A convenient statistical coincidence shows just how slow US economic recovery is in this business cycle compared to previous ones. The new US GDP data for the 1st quarter of 2012 is for the 17th quarter since the peak of the previous business cycle in the 4th quarter of 2007. In all US business cycles since 1973 by the 17th quarter in the cycle the economy had expanded by almost exactly 10.5% – as can be seen in the chart. In this cycle US growth since the previous peak has been only 1.3%. That is the US economy has been growing at only 12.6%, one eighth, of its rate in previous business cycles.
international financial crisis
April 28, 2012
April 27, 2012
New US GDP figures are not 'disappointing' - they confirm long term deceleration in the US economy
The new US GDP data was widely seen as 'disappointing'. But the most important trend is not the short term figure of 2.2% annualised growth for 1st quarter of 2012 but the confirmation of the long term deceleration of the US economy. The charts below show that the moving average for US 20 year GDP growth has fallen to 2.6% and the moving average for 10 year US GDP growth has fallen to 1.6%. In both cases the declining long term trend for growth is clear from the charts.
It is because there is a persistent long term slowing of the US economy that the US growth data is consistently seen as 'disappointing'. In fact the problem is a wrong perception. Analysts are surprised by new data only when they have not internalised or built into their models this long term deceleration of the US economy. A more fundamental and longer term analysis of this long term slowing of the US economy can be found here.
PS for those interested more detailed analyses of the new US GDP figures will be found on my Sina Weibo - the Chinese equivalent of Twitter. Having used both Weibo is a better product than Twitter for economists as it has built in facilities for showing charts. Posts are in both English and Chinese. My Weibo is here.
Figure 1 – 10 year moving average of US annual GDP growth
Figure 2 – 20 year moving average of US annual GDP growth
April 09, 2012
Analysing China's new 3.6% inflation data and its implications for the world economy
This blog has frequently drawn attention to the extremely close correlation between China’s consumer inflation (CPI) trends and world commodity prices – Figure 1. It is world commodity prices, rather than monetary data, which provides the best indicator of China’s inflation trends. In that light how is China’s 3.6% CPI figure for March to be analysed? As China’s inflation trend is a major determinant of China’s ability, or otherwise, to pursue expansionary economic policies this is a major issue not only for that country but for the world economy.
Figure 1
It is evident China’s CPI is not powerful enough to drive world commodity prices. The correlation between the two indicators therefore necessarily shows either, or both, that world commodity prices determine China’s CPI shifts, or more probably that some third factor, for example overall global economic trends, determines both. In either case China’s CPI would be expected to follow trends in global commodity prices.
In that light China’s 3.6% CPI for March is not particularly surprising. Despite the monthly increase from 3.2% in February the overall downward trend in China’s inflation continues – Figure 2. The 3.6% CPI figure in March is a decline of almost half since the 6.5% peak in July 2011 and is within the government’s 4.0% target.
Figure 2
The fact that March saw an upward tick within a descending trend of China’s inflation is in line with the fact that, as this blog has analysed, world commodity prices stopped falling between December and the end of March – Figure 3. This, as was noted here, was likely to slow the decline of China’s inflation rate and therefore the March figure was not highly surprising. What is significant, however, is that late in March and so far in April a new downturn in international commodity prices started, probably under the impact of softening in the global economy – Figure 3. If that downturn continues then, as analysed here, it would be expected that China’s CPI would start to decline again.
Figure 3
Therefore, to have a perspective on China’s economy, world commodity prices and China’s CPI in April must be watched closely. If global commodity price changes continue their downwards trend it would also be anticipated, on the basis of existing trends, that China’s CPI will also fall – creating further room for expansionary policies. If world commodity prices were to fall, but China’s CPI did not, it would indicate that existing correlations between global commodity prices and China’s CPI no longer held.
April will therefore be a significant month not only for China’s economy but for the theoretical analysis of it.
April 08, 2012
Commodity price falls suggest global economic slowdown but good news for China's inflation
After stability from December to March world commodity prices have started falling again - Figure 1. This indicates global economic softening but good news for China’s inflation and therefore increased possibilities for China’s economic policy to adopt an expansionary approach.
Figure 1
Looking at the trends in greater detail, world commodity prices fell sharply during the second half of 2011. The Dow Jones-UBS spot commodity index fell from a year on year increase of 46.4% in June 2011 to a fall of minus 7.8% in December 2011. However then until mid-March 2012 no further decline occurred. As China’s consumer price index (CPI) is highly correlated with global commodity prices this raised the danger that inflationary pressures in China had ceased lessening - with negative consequences for the ability of China to undertake expansionary economic policies.
However during the latter part of March and the beginning of April 2012 commodity prices resumed their year on year fall. By 5 April the Dow Jones-UBS spot commodity index had fallen 12.9% below its level a year previously.
As commodity prices are an extremely sensitive and up to date indicator of global economic conditions two conclusions may be drawn from this.
- Global economic conditions may be softening – which would be in line with the latest unfavourable US jobs report for example.
- A decline in global commodity prices will significantly reduce inflationary pressures in China – creating more space for expansionary economic policies.
Because of the significance of such trends further development of world commodity prices must be be watched closely.
April 06, 2012
Globalization not protectionism remains the main trend in the world economy
Protectionist measures by the US government have received considerable publicity. These include tariffs against China's solar panel exports, the dispute over rare earths, a bill against "subsidized" exports passed by both houses of the US Congress and other steps.
These measures are real. But it is also important not to exaggerate them. Protectionism is not the main trend in the global economy. This is shown both by factual economic trends and considering the underlying forces at work. Protectionist measures affect trade at the margins but do not alter the core of world trade which continues to expand.
To show this first consider the facts. The volume of world trade fell severely during the international financial crisis, declining by 19.7 percent between April 2008 and May 2009. But it then more than recovered. According to the latest available data, by January 2012 the volume of world trade was 4.8 percent above pre-crisis levels - Figure 1.
Figure 1
After the financial crisis US imports fell sharply, from 15.7 percent of GDP in the third quarter of 2008 to 10.6 percent of GDP in the second quarter of 2009, but then recovered to 14.8 percent of GDP by the fourth quarter of 2011.
Regarding relations between China and the US, frequently seen as the main area of protectionism, in dollar terms China's exports to the US rose 22 percent between their pre-crisis peak in September 2008 and the same month in 2011, well above the 15.4 percent increase to the EU, and not far behind the 27 per cent increase to Japan. In short, US post-financial crisis trends showed trade recovery, not deepening protectionism. Nor was protectionist actions even the main trend in trade between the US and China.
Claims that protectionism is the dominant trend in the world economy are therefore factually exaggerated, and take individual developments out of context without examining their overall weight.
Analysis of fundamental economic forces confirms why protectionism is not the main trend. Modern production is on such a large scale that it cannot find an adequate market for its volume of production, at efficient levels, purely within a national economy. That is why, for example, China's reform and opening-up was necessary, but exactly the same pressures affect the US.
Even in 1929 serious retreat into protectionism led to disastrous economic decline and crisis, culminating in economic and political destabilization of all countries and finally world war. Today, when production is on a far larger scale than 1929, the economic results would be more catastrophic. This is why all major economies have so far rejected large-scale protectionism.
Fundamental economic analysis therefore confirms what the facts reveal, that certainly there will be some protectionist actions, but these will be at the margins, and globalization, not protectionism, will remain the main trend in the world economy.
Nor is protectionism likely to be the main instrument of US 'neo-cons' or a Republican president. US neo-cons have much experience in how to slow Asian economies. This was successfully achieved against Japan and then the South East Asian "Tiger" economies during the 1997 debt crisis. In neither case was protectionism the main weapon.
The first 'neo-con' strategy was to transfer disputes from the economic realm, where the US is gradually weakening, to the military and political fields, where the US remains much stronger.This tactic is followed in the US 'pivot' toward the Asia-Pacific region.
Within the economic realm the main methods US 'neo-cons' used were forcing other countries to overvalue their currency, forcing cuts in investment levels, which slow economies, and lower foreign inward investment to reduce technology transfer. All these methods are being attempted against China. Protectionism is not dominant in any of these methods.
Attention must certainly be paid to real protectionist measures but exaggerating the degree of protectionism is factually incorrect, not based on analysis of the world economy's main forces, and fails to identify the main economic tactics used by US 'neo-con' circles.
Competition within globalization, not protectionism, is still the world economy's main trend.
* * *
An earlier version of this article appeared, in Chinese and English, in Global Times.
March 09, 2012
February 09, 2012
China's inflation increase - not just a holiday effect?
The increase in China’s January annual consumer price index (CPI) to 4.5 per cent, from January’s 4.1 per cent, ending a five month period of decline, has been generally ascribed to inflationary effects caused by China’s Spring Festival (Chinese New Year). The Financial Times, for example, tagged its coverage ‘Spike blamed on food prices ahead of New Year celebrations‘. The FT’s report noted: 'Chinese inflation jumped in January, breaking a streak of five straight monthly declines, but seasonal factors were largely to blame and price pressures were expected to weaken in the coming months.’
It is certainly true that China’s Spring Festival has powerful, and well known, distorting effects on statistical comparisons, and therefore undoubtedly not too much should be read into one month’s figures. Nevertheless there are reasons to consider that the inflation increase was not purely a holiday effect but reflects international factors.
As this blog has noted previously China’s CPI is not, contrary to claims to the contrary, closely linked to China’s money supply data but it is extremely closely tied to international commodity prices. In this regard it is important to note that since December the annual change in international commodity prices has stopped falling. This may be seen clearly in the end of the decline in the year on year data for the Dow Jones-UBS Commodity Spot Price Index – see Figure 1.
Furthermore year on year data somewhat flatter as they are affected by the base effects of the rapid rise in prices during the early part of 2011. If absolute price levels are analysed then commodity prices reached their recent minimum on 4 October 2011, since which they have risen by 8.2 per cent – Figure 2.
Figure 1
Figure 2
International commodity prices, as always, show strong fluctuations and it would be too early to definitively state that a new round of commodity price inflation is taking place. But certainly the sharp fall in commodity prices, which took place from spring to autumn 2011, has ended. In that case, given the very close correlation between China’s inflation and global commodity prices, this substantial downward pressure on China’s CPI will also have halted.
The halt to the downward trend in global commodity prices is logical given two factors - that talk in the second half of last year of a double dip US recession, popularised by Nouriel Roubini and others, was exaggerated and that the US Federal Reserve and European Central Bank (ECB) are both engaged in major rounds of quantitative easing (QE) – i.e. printing money. This monetary stimulus is further added to by the financial support the Federal Reserve is giving to the ECB. This new wave of QE has been supporting both bond and share prices and may now be spilling into commodity markets. The partial recovery of gold prices from recent lows is another indicator of the same process. In short upward pressure on commodity prices may well not be temporary.
What conclusions follow?
- International commodity prices need to be very carefully tracked.
- Inflation data not only in China but in other developing economies, notably India and Brazil, needs to be carefully watched to see whether an international effect of a slowing or reversal of the decline in inflation takes place.
- China’s authorities are clearly correct to have taken a relatively cautious approach so far to economic loosening – inflationary pressures may be stronger than generally assumed outside China.
There certainly was a seasonal effect in China’s higher January CPI data. For that reason it is likely China's CPI will fall in February. But nevertheless there is also evidence that the rise in the CPI figure was not only a seasonal holiday effect. As it continues to be the case that international commodity prices, not money supply, shows a close correlation with China’s inflation the data on global commodity prices must be extremely carefully watched to understand trends in China's economy.
Higher international commodity prices, of course, are not due to, or under the control of, China’s economic authorities. But China cannot escape their effect. Both global commodity prices and the inflationary situation in other major developing economies must be carefully followed. While China's inflation is likely to continue to decline from its peak levels there are grounds to consider that China’s, and other countries, CPI will continue to be above market expectations.
February 08, 2012
Europe's largest economic failure is not in Greece - but in the UK, Italy and Spain
With the European Union (EU) heading into a double dip recession, even before the peak level of GDP of the previous business cycle has been regained (Figure 1), it is evident that the solutions adopted to deal with Europe's economic crisis have failed. But the focus of financial markets on Greece's debt crisis should not obscure the fact that the largest scale economic failures in Europe, with the most direct impact on world growth, are not in Greece, the GDP of which accounts for only 1.8 per cent of the EU’s, but in the UK, Italy and Spain. The latter economies collectively account for over one third, 34.7 per cent, of EU GDP. Furthermore these large EU economies, having failed by significant margins to regain their previous peak levels of GDP, are again turning down.
To give some idea of the relative scale of these problems it may be noted that the combined GDP of the UK, Italy and Spain is equivalent to 40.9 per cent of US GDP, whereas Greece’s GDP is equivalent to a mere 2.0 per cent of US GDP. Even the combined GDP of the three economies under EU bailout measures (Portugal, Ireland and Greece) is only 5.1 per cent of US GDP. In short, while they pose significant problems for financial markets the recessions in the peripheral Eurozone economies are simply to small to make a direct significant difference to global growth prospects.
In contrast the failures in the UK, Italy and Spain - respectively Europe’s 3rd, 4th and 5th largest economies - are on quite large enough scale to create a serious negative impact on global growth – economies approaching half the size of the US are, at best, essentially stagnant and now facing new downturns.
The aim of this article, therefore, is to place the financial difficulties in Greece against the background of these larger growth failures in Europe.
Overall trends in the EU
The overall trends in the EU’s GDP are compared to the US and Japan in Figure 1. They are shown in detail in Table 1 below.
GDP data for the EU for the 4th quarter of 2011 is not yet available – on the basis of partial statistics it is highly likely to show downturn. But on the most up to date data available, for the 3rd quarter of 2011, EU GDP was still 1.7 per cent below its peak in the previous business cycle and Eurozone GDP 1.9 per cent below, In contrast by the 4th quarter of 2011 US GDP was 0.7 per cent above its last business cycle peak. With EU GDP likely to have turned down in the 4th quarter of 2011, Europe is suffering a strictly defined ‘double dip’ recession - i.e. a fall in output before the previous peak level of GDP has been regained .
Figure 1
Considering the detailed data for the EU economies, plus those in Eastern Europe, in Table 1 below, the overwhelming majority of European economies have not regained the peak levels of GDP recorded in the previous business cycle. All three economies which have published official Eurostat data for the 4th quarter of 2012 (Spain, Lithuania and the UK) showed a renewed fall in output - a more detailed analysis of the groupings within the European economies is given below.
Failure of recovery in the UK, Italy and Spain
The focus of attention in the European crisis has been on small peripheral Eurozone economies – Portugal, Ireland and Greece – or on a 'Germany v the periphery' divide. But from the point of view of EU GDP by far the most serious situation is the failure of recovery in three large EU economies – the UK, Italy and Spain. These are respectively the 3rd, 4th and 5th largest EU economies. The GDP trends in the five largest EU economies are shown in Figure 2.
Figure 2
By themselves the peripheral Eurozone economies are far too small to pull the Eurozone economy into recession - for comparison the combined economies of Portugal, Ireland and Greece are only one eighth of the size of combined economies of the UK, Italy and Spain. The key problem in European output is that while Germany’s economy has recovered - up to the 3rd quarter of 2011 its GDP performance since the peak of the last business cycle was marginally better than the US, and France’s recovery was significant, reaching only 0.6 per cent below the pre-financial crisis peak, the EU’s other large economies had not recovered and were heading into a new downturn. On the latest available data the UK’s GDP was still 3.8 per cent below its peak in the previous business cycle, Spain’s GDP was 3.9 per cent below and Italy’s was 4.7 per cent below. Furthermore in all three economies the latest available data shows a further downturn in GDP.
Failure in the European bail-out economies
In addition to the failure of recovery in the EU as a whole, primarily due to this situation in the UK, Italy and Spain, a further striking feature is that none of the economies subject to special EU bail out programmes – Portugal, Ireland, Greece – shows any sign of recovery (Figure 3). The latest data for both Ireland and Portugal shows renewed economic downturn, while no Eurostat certified Greek GDP data has been published since the 1st quarter of 2011 – it would be highly likely to show further economic decline. This failure of recovery is despite the fact that Ireland, for example, has undergone almost four years of economic downturn and Portugal is well into the third year of downturn.
The EU bailout programmes may therefore be correctly characterised as having failed.
Figure 3
Widespread downturn in Eastern Europe
An equallly severe, although less reported, decline in European production than in the bail-out countries has taken place in the Baltic republics – Estonia, Latvia and Lithuania (Figure 4). The downturn in Latvia (16.6 per cent) is the worst for any European country while those in Estonia (8.6 per cent) and Lithuania (9.0 per cent) are only slightly better than Greece (9.9 per cent) and Ireland (11.6 per cent)
This crisis in the Baltic Republics, incidentally, as with the different case of the UK, shows that the European crisis spreads to far more than Eurozone – only Estonia of the Baltic republics is a Eurozone member.
Figure 4
In addition to the Baltic Republics economic downturn has continued in most of Eastern Europe (Figure 5) – with only Poland and Slovakia having recovered to pre-crisis levels of output (Figure 6).
Figure 5
Recovery economies
The trends above leave only two large European economies, Germany and France, together with a number of medium sized ones (Netherlands, Switzerland, Belgium, and Poland) having undergone serious economic recovery (Figure 6). However, although Germany and France are the 1st and 2nd largest economies in the EU their combined GDP, at 36.2 per cent of the EU total, is only slightly greater than the 34.7 per cent of the UK, Italy and Spain combined.
In short the stagnant and declining situation in the UK, Italy and Spain is enough to essentiallly entirely offset recovery in Germany and France.
Figure 6
Large stagnant economies
Finally the position of the UK, Italy and Spain as large economies which have failed to significantly recover, together with smaller economies in the same situation, is clear in Figure 7.
Figure 7
Conclusions
A number of clear conclusions follow from these factual trends in Europe.
- Financial crisis may be focussed at present in Greece, but the most serious drags in output are not the peripheral Eurozone economies but the UK, Italy and Spain.
- Remaining outside the Eurozone is unlikely by itself to be sufficient to ensure economic recovery. Economic downturn in the UK, which is outside the Eurozone and has undergone substantial devaluation during the international financial crisis, is as severe as in the other large sluggish economies of Italy and Spain within the Eurozone. The non-Eurozone Baltic Republics of Latvia and Lithuania have undergone as serious declines in GDP as Eurozone member Estonia. Poland, which is outside the Eurozone, has largely escaped recession but due to large scale public investment.
- Given these trends, overcoming the financial crisis in Greece is unlikely to relaunch economic growth as the largest problems in Europe's economic recovery are located in the UK, Italy and Spain. Of these UK is not even a number of the Eurozone, while the lack of growth in Italy's economy has been prolonged - annual average GDP growth in Italy in the last decade has been only 0.2 per cent.
The overall conclusion is clear. The Eurozone crisis was predictable - the present author noted 15 years ago in 'Fundamental Economic Implications of a Single European Currency' that: '‘The process that would unfold with the creation of a single currency by this method [the Treaty of Maastricht] may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join. There will be sharply deepening regional imbalances and inequalities. The malignant expressions of economic depression — unemployment, poverty, collapse of the welfare system, weakening of trade unions, racism, chauvinism, crime — will multiply. The end will be either an economic tragedy, or the deepest crisis in the history of the EU, or more probably both.’
This analysis has clearly been vindicated. But it would, nevertheless, as seen above, be wrong to conclude that the exclusive core of the problems in Europe's economy is the Euro - or to see the situation exclusively in terms of a 'Germany and periphery' situation.
The greatest drag on economic growth in Europe is its 'stagnant middle' of the UK, Italy and Spain. These three economies together are equivalent in size to Germany and France. If Germany and France are supposed to provide the 'growth engine' of Europe these three economies may be conceived of as currently providing its 'drag factor'.
Unless the situation within the UK, Italy and Spain can be resolved it is most unlikely that overcoming the economic problems in Greece will relaunch substantial European growth. For this reason, whatever occurs in Greece, the European crisis is going to be prolonged and other parts of the world economy must both take this into account and understand the more powerful factors in European economic stagnation.
Table 1
February 05, 2012
Deng Xiaoping and John Maynard Keynes
Introduction
The international importance of China’s economy is twofold. The first is practical - the scale of China’s economic growth, its global impact, and the consequences for the improvement of the social conditions of China and the world’s population. The second is theoretical, including the potential international applicability of conclusions drawn from China’s economic policies.
Regarding the latter it is necessary to clearly state that no country can mechanically copy another. As China’s political leaders and economic theorists stress its economy has unique ‘Chinese characteristics’. This was formulated as a cardinal principle by the initiator of China's economic reform, Deng Xiaoping: ‘To accomplish modernization of a Chinese type, we must proceed from China’s special characteristics.’ (Deng, 30 March 1979) Therefore China must: ‘blaze a path of our own.’ (Deng, 21 August 1985). As recently reiterated by Justin Yifu Lin, Chinese Chief Economist and Senior Vice President of the World Bank: ‘we can never be too careful when it comes to the application of a foreign theory, because with different preconditions, no matter how trivial they seem, the result can be very different.’ (Lin, 2012, pp. 66 - emphasis in the original) In that sense, therefore, there is no ‘Chinese model’. However as Lin simultaneously states: ‘Some may think that the performance of a country as unique as China, with more than 1.3 billion people, cannot be replicated. I disagree. Every developing country can have similar opportunities to sustain rapid growth for several decades and reduce poverty dramatically if it exploits the benefits of backwardness, imports technology from advanced countries, and upgrades its industries.’ (Lin, 2011)
There is, however, no contradiction between these different statements. The fundamental structural elements of which an economy is composed (consumption, investment, savings, primary industry, secondary industry, tertiary industry, trade, money etc.) are universal. However the particular way in which these elements combine and are interrelated in any economy is unique and entirely specific both in place and time – which is why no country can copy another’s economic policy, while it can learn from other economies. As analysed below, China has solved in practice problems stated in general macro-economic theory. For that reason such elements, in very different forms and combinations, are of major importance for economic policy elsewhere. However the specific forms and combinations in which such policies are applied are entirely unique both in each country and at different points in time.
The practical impact of China’s economic rise have been considered extensively elsewhere.1 The focus of this article is on the theoretical economic issues. In particular it aims to relate China’s economic performance to Western economic theory which will be more familiar to most readers.
China and macro-economic theory in Keynesian and Marxist terms
China’s ‘reform and opening up’ process under Deng Xiaoping was, of course, formulated in a Marxist economic framework. It can indeed be clearly outlined in those terms – see the appendix below, for a more detailed account of Chinese discussions on these issues see (Hsu, 1991), but an alternative statement in Western economic terms, those of Keynes, is considered here.
Stated briefly in Marxist terms, China’s reform policy included a critique of Soviet economic policy that this had made the error of confusing the ‘advanced’ stage of socialism/communism, in which the regulation of the economy is ‘for need’, and therefore not market regulated, with the socialist, or more precisely ‘primary’ developing stage of socialism, during which the transition from capitalism to an advanced socialist economy takes place and in which market regulation takes place. This transition should be conceived as extending over a prolonged period. The final formulation arrived at was that China’s was a ‘socialist market economy with Chinese characteristics’. Contrary to suggestions by some writers, for example (Hsu, 1991), such an analysis is in line with Marx’s own writings although, as shown below, it is not necessary to be a Marxist understand it - a more detailed analysis is given in the appendix.
This debate was framed in Chinese terms, without primary reference to previous economic theory in other countries other than Marx himself. The approach, in a Chinese phrase emphasised by Deng, was to ‘seek truth from facts’ (Deng, 2 June 1978). In practical terms in China, such analysis meant abandonment of an administratively planned economy and substitution of a market economy in which the state would control certain key macroeconomic parameters. In terms of ownership it led to ‘Zhuada Fangxiao’ – maintaining large state firms and releasing small ones to the non-state/private sector.
Restatement of Chinese economic policy in terms of Keynesian economics
Most people in the US and Europe are unaware of, or disagree with, Marxist economic categories. To make the essential economic policies clear, therefore, this article will put them in more familiar terms of Western economics – those of Keynes. The proviso is that this is the actual Keynes of The General Theory of Employment Interest and Money - not the vulgarised version in economics textbooks. Geoff Tily’s Keynes Betrayed (Tily, 2007) is one of the best in a series of works outlining the difference between the two. However, there is no substitute for reading Keynes General Theory itself, which differs sharply from the presentation of what is frequently presented as ‘Keynesian’ economics. For example, budget deficits play only a secondary role in both Keynes General Theory and in China’s stimulus packages – even during 2009’s maximum anti-crisis measures China’ s budget deficit was only 3% of GDP. The core of Keynes’ General Theory itself, unlike vulgarisations, centres on factors determining investment. It is therefore through this optic that both Keynes and Chinese economic strategy can be best approached.
The rising proportion of the economy devoted to investment
In the founding work of classical economics, The Wealth of Nations, Adam Smith identified division of labour as the fundamental force raising productivity, stating as the opening sentence of the first chapter: ‘The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seems to have been the effects of the division of labour.’ (Smith, 1776, p. 13) Smith concluded that a necessary consequence of the increasing division of labour was that the proportion of the economy devoted to investment rose with economic development: ‘accumulation of stock must, in the nature of things, be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock is previously more and more accumulated… As the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things must be accumulated beforehand.’ (Smith, 1776, p. 277) A more comprehensive treatment of Smith’s views may be found in (Ross, 2011). Marx reached the same conclusion as Smith, concluding that the contribution of investment rose as an economy developed, which he termed the rising ‘organic composition of capital’ (Marx, 1867, p. 762).
Keynes similarly analysed that the proportion of the economy devoted to investment rose with economic development. His explanation was, however, somewhat different to Smith’s as Keynes rooted this in rising savings levels accompanying development. As the percentage of income consumed fell with increasing wealth, the proportion devoted to saving necessarily rose proportionately: ‘men are disposed… to increase their consumption as their income increases, but not by as much as the increase in their income… a higher absolute level of income will tend… to widen the gap between income and consumption.’ (Keynes, 1936, p. 36) As total savings necessarily equals total investment, a rising proportion of saving therefore necessarily means a rising proportion of investment.
A necessary consequence of an increase in the proportion of the economy devoted to investment is that any investment decline will have increasingly serious consequences: ‘the richer the community, the wider will tend to be the gap between its actual and its potential production… For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak… the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.’ (Keynes, 1936, p. 31)
Failure of attempts to refute Keynes on the rising proportion of investment
In the mid-20th century attempts were made to dispute this conclusion of classical economics, originally deriving from Smith, of a rising proportion of investment in the economy - Milton Friedman devoted a book, A Theory of the Consumption Function, to attempting to refute Keynes on this (Friedman, 1957). However modern econometrics findings are conclusive in support of Smith and Keynes and against Friedman – the definitive demonstration, as frequently on matters of long term economic growth, being given by Angus Maddison. (Maddison, 1992) Factually, as classical economics and Keynes analysed, the trend is for the proportion of the economy devoted to investment to rise. To illustrate this, Figure 1 shows the percentage of fixed investment in GDP of the leading economies of successive periods of growth over the 300-year period for which meaningful statistics exist.
Figure 1
A reason Friedman attempted, unsuccessfully, to refute Keynes over the rising proportion of investment in the economy is that such a trend, as will be seen, is potentially destabilising - Friedman noted: ‘the central analytical proposition of the [theoretical] structure is the denial that the long-run equilibrium position of a free enterprise economy is necessarily at full employment.’ (Friedman, 1957, p. 237)
Effective demand
There is a parallelism between Keynes’s analysis and Marx’s regarding the role of profit and investment. The latter noted that without offsetting factors, a rise in the proportion of investment in the economy would led to a falling rate of profit as a necessary consequence of a rise in capital relative to the profits stream – i.e. Increasing division of labour, through its effect in raising investment as proportion of the economy, as analysed by Smith, created a tendency to a declining rate of profit (Marx, 1894, pp. 317-375).
Keynes also approached economic fluctuations via profit: ‘The trade cycle is best regarded… as being occasioned by a cyclical change in the marginal efficiency of capital.’ (Keynes, 1936, p. 313) However, Keynes specific development was to approach the potentially destabilising consequences of the rising proportion of investment in the economy via effective demand.
Effective demand is composed of both consumption and investment, with the latter, as noted, tending to rise relative to the former over time. Keynes therefore noted: ‘when aggregate real income is increased aggregate consumption is increased but not by as much as income… Thus to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level… It follows… that given what we shall call the community’s propensity to consume, the equilibrium level of employment, i.e. the level at which there is no inducement to employers as a whole either to expand or to contract employment, will depend on the amount of current investment.’ (Keynes, 1936, p. 27)
Keynes noted no automatic mechanism ensures a necessary volume of investment to maintain effective demand: ‘the effective demand associated with full employment is a special case… It can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed.’ (Keynes, 1936, p. 28) Put aphoristically: ‘An act of individual saving means – so to speak – a decision not to have dinner today. But it does not necessitate a decision to have dinner or buy a pair of boots a week hence or a year hence.’ (Keynes, 1936, p. 210). In more technical terminology: ‘The error lies in proceeding to the … inference that, when an individual saves, he will increase aggregate investment by an equal amount.’ (Keynes, 1936, p. 83)
Any investment shortfall would be amplified by the well known economic ‘multiplier’ into much stronger cyclical fluctuations: ‘It is… to the general principle of the multiplier to which we have to look for an explanation of how fluctuations in the amount of investment, which are a comparatively small proportion of the national income, are capable of generating fluctuations in aggregate employment and income so much greater in amplitude than themselves.’ (Keynes, 1936, p. 122) Such fluctuations in investment, combined with consumption, in turn determined employment: ‘The propensity to consume and the rate of new investment determine between them the volume of employment.’ (Keynes, 1936, p. 30)
From this analysis Keynes derived key policy conclusions.
Budget deficits
One, well known, is countering recession with budget deficits, which Keynes dealt with as ‘loan expenditure’ – vulgarisation of Keynes lies in reducing his theories to support for budget deficits, not in the fact that he supported deficit spending. Keynes noted: ‘”loan expenditure” is a convenient expression for the net borrowing of public authorities on all accounts, whether on capital account or to meet a budgetary deficit. The one form of loan expenditure operates by increasing investment and the other by increasing the propensity to consume.’ (Keynes, 1936, p. 128)
Therefore, in a famous passage: ‘If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines… and leave it to private enterprise… to dig the notes up again... with the help of repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater… It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.’ (Keynes, 1936, p. 130)
Such a view of deficit spending naturally did not mean Keynes was indifferent to what deficits should be spent on - today environmentally sustainable investment would be added to his existing list. He had scathing contempt for double standards regarding when deficits were justifiable: ‘Pyramid-building, earthquakes, even wars… may serve to increase wealth, if… our statesmen… stands in the way of anything better… common sense… has been apt to reach a preference for wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which because they are not wholly wasteful, tend to be judged on strict “business” principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest…wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable.’ (Keynes, 1936, p. 129)
Interest rates
While Keynes supported deficit spending, the causes of recession lay in more fundamental factors affecting investment, which in turn were affected by interest rates: ‘the succession of boom and slump can be described and analysed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest.’ (Keynes, 1936, p. 144) This was because marginal efficiency of capital was ‘equal to the rate of discount which would make the present value of the series of annuities given by returns expected from the capital-asset during its lift just equal to its supply price.’ (Keynes, 1936, p. 135) Consequently, ‘inducement to invest depends partly on the investment-demand schedule and partly on the rate of interest.’ (Keynes, 1936, p. 137)
As investment was affected by interest rates, therefore, a crucial issue to maintain investment at a sufficient level to sustain effective demand was a low interest rate. This problem, in turn, tended to become more acute because of the rising proportion of the economy devoted to investment: ‘Not only is the marginal propensity to consume weaker in a wealthy community, but owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate; which brings us to the theory of the rate of interest and… reasons why it does not automatically fall to the appropriate levels.’ (Keynes, 1936, p. 31)
The aim of low interest rates was to relaunch investment by ensuring that the return on investment was above the rate of interest plus whatever was the required premium to overcome liquidity preference. But, as Keynes openly acknowledged, such low term interest rates destroy the ability to live from income from interest – which is why, in his famous phrase, Keynes foresaw ‘euthanasia of the rentier.’ (Keynes, 1936, p. 376) He concluded: ‘I see… the rentier aspect of capitalism as a transitional phase which will disappear.’ (Keynes, 1936, p. 376)
‘A somewhat comprehensive socialisation of investment’
Nevertheless, despite support for low interest rates Keynes, did not judge these would be likely by themselves to overcome the effects of an investment decline. It would therefore be necessary for the state to play a greater role: ‘Only experience… can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment… I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest… I expect to see the State… taking an ever greater responsibility for directly organising investment.’ (Keynes, 1936, p. 164) Consequently Keynes believed that regulating the level of investment would have to be undertaken by the state and not by the private sector: ‘I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.’ (Keynes, 1936, p. 320) It was necessary, therefore, to aim at ‘a socially controlled rate of investment.’ (Keynes, 1936, p. 325)
If, however, the state were to determine ‘the current volume of investment’ then this led Keynes to the conclusion: ‘It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.’ (Keynes, 1936, p. 378)
Keynes noted that this ‘somewhat comprehensive socialisation of investment’ did not mean the elimination of the private sector, but socialised investment operating together with a private sector: ‘This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative… the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society… apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest there is no more need to socialise economic life than there was before…. The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government.’ (Keynes, 1936, p. 378)
The conclusion
It is now possible to clearly see the structure of Keynes’s argument. The rising proportion of the economy devoted to investment meant any downturn in the latter would have increasingly destabilising consequences. Budget deficits could deal with this to some degree, but as the key element was investment, which was determined by interaction between profits and interest rates, low interest rates was necessary. This would lead to the ‘euthanasia of the rentier’. However it was unlikely interest rates would be sufficient themselves and therefore the state would need to step in with ‘a somewhat comprehensive socialisation of investment’ which would however work alongside a private sector.
Tracing this argument one has now arrived at a ‘Chinese’ economic structure - although approaching it via a Keynesian and not a Marxist framework. ‘Zhuada Fangxiao’, grasping large state firms and releasing small ones to the non-state/private sector, coupled with abandonment of quantitative planning, means that China’s economy is not being regulated via administrative means but by general macro-economic control, including centrally of the level of investment – as Keynes advocated.
Implications
What is the overall significance of this? Deng Xiaoping’s most famous economic statement is ‘cats theory’ – ‘it doesn’t matter whether a cat is black or white provided it catches mice’. But ‘cats theory’ can be applied to economics itself – it doesn’t matter whether something is described in Marxist or Western economic terms provided the same economic policies exist. ‘Zhuada Fangxiao’ may be arrived at from either a Keynesian or a Marxist framework.
But while one may be indifferent to the colour of theoretical cats it is not possible to be indifferent as regards the policy measures to be taken – steps in budget deficits, interests rates, investment etc are material and precise. Here there is a radical difference in between the US and Europe on one side and China on the other.
In the US and Europe budget deficits have been utilised – although they are under increasing attack. Low central bank interest rates have been pursued and some forms of quantitative easing, driving down long term interest rates through central bank purchases of debt, have been used. But no serious programmes of state investment have been launched – let alone Keynes’s ‘somewhat comprehensive socialisation of investment’.
In China, in contrast, relatively limited budget deficits have been combined with low interest rates, a state owned banking system (‘euthanasia of the rentier’) and a huge state investment programme. While the West’s economic recovery programme has been timid, China has pursued full blooded policies of the type recognisable from Keynes General Theory as well as its own ‘socialism with Chinese characteristics.’ Why this contrast and why has China’s stimulus package been so much more successful than the West’s?
Because in the US and Europe, of course, it is held that the colour of the cat matters very much. Only the private sector coloured cat is good, the state sector coloured cat is bad. Therefore even if the private sector cat is catching insufficient mice, that is the economy is in severe recession, the state sector cat must not be used to catch them. In China both cats have been let lose – and therefore far more mice are caught.
The recession in the Western economies, as foreseen by Keynes, is driven by decline in investment – in most countries decline in fixed investment accounted for two thirds to more than ninety per cent of the GDP fall (Ross, Li, & Xu, 2010). Keynes’s calls for not only budget deficits and low interest rates but also for the state to set about ‘organising investment’ are evidently required. But this is blocked because the state coloured cat is not allowed to catch mice.
To put it another way, the US and Europe insist on participating in a race while hopping on only one leg – the private sector. China is using two legs, so little wonder it is running faster.
To turn from metaphors to economic measures, a large scale state financed house building programme, or large scale expansion of transport, of the type China is following as part of anti-crisis measures not only delivers goods that are valuable in themselves but boosts the economy through macro-economic effects in raising investment. But in the West such state investment is blocked as it creates competition for the private sector. As the top aim in the US and Europe is not to revive the economy, but to protect the private sector, therefore such large-scale investment must not be undertaken.
It is an irony. Keynes explicitly put forward his theories to save capitalism. But the structure of the US and European economies has made it impossible to implement Keynes’s policies even when confronted with the most severe recession since the Great Depression. The anti-crisis measures of China’s ‘socialist market economy’ are far closer to those Keynes foresaw that any capitalist economy. Whereas in the US, for example, fixed investment fell by over twenty five per cent during the financial crisis in China urban fixed investment rose by over thirty per cent. Consequently, there is no mystery why China’s economy has grown by 41.4 per cent in the four years since the peak of the last US business cycle, in the 4th quarter of 2007, while the US economy has grown by 0.7 per cent.
Deng Xiaoping famously said his death was ‘going to meet Marx’. But Deng may also be having an intense talk with John Maynard Keynes. And Keynes would be interested to discuss with Deng’s two cats – who appear to have read the General Theory more closely and accurately than any administration in the West.
Put in more prosaic terms, China’s economic structure, because it allowed ‘a socially controlled rate of investment’ and a ‘somewhat comprehensive socialisation of investment’, could utilise policy tools developed by Keynes but the US and European economies could not. Although Keynes explicitly wished to save capitalism it turned out that Western capitalism could not use his tools, but China’s ‘socialism with Chinese characteristics’ could. Deng Xiaoping could not fit in the framework of Keynes, but Keynes could fit rather neatly within the framework of Deng Xiaoping.
Appendix – the issues restated in Marxist terms
In the article above an account has been given of China’s macro-economic policy in terms of a theoretical framework derived from Keynes. Deng Xiaoping, however, as a Communist naturally explicitly formulated China’s economic policy in Marxist terms - China’s economic reform policies were seen as the integration of Marxism with the specific conditions in China. More precisely Deng stated: ‘We were victorious in the Chinese revolution precisely because we applied the universal principles of Marxism-Leninism to our own realities.’ (Deng, 28 August 1985) Consequently: ‘Our principle is that we should integrate Marxism with Chinese practice and blaze a path of our own. That is what we call building socialism with Chinese characteristics.’ (Deng, 21 August 1985)
Authors, including (Hsu, 1991), have contended that Deng’s economic policies were not in accord with those of Marx. However while China’s economic policies clearly differed from those of the USSR after the introduction of the First Five Year Plan in 1929, which introduced comprehensive planning and essentially total state ownership, it is clear that China’s economic policies were in line with those indicated by Marx. Whether people wish to formulate Chinese economic policy in Keynesian or Marxist terms may be left to them. What is most crucial is not the colour of the cat but whether it catches mice – that is, the practical policy conclusions drawn. This appendix therefore briefly shows that Deng’s essential concepts in launching China’s economic reform in in 1978 corresponded to Marx’s.
The primary stage of socialism
Regarding China’s economic reform policies Deng noted, as stated in Marxist terms, that China was in the socialist and not the (higher) communist stage of development. Large scale development of the productive forces/output was the prerequisite before China could make the transition to a communist society: ‘A Communist society is one in which there is no exploitation of man by man, there is great material abundance, and the principle of from each according to their ability, to each according to his needs is applied. It is impossible to apply that principle without overwhelming material wealth. In order to realise communism, we have to accomplish the tasks set in the socialist stage. They are legion, but the fundamental one is to develop the productive forces.’ (Deng, 28 August 1985) More precisely, in a characterisation maintained to the present, China was in the ‘primary stage’ of socialism, which was fundamental in defining policy: ‘‘The Thirteenth National Party Congress will explain what stage China is in: the primary stage of socialism. Socialism itself is the first stage of communism, and here in China we are still in the primary stage of socialism – that is, the underdeveloped stage. In everything we do we must proceed from this reality, and all planning must be consistent with it.’ (Deng, 29 August 1987)
The fundamental characterisations by Deng have been maintained to the present – thus for example in July 2011 President Hu Jintao stressed that ‘China is still in the primary stage of socialism and will remain so for a long time to come’ (Xinhua, 2011), while speaking to the UN premier Wen Jiabao noted ‘Taken as a whole, China is still in the primary stage of socialism’ (Xinhua, 2010). The conclusion flowing from this as noted by Hsu, was that: ‘From this perspective, a serious error in the past was the leftist belief that China could skip the primary stage and practice full socialism immediately.’ (Hsu, 1991, p. 11)
The conclusion of such a contrast between a primary socialist stage of development and and the principle of a communist society (which, as noted by Deng above, was regulated by ‘from each according to their ability to each according to each according to his needs’) was that in the present 'socialist' period the principle was ‘ to each according to their work’: ‘We must adhere to this socialist principle which calls for distribution according to the quantity and quality of an individual’s work.’ (Deng, 28 March 1978) In Marxist theory, outlined by Marx in the opening chapter of Capital (Marx, 1867), economic distribution according to work/labour is the fundamental principle of commodity production – and a commodity necessarily implies a market. In this socialist period a market would therefore exist – hence the eventual Chinese terminology of a ‘socialist market economy.’ As presented by Deng Xiaoping and his successors above such Chinese analysis is highly compressed but clearly in line with Marx himself.
It is clear Marx envisaged that the transition from capitalism to communism would be a prolonged one, noting in The Communist Manifesto: ‘The proletariat will use its political supremacy to wrest, by degree, all capital from the bourgeoisie, to centralise all instruments of production in the hands of the State, i.e., of the proletariat organised as the ruling class; and to increase the total productive forces as rapidly as possible.’ (Marx & Engels, 1848, p. 504) The ‘by degree’ may noted – Marx therefore clearly envisaged a period during which state owned property and private property would exist. China’s system, after Deng, of simultaneous existence of sectors of state and private ownership is therefore clearly more in line with Marx’s conceptualisation than Stalin’s introduction ‘all at once’ of essentially 100 per cent state ownership in 1929.
Regarding Deng’s formulations on communist society being regulated by ‘to each according to their need’ versus the primary stage of socialism regulated by ‘each according to their work’ Marx noted in the Critique of the Gotha Programme of the post-capitalist transition to a communist society: ‘What we are dealing with here is a communist society, not as it has developed on its own foundations, but on the contrary, just as it emerges from capitalist society, which is thus in every respect, economically, morally, and intellectually, still stamped with the birth-marks of the old society from whose womb it emerges.’ (Marx, 1875, p. 85)
In such a transition Marx outlined payment in society, and distribution of products and services, necessarily had to be 'according to work' even within the state owned sector of the economy:‘Accordingly, the individual producer receives back from society - after the deductions have been made - exactly what he gives to it. What he has given to it is his individual quantum of labour. For example, the social working day consists of the sum of the individual hours of work; the individual labour time of the individual producer is the part of the social working day contributed by him, his share in it. He receives a certificate from society that he has furnished such-and-such an amount of labour (after deducting his labour for the common funds); and with this certificate, he draws from the social stock of means of consumption as much as the same amount of labour cost. The same amount of labour which he has given to society in one form, he receives back in another.
‘Here obviously the same principle prevails as that which regulates the exchange of commodities, as far as this is exchange of equal values…. as far as the distribution of the latter among the individual producers is concerned, the same principle prevails as in the exchange of commodity equivalents: a given amount of labour in one form is exchanged for an equal amount of labour in another form.
‘Hence, equal right here is still in principle - bourgeois right… The right of the producers is proportional to the labour they supply; the equality consists in the fact that measurement is made with an equal standard, labour.’ (Marx, 1875, p. 86)
In such a society inequality would necessarily still exist: ‘one… is superior to another physically or mentally and so supplies more labour in the same time, or can labour for a longer time; and labour, to serve as a measure, must be defined by its duration or intensity, otherwise it ceases to be a standard of measurement. This equal right is an unequal right for unequal labour... it tacitly recognises the unequal individual endowment and thus the productive capacities of the workers as natural privileges. It is, therefore, a right of inequality in its content like every right. Right by its very nature can consist only as the application of an equal standard; but unequal individuals (and they would not be different individuals if they were not unequal) are measurable by an equal standard only insofar as they are made subject to an equal criterion, are taken from a certain side only, for instance, in the present case, are regarded only as workers and nothing more is seen in them, everything else being ignored. Besides, one worker is married, another not; one has more children than another, etc. etc.. Thus, given an equal amount of work done, and hence an equal share in the social consumption fund, one will in fact receive more than another, one will be richer than another, and so on. To avoid all these defects, right would have to be unequal rather than equal.’ (Marx, 1875, pp. 86-87)
Marx considered only after a prolonged transition would payment according to work be replaced with the ultimately desired goal, distribution of products according to members of society’s needs.
‘Right can never be higher than the economic structure of society and its cultural development which this determines.
‘In a higher phase of communist society… after the productive forces have also increased with the all-around development of the individual, and all the springs of common wealth flow more abundantly - only then can the narrow horizon of bourgeois right be crossed in its entirety and society inscribe on its banners: From each according to his abilities, to each according to his needs!’ (Marx, 1875, p. 87)
It is therefore clear that post-Deng policies in China were more in line with Marx’s prescriptions than post-1929 Stalin policies in the USSR. Given the essentially 100 per cent state ownership of industry in China in 1978 'Zhuada Fangxiao' – maintaining the large enterprises within the state sector and releasing the small ones to the non-state sector – together with the creation of a new private sector created an economic structure clearly more in line with that envisaged by Marx than the essentially 100 per cent state ownership in the USSR after 1929. Deng’s insistence on the formula that in the transitional period reward would be ‘according to work’ and not ‘according to need’ was clearly in line with Marx’s analyses. It is notable that in the USSR itself a number of economists opposed Stalin’s post-1929 policies on the same or related grounds – including Buhkarin (Bukharin, 1925) , Kondratiev (Kondratiev), Trotsky (Trotsky, 1931) and Preobrazhensky (Preobrazhensky, 1921-27) (Preobrazhensky, 1921-27). Their works were, however, almost unknown as these issues were ‘resolved’ by Stalin killing those economists who disagreed with him and banning their works - although several accounts have been published outside the USSR – see for example (Jasny, 1972) (Lewin, 1975). China’s economic debates therefore appear to have preceded with reference to China’s conditions and Marx and not any preceding debates in the USSR.
It is therefore clear that China’s post-reform economic policy is in line with Marx’s analysis and that, as stated in Chinese analysis, post-1929 Soviet policy departed from Marx’s analysis – the argument that the converse is true, by Hsu and others, is invalid.
As China’s economic policy and structure can be understood in either Keynesian or Marxist terms it is a more general issue which is to be preferred. ‘It doesn’t matter whether a cat is black or white provided it catches mice’ might appear an appropriate response.
* * *
An earlier and shorter version of this article appeared in Soundings.
Notes and Bibliography
February 04, 2012
US workers dropping out of the labour force, not jobs creation, dominates in this US business cycle
Considerable publicity was given to the decline in the official US unemployment rate to 8.3 per cent in January 2012 and the creation of 243,000 non-farm payroll jobs. The problem is that, as usual, no baseline or serious study of overall trends was given to evaluate this monthly data.
The reality is the number in US non-farm employment still remains 5.6 million, 4.1%, below its peak level in January 2008 (Figure 1). But this figure very substantially flatters as since then the US population has grown by almost 4%.
In fact there has been no significant increase in the percentage of the US population of working age in employment since the depth of the recession, and the participation rate in the labour force of the US population of working age continues to drop.
Figure 1
The sharp drop in the participation of the US participation of working age in the total labour force (i.e. employed and unemployed) is shown in Figure 2. Between January 2008, the peak of US non-farm employment, and January 2012 the participation rate in the US labour force of the population over the age of 16 fell by 2.5 per cent – from 66.2 per cent to 63.7 per cent.
Figure 2
Regarding those actually in employment the situation is worse. The percentage of the US population over the age of 16 in employment fell by 4.4 per cent, from 62.9 per cent to 58.5 per cent, between January 2008 and January 2012. There has been essentially no significant recovery from the low point of 58.2 per cent in December 2008 to the 58.5 per cent in January 2012 (Figure 3).
Figure 3
US GDP recovery is the slowest in this business cycle of any since World War II, and in December 2011, the latest available data, US industrial production was still 5.4% below its level in the previous business cycle. As productivity growth means that less workers are required even when previous peak levels of output are regained it will be a substantial period before the US regains its previous employment level. Paul Krugman therefore noted the situation accurately: ‘the gap remains huge. Suppose that we need 100,000 jobs a month to keep up with population growth, and that we’re 10 million jobs in the hole — both conservative estimates. Then we need about 7 years of growth at this rate to restore full employment.’
It remains to be seen whether US employment growth can continue at its present rate for seven years, But the fundamental trend so far during this business cycle has not been a decline in real unemployment but an increase in the proportion of the US population dropping out of the labour force.
John Ross
- Is Visiting Professor at Antai College of Economics and Management, Jiao Tong University, Shanghai
Recent Posts
- US economic recovery is only one eighth of its rate in previous business cycles
- New US GDP figures are not 'disappointing' - they confirm long term deceleration in the US economy
- Analysing China's new 3.6% inflation data and its implications for the world economy
- Commodity price falls suggest global economic slowdown but good news for China's inflation
- Globalization not protectionism remains the main trend in the world economy
- Changing perceptions of China in Europe
- China's achievement is literally the greatest in world economic history
- China's inflation increase - not just a holiday effect?
- Europe's largest economic failure is not in Greece - but in the UK, Italy and Spain
- Deng Xiaoping and John Maynard Keynes
