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COLUMN-We can’t consume our way to healthy growth: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

March 6 (Reuters) - However you explain it, the fact that leading economies like the U.S. are increasingly reliant on consumption to drive economic growth is a worrying sign.

Unlike many previous expansions, those since the great financial crisis are heavy on consumption growth, and comparatively light on investment in infrastructure, capacity or new products.

A new study from the Bank for International Settlements finds that periods of consumption-led growth, defined as when private consumption grows more quickly than overall growth, tend to show both sluggish growth and weak increases in investment and net exports.

“Increasing shares of private consumption in GDP can be a leading indicator of future growth slowdowns, particularly if consumption-led expansions come on the back of growing imbalances and rising debt burdens,” Enisse Kharroubi and Emanuel Kohlscheen of the BIS, the central bank of central banks, said in the study.

“High household debt service ratios tend to become a potent drag on economic growth, frequently leading to costly deleveraging processes.” (https://www.bis.org/publ/qtrpdf/r_qt1703e.pdf)

The study, which looked at a range of developed and emerging market economies, found that if you measure over three years, annualized GDP growth is just 1.9 percent during consumption-led periods compared to 2.6 percent when the rest of the economy led the way.

Of course, we can’t know for certain if higher relative growth of consumption rather than investment drives subsequent sub-par growth or is simply a consequence of other conditions which make growth tough to achieve.

Looking at the past 20 years, particularly in the U.S., you can construct an argument that we find ourselves relying on consumption to fuel what growth there is because we are constrained by less favorable demographics and the erosion of middle-income buying power. This may have encouraged monetary policy-makers to encourage the only growth they felt was available: consumption-led.

High debt levels may impair future growth, leaving businesses and households less able to invest, or for that matter to consume, as they must service and pay down debts. Similarly the wealth effect from housing price increases can tie up too much of future incomes needed to pay for shelter. These two, housing and debt, are obviously connected; though the study found that debt service levels were a better predictor of future growth, there was also evidence of short-term stimulus from house price rises, particularly in economies where home owners can refinance and spend some of their housing gains.


Yet the idea that investment is low because opportunities for profitable investment are lacking is compelling. In the U.S. and elsewhere, notably Japan and Europe, an aging population may be suppressing investment, as companies recognize that there will be lower future benefits to new capacity.

Looking specifically at the U.S., we may have found ourselves in the great financial crisis precisely because of this, and because globalization and trade patterns combined to suppress income growth for most households.

Following on the brief dotcom euphoria the recession in the early years of the millennium was arrested in part because the Federal Reserve kept rates too low. This boosted investment in housing, which is after all not a route to greater productivity growth. That put some people to work building and improving houses, and drove house prices higher, which allowed some people to boost their consumption by taking cash out of their now more valuable house.

Sadly, but inevitably, the housing bubble and credit orgy led to a destructive and debilitating financial crisis. While you can hardly blame them, the medicine applied to this crisis by central bankers, first very low rates and then the addition of quantitative easing, was very much like the loose money which helped the bubble inflate.

In some ways the more interesting question isn’t why consumption is leading the way, but why investment isn’t. To understand, have a look at how companies in countries like Japan react to seeing their currencies fall after bouts of easy money, something which should make them more globally competitive. The tendency is not to crank up production via investment, but just to allow the cash to roll in from newly profitable overseas sales.

In part this may be because companies in places like Japan look at a dwindling population and just don’t see the upside to new investment. Elsewhere, such as in the U.S., it may also be because the capital allocation process favors hot high-growth sectors (does Snapchat ring a bell?) over more capital-intensive areas.

What seems clear is that the solution to either issue will not be found principally in monetary policy.

(Editing by James Dalgleish) )