Nearly two years into the financial crisis it is possible to show clearly in figures which of these two contrasting analyses is correct – they evidently lead to different conclusions as regards policies. As will be shown below the overwhelming driving force of the Great Recession is a collapse in fixed investment, not a decline in US consumption - or consumption in other economies. This also casts clear light on why China has been the country which has come the most successfully through the financial crisis. To summarise the statistical conclusions below:
'Decline in fixed investment accounts for approximately 96% of the fall in GDP in the OECD area as a whole and for 76% of the decline of GDP in Europe. In three countries - the US, Spain, and Portugal - the decline in fixed investment was greater than the decline in GDP. In Japan, France and Greece the proportion of the fall in GDP due to the decline in fixed investment was over 70%, 80% and 90% respectively. In every country except Germany the fall in fixed investment was the single biggest component of the decline in GDP. In short the decline in fixed investment entirely dominates the Great Recession'
The focus of this article is therefore a detailed factual account of what has actually occurred during the Great Recession. These facts leave no doubt. The ‘Great Recession’ is actually ‘The Great Investment Collapse’. Policies for dealing with the Great Recession must therefore primarily address reversing the investment decline.
The OECD as a whole
Taking first aggregate changes in the components of GDP in the OECD area as a whole, i.e. all advanced economies, Figure 1 shows these since the beginning of the economic downturn after the first quarter of 2008 up to the latest available aggregated OECD data. As may be seen the GDP fall is entirely dominated by the decline in fixed investment.
During the period from the first quarter of 2008 to the fourth quarter of 2009 OECD GDP fell by $1.04 trillion dollars in constant parity purchasing power (ppp) terms - the form in which the OECD aggregates data. Of this fall $0.99 trillion, equivalent to approximately 96 percent, was accounted for by a decline in fixed investment. In contrast the decline in personal consumption expenditure was $0.25 trillion, only one quarter of the decline in investment, government consumption rose by $0.23 trillion and the balance of trade of the OECD economies improved by $0.23 trillion.
Figure 1
The US
Turning to the US, the changes in the components of GDP in the downturn after the second quarter of 2008 to the first quarter of 2010 are shown in Figure 2. Again, as may be seen, the fall in US GDP is entirely dominated by the decline in fixed investment. During this period US GDP in constant price terms, 2005 dollars at annualised rates, fell by $177bn. However most components of US GDP actually rose over the period as a whole – consumer expenditure by $8bn, government expenditure by $58bn, inventories by $78bn, and net trade by $108bn.
The entire decline of US GDP is therefore due to the $420bn decline in fixed investment.
Figure 2
In order to avoid any suggestion that this investment decline is due simply to the fall in residential investment, propelled by the sub-prime mortgage crisis, Figure 3 divides the decline in US fixed investment in the period into residential and non-residential. The decline in non-residential fixed investment is $310bn and the decline in residential fixed investment is $110bn – i.e. the decline in US fixed investment is overwhelmingly accounted for by the fall in non-residential investment.
Figure 3
Europe
Taking Europe as a whole, the changes in the components of GDP in the downturn after the first quarter of 2008, up to the latest available OECD data, are shown in Figure 4. The fall in GDP is again dominated by the decline in fixed investment.
In constant price ppp dollars, the form in which the OECD calculates aggregated data, the GDP of the OECD area in Europe fell by $583.5bn. Of this $445.7bn, or approximately 76%, was due to the decline in fixed investment. Personal consumer expenditure fell by $145.6 bn, while government consumption rose by $123.3 bn and net trade improved by $47.4bn.
Figure 4
Japan
Turning to Japan, the changes in the components of GDP in the downturn after the first quarter of 2008, up to the latest available OECD data, are shown in Figure 5. The downturn in almost all components of Japan's GDP, except government consumption, is severe. However by far the largest decline is accounted for by the fall in fixed investment.
During the period since the start of the economic downturn Japan's GDP, in constant price terms, fell by ¥8.3 trillion. Government consumption rose by ¥0.3 trillion while personal consumption fell by ¥1.1 trillion, and net trade worsened by ¥2.2 trillion. However fixed investment fell by ¥5.7 trillion - i.e. approximately 69% of the fall in Japan's GDP was due to the decline in fixed investment.
Figure 5
Germany
Turning to the individual major European economies, the components of GDP in the downturn in Germany's economy after the first quarter of 2008, up to the latest data for the first quarter of 2010, are shown in Figure 6. Germany is specific in that, as will be seen, it is the only major economy in which the worsening of the net trade balance is greater than the decline in fixed investment in terms of its impact on GDP. The combination of the fall in investment plus the worsening of the net trade balance accounts for the severity of the German recession - GDP in Germany in the first quarter of 2010 was still 5.3% lower than in the first quarter of 2008.
In constant price terms German GDP fell by €30.4bn between the first quarter of 2008 and the first quarter of 2010. Government expenditure rose by €6.0bn, personal consumption fell by €5.6bn, fixed investment fell by €14.7bn and net trade worsened by €21.6bn.
Figure 6
France
For France Figure 7 shows the changes in the components of GDP in the downturn after the first quarter of 2008 up to the first quarter of 2010. As may be seen, the fall in GDP is dominated by the decline in fixed investment. During this period France's GDP in constant price terms fell by €11.7bn. Net trade worsened by €1.0bn while personal consumption rose by €3.6bn and government consumption by €4.6bn. However fixed investment fell by €11.7bn - i.e. approximately 87% of the fall in France's GDP was due to the decline in fixed investment.
Figure 7
The UK
Figure 8 shows the changes in the components of UK GDP in the recession after the first quarter of 2008 up to the first quarter of 2010. Again, as may be seen, the largest component of the fall in GDP is fixed investment.
In constant price terms UK GDP fell by £18.6bn. Net trade improved by £2.0bn, government consumption rose by £3.6bn, and personal consumption fell by £8.3bn. However fixed investment fell by £10.5bn - i.e. approximately 56% of the fall in UK GDP was due to the decline in fixed investment.
Figure 8
Italy
Turning from the major north European economies to the southern European states, the so called PIGS (Portugal, Italy, Greece, Spain), the situation is equally clear. Figure 9 shows the changes in the components of GDP in Italy in the recession following the first quarter of 2008 up to the first quarter of 2010. In constant price terms Italy's GDP fell by €19.6bn. Government consumption rose by a marginal €0.3bn, net trade worsened by €4.4bn and personal consumption fell by €4.8bn. Fixed investment however fell by €10.0bn - i.e. 51% of the fall in Italy's GDP was due to the decline in fixed investment.
Figure
9
Spain
Turning to Spain the changes in the components of GDP in the downturn after the first quarter of 2008, up to the first quarter of 2010, are shown in Figure 10. The fall in GDP is dominated by the decline in fixed investment.
During this period Spain's GDP in constant price terms fell by €9.2 billion. Government consumption rose by €3.0 billion and net trade improved by €10.6 billion as Spain began to reverse its wide balance of payments deficit. There was a significant fall in personal consumption of €7.1 billion but by far the dominant element was the €13.7 billion fall in fixed investment. The fall in fixed investment in Spain was greater than the entire decline in GDP.
Figure
10
Portugal
Figure 11 shows the changes in the components of GDP in Portugal in the recession after the first quarter of 2008 up to the first quarter of 2010. In constant price terms GDP fell €0.8bn, net trade improved by €0.2bn while personal consumption increased by €0.3bn and government consumption by €0.4bn. Fixed investment however fell by €1.5bn - more than the entire decline in GDP.
Figure 11
Greece
Finally Figure 12 shows the changes in the components of GDP in Greece from the beginning of its recession, which commenced in the third quarter of 2008, up to the first quarter of 2010. In constant price terms Greece's GDP fell €2.0bn. Net trade improved by €0.2bn while personal consumption fell by €0.1bn and government consumption by €0.3bn. Fixed investment fell by €1.8bn - i.e. approximately 90% of the fall in GDP was due to the decline in fixed investment.
Figure 12
China
It is evident from the above data that whether considering the advanced economies as a whole, or looking at individual economies, the overwhelmingly dominant element in the economic downturn is the fall in fixed investment. Decline in fixed investment accounts for approximately 96% of the fall in GDP in the OECD area as a whole and for 76% of the decline of GDP in Europe. In three countries - the US, Spain, and Portugal - the decline in fixed investment was greater than the decline in GDP. In Japan, France and Greece the proportion of the fall in GDP due to the decline in fixed investment was over 70%, 80% and 90% respectively. In every country except Germany the fall in fixed investment was the single biggest component of the decline in GDP. In short the decline in fixed investment entirely dominates the Great Recession. The policy conclusions which follow from this are evident. The decisive question is to reverse the decline in investment.
It is equally clear from this data why China has come most successfully through the financial crisis. China's government carried out its stimulus package not via an increase in the budget deficit, which has remained at less than 3% of GDP, but by a major increase in infrastructural and other fixed investment.The comparative paths of fixed investment in China and the US under the impact of their stimulus packages in 2009 are shown in Figure 13. Whereas in the US fixed investment fell by twenty percent China's urban fixed investment rose by more than thirty percent due to the stimulus package. The impacts, in terms of the changes in US and China's GDP in 2009, are shown in Figure 14.
China's stimulus package dealt directly with the central issue in the Great Recession. China focussed on investment - rather than attempting primarily to influence this indirectly via the hope that a stimulus to personal and government consumption, maintained by a large budget deficit, would induce a reversal of the investment decline. Consequently China was able to launch a large stimulus package without running a large budget deficit. The GDP growth induced by the investment rise in turn produced large scale tax revenue - China's fiscal income in 2009 rose by 11.7%, compared to major declines in tax revenue in the US and European economies. China therefore currently does not face the choice faced by the US and European governments of whether to maintain large scale budget deficits, to attempt to sustain economic stimulus, or whether to engage in fiscal consolidation. In light of the actual character of the Great Recession China's stimulus package was therefore significantly better designed than those in the US and Europe.
Understanding what has been the real core of the Great Depression will therefore better aid the policy response in recovering from it.
Figure 14
On the question by Giles Chance in his comment, Figure 3 does not separate commercial real estate from overall US private fixed investment - it is the total decline in private investment.
However using chained 2005 dollars, the total decline in US private investment was $420 billion, the decline in non-residential structures was $146 billion and the decline in residential structures $110 billion. The total decline in investment in structure was $264 billion - the sum of the components differs slightly from the total as these are chained dollars.
As examination of the difference between the total and the components is not huge, as with other parts of investment, and sharp changes in relative prices have therefore not taken place, it is reasonable to say that approximately 63% of the decline in US fixed investment is due to decline in investment in structures of which approximately 26% is due to the decline in investment in residential structure and 35% to the decline in investment in non-residential structure - again there is a (slight) disparity between components and total due to the fact chained dollars are being used.
These figures confirm Giles Chance's point that the biggest element by far in the decline in US fixed investment is in real estate of which the largest part is in non-residential real estate.
(Data calculated from US Bureau of Economic Analysis NIPA Table 5.3.6)
Posted by: John Ross | 01 July 2010 at 13:18
Interesting, valuable analysis. I believe in order to judge the potential for a GDP bounce-back resulting from a reversal in weak corporate investment, one should separate out the private real estate effect from the overall fixed investment impact. Breaking out private residential investment in the European numbers is important, and in the cases particularly of Spain and the UK would probably show that the decline in property speculation has been a major part of the downturn. Included in fixed investment is also commercial property investment, which of curse has been an even larger component of the boom and bust- does your US breakdown in figure 3 separate commercial real estate out from the overall private fixed investment number ? COMMENT FROM Giles Chance, visiting professor at Guanghua School, Peking University, and author of 'China and the Credit Crisis: the emergence of a new world order' published by John Wiley 2009.
Posted by: Giles Chance | 01 July 2010 at 09:21
Thank you for this. I wish our commentariat had known this much earlier! Evidence-based economics has been in short supply these few years.
Posted by: Phil Hand | 01 July 2010 at 04:41