US consumers can't buy out of this crisis

Opinion Article

2011 August, 20

Karl Marx was right. This was the striking assertion of Nouriel Roubini in an  interview with The Wall Street Journal this week.


The Persian Jewish American economist rose to fame in the wake of the global  financial crisis for having predicted the crisis. In September 2006 Roubini told  the International Monetary Fund that "the US was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and,  ultimately, a deep recession". 


Fortune magazine acknowledged: "In 2005 Roubini said home prices were riding  a speculative wave that would soon sink the economy. Back then the professor  was called a Cassandra. Now he's a sage." 


Nobel laureate Paul Krugman wrote in 2009: "Nouriel Roubini was right. At a  time when the likes of Alan Greenspan were dismissing concerns about excessive  home prices and declaring that banks were stronger than ever, Roubini warned  that there was a monstrous bubble in the housing market and that the bursting  of that bubble would cause much of the financial system to collapse. And so it has  turned out, with even the most seemingly outlandish of Roubini's predictions  matched or even exceeded by reality." 


In response to a question from the Journal about what could be done to get the  economy going again, Roubini answered: "[Business] claim they're not doing  pacts because there is excess capacity and not hiring workers because there's  not enough final demand, but there's a paradox and a catch-22. 


"If you are not hiring workers, there is not enough labour income, there is not  enough consumer confidence, there is not enough consumption, there is not  enough final demand.


"And the last two to three years we've had actually worse than this because we  had the massive redistribution of income from labour to capital, from wages to  profits, inequality of income and wealth has increased. The margin of propensity  to spend of a household is greater than the margin of propensity to spend of a  firm because they have a higher margin of propensity to save, firms compared to  households. So that redistribution of income and wealth makes the problem of  excessive lack of aggregate demand even worse. 


"Karl Marx had it right. At some point capitalism can self-destroy itself because  you cannot keep on shifting income from labour to capital without not having  excess capacity and a lack of aggregate demand, and that's what's happening."


Roubini's analysis is fascinating, not because of the more lurid possibilities he  suggests following Marx but because he sets out a strong answer in relation to a  question of economic theory that eludes me. 


The question is this: what drives economic activity and investment? Are the  supply-siders right that it is favourable tax treatment that makes it attractive for  the owners of capital to invest? Or does rising consumer demand drive  investment? 


Clearly the supply-siders have held the commanding heights. While the Keynesians remain credible and demand stimulus is still part of the macroeconomic management repertoire of governments throughout the world, the  role of demand in driving supply is obscure. 


One thesis about America's descent into economic malaise is that wage gains to  consumers have not kept up with productivity gains in the economy and the gap  has inexorably widened through time. The decreasing ability of consumers to  consume at the level of supply has been solved through increasing borrowing.  Soaring levels of personal debt serviced consumption, but eventually the credit  card was maxed out. 


My layman's commentary here makes no claims as to which of the pro or antiKeynesian camps is correct. Rather, I am interested in whether there comes a  point where the means of consumers is so minimised that they can no longer  consume at the levels necessary for economic health and growth. 


I suspect we in Australia have little appreciation of the extent to which many  American consumers are down to the bones of their backsides.


Contrary to popular progressive opinion about the heartless Howard and Costello governments that prevailed for 13 years, the truth was plainly pointed  out by the National Centre for Social and Economic Modelling that Howard and  Costello were in truth champion redistributors of the country's wealth. 


Extraordinary natural resource revenues and our government's preparedness to  distribute the boom shielded us from the relative diminution of the buying  power of American workers and the middle class. Since the post-war heyday of  middle-class prosperity, the American dream has been kept alive through  unsustainable debt. 


Robert Reich, former labour secretary to president Bill Clinton and a centre-left  economist, lays out this diagnosis of the American malaise in Aftershock: The  Next Economy and America's Future (2010). What he calls "The Basic Bargain"  between capital and labour, between business and consumers, has broken down  in the US. 


Reich starts his book referring to Marriner Eccles, chairman of the Federal Reserve Board from 1934 to 1948. Having been in the thick of the action during  the Roosevelt years following the Depression, Eccles wrote in his memoir: "As mass production has to be accompanied by mass consumption, mass  consumption, in turn, implies a distribution of wealth – not of existing wealth but  of wealth as it is currently produced – to provide men with buying power equal  to the amount of goods and services offered by the nation's economic machinery. 


"Instead of achieving that kind of distribution, a giant suction pump had by 1929- 30 drawn into a few hands an increasing portion of currently produced wealth.  This served them as capital accumulations. But by taking purchasing power out  of the hands of mass consumers, the savers denied to themselves the kind of  effective demand for their products that would justify a reinvestment of their  capital accumulations in new plants. 


"In consequence, as in a poker game where the chips were concentrated in fewer  and fewer hands, the other fellows could stay in the game only by borrowing.  When their credit ran out, the game stopped."

US consumers can't buy out of this crisis