Last updated: September 10, 2013 7:48 pm
America’s economic growth is built on sand
Washington could do much to place the recovery on firmer foundations, says Robin Harding
Twelve weeks into his presidency, when the Great Recession was at its darkest and he was still the embodiment of hope, Barack Obama gave a speech about rebuilding and rebalancing the US economy. In the biblical mode that suits him so well, Mr Obama told a parable from the Sermon on the Mount about the foolish man who built his house on sand and the wise man who built his house on rock.
“We cannot rebuild this economy on the same pile of sand,” said Mr Obama. “We must build our house upon a rock. We must lay a new foundation for growth and prosperity – a foundation that will move us from an era of borrow and spend to one where we save and invest; where we consume less at home and send more exports abroad.”

Four years on, that rebalancing has stalled; the US is building again, but on foundations of sand. It is depressing to consider, but on its current path the US is headed back to the same economic structure as before the recession: driven by consumption and sucking in imports. These are the first steps towards a future crisis.

In 2009, Mr Obama was speaking for a consensus about how the US should rebalance. The share of exports and investment should rise while consumption, imports and housing should fall. In terms of financial balances, household and government savings needed to rise and corporate savings to fall. As for incomes, labour should earn more relative to capital, and that should be more evenly distributed.

With a better balance of demand, the economy should be less vulnerable to shocks, less prone to build-ups of debt, and better able to grow because of higher investment. For a year or two it looked promising – but rebalancing stopped.

Start with trade. The current account deficit fell to 2.5 per cent of gross domestic product in 2009 but then got stuck. Mr Obama’s 2010 goal of doubling exports in five years looks like a pipe dream. As the US recovers and emerging economies slow down, the current account deficit looks likely to widen.
The personal savings rate tells a similar story. In the wake of the crisis it jumped from 3 per cent of incomes to 6 per cent, but has since drifted down again nearer to 4 per cent. Corporate savingall that cash on corporate balance sheets – remains high even as the public sector battles to reduce its deficit.
Labour’s share of national income has stabilised at about 59 per cent of GDP; it was 62 per cent before the recession. Median household incomes are lower than before the recession as inequality rises. Worst of all, private investment remains below even its long-run share of national output, while public investment peaked with the stimulus in 2010 and has been falling ever since.
There are one or two bright spots. The brightest is the rise of shale oil, supporting trade and investment; while new financial regulations should limit the chances of a build-up in credit and thus encourage a higher savings rate. But this is not a balanced economy.

Policy makers cannot prescribe the balance of the economy but there is still much they could do to build the US recovery on firmer foundations. The first and most obvious step is reform of the housing finance agencies Fannie Mae and Freddie Mac. Remarkably, given their role in the crisis, there has been no legal change to reduce the artificial subsidy they put into the mortgage market. The more time passes, the harder that change becomes.

If – or rather when – the current account deficit starts to rise again, Mr Obama should take on any country that manipulates its currency against the dollar. Many emerging markets, including China as it struggles with its own rebalancing, may be tempted in the next couple of years. The US should resist going down that path again.

The most important element of a better balanced economy is investment, both public and private. That means finding a way to stop the macroeconomic insanity of sequestration cuts to investment in scientific research, education and infrastructure. Not only do they leach short-term demand for the economy, they also actively reduce the very things that America needs more of, in return for minimal reduction to the budget deficit.

Republicans in Congress do not seem overly concerned, preferring to use the sequestration as leverage to seek cuts in long-term entitlement spending. Mr Obama will have to decide whether he wants to win a once-in-a-generation political battle about the size of government in the US – which will mean holding out for higher tax revenues even as the public sector falls apart around him – or else look to the short and medium-term health of the economy by cutting a deal that delivers relief from the sequestration.

There are few levers to pull on private investment. The most obvious path to a short-term recovery is a healthier economy; and the best way to promote that is by doing something about the sequestration. Corporate tax reform could boost incentives to invest in the US. It is also worth looking at whether executive pay practices have become a disincentive to investment at public companies.
The balance of an economy seems abstract most of the time so long as it produces growth and jobs – but in the long run it affects the quality of the jobs, the level of growth and the stability of the whole. It would be a tragedy if a shift towards sustainability was not a legacy of the financial crisis for the US economy.

Mr Obama was upbeat in his 2009 speech, and chose not to mention it, but this is what becomes of the house built on sand: “And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell: and great was the fall of it.”

Copyright The Financial Times Limited 2013.

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