economist, as published on the Global Economic Forum