Friday, October 17, 2003

The US economy could boom again?

Ricardo Caballero of MIT believes that the U.S. was in the middle of a generation-long shift to a richer, higher capital-intensity growth path when the NASDAQ crash occurred--and that there is no reason to think that the United States cannot grow in this decade at the same boom-time rates at which it grew in the late 1990s: Home US: ...the correct comparison instead is between the current capital-output ratio and the long-run equilibrium ratio under plausible conditions. If we follow the latter strategy, and assume that private saving remains at its (recent) historical levels, the conclusion is very different from that of the pessimists: the new equilibrium capital-output ratio should be about 1.6, well above the current 1.36. In other words, the 1990s boom still had energy when it was interrupted. What lies behind this jump in the long-run capital-output ratio? The accelerating decline in machinery prices, which is a consequence of technological progress in machinery-producing sectors. (Here I conservatively assume that the decrease returns to its historical trend, slower than that of the 1990s.)

But not everything looks so favourable. In the calculations above I assume that the sources of funding available during the 1990s remain in place. In particular, I assume that fiscal saving does not disappear and that external saving decreases only gradually. Are these assumptions warranted? If all goes well, the external side is less complicated than is generally thought. The $500bn in external financing that the US requires each year is a huge amount - but we are talking about the US at a time when the global alternatives are not very exciting or are too small to make a difference. Of course, the dollar may suffer turbulence in the medium run. This could happen if, for political reasons, the US keeps pressing China and other Asian economies to revalue their currencies; this would entail a fall in those countries' reserve accumulation, most of which is being invested in US government securities.

However, the real danger lies in the other source of funds: public savings. If the fiscal accounts - particularly for the medium and long term - are not improved, the whole benign equilibrium may collapse. In the capital output calculations above, I assumed balanced fiscal accounts. If we assume sustained fiscal deficits of 4-5 per cent of gross domestic product that are not compensated for by a one-for-one increase in private savings (which seldom happens), the new equilibrium capital-output ratio falls as low as 1.1. In this scenario, the pessimists are correct and the US has a large excess- capacity problem; the obvious corollary of this is a huge increase in the long-run interest rate.

The US economy is indeed a "tightly coiled spring", with plenty of growth potential - definitely enough for a very good second half of this year and beginning of next year, but also way beyond that. However, this opportunity will be squandered unless a much sounder fiscal path is credibly outlined soon.

I actually thought this was a positive article when I first posted it; I thought I'd say something good for a change. It was only on rereading and editing that I noticed the mathematics assume Clintonomics. Instead, we have Dubyanomics -- massive deficits extending forever.

So even though Dubya didn't cause the collapse of the 90s boom, he may be responsible for a decade of meager growth. Sigh.

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