The conservative economic counter-revolution associated with the names of Ronald Reagan and Margaret Thatcher began some three decades ago. The Great Recession almost certainly marks its end. What follows will be something different, though how different it will is still unclear. This is a good opportunity to assess the broad economic consequences of that revolution.
For the sake of simplicity, I focus on gross domestic product per head in the six biggest high-income economies: the US; Japan; Germany; the UK; France; and Italy. (I also use the Conference Board database. These data are in purchasing power parity (Elteto-Koves-Szulc (EKS) method).)
There is much more to performance than GDP per head. These data ignore the distribution of income, which is of crucial importance, especially for the US, where a very large proportion of additional income seems to have accrued to the wealthiest. The data also ignore the underlying causes of changes in GDP per head: changes in output per hour, in hours per worker and in employment. Even so, they are revealing.
The single most important point from the chart on relative GDP per head is that the US remains where it has been for over a century: the most productive large economy in the world. At its peak, in 1991, Japan’s GDP per head reached 89 per cent of US levels. It then fell substantially in the 1990s. United Germany, France and Italy also experienced substantial relative declines in GDP per head over this period. The UK was the only one of these five countries to have achieved rising GDP per head, relative to the US, since 1990. This surely suggests that reforms led by American and British policymakers did bear some fruit.
The chart on growth of GDP per head elaborates this picture somewhat. The UK and US had the highest trend growth of GDP per head between 1980 and 2009. (All-German data are unavailable for the entire period.) But there are other interesting events: first, there is a progressive deceleration in trend growth: only Japan achieved faster trend growth in GDP per head between 2000-07 (that is, before the recent deep recession) than it did in the 1990s; second, the US growth deceleration in the most recent periods is marked, with growth in GDP per head only at the same rate as Japan between 2000 and 2007 – so much for the magic of the Bush-era tax cuts – and also between 2000 and 2009; third, GDP per head grew at less than 1 per cent a year in Germany, France and Italy in the most recent decade.
At first glance, then, the conservative revolution seems to have achieved some improvements in the previously lagging US and UK economies. But the magic potion started to lose effectiveness in the 2000s, particularly in the US.
The more interesting question, however, is how far this improved performance of the US and UK will turn out to have been a blip. There are two reasons for believing this.
First, the expansion of the financial sector and associated leveraging of the household sector played a big part in the growth of the economies of the US and UK. The question is how far growth driven by these two linked developments will turn out to have been a mirage. It is not difficult to see why that might be the case. The financial sector creates money and credit not only used to pay fees to itself and to a host of brokers and agents, but also to finance construction booms. Furthermore, the next decade is likely to see deleveraging in the US and UK, in both household and financial sectors, while the willingness to leverage up the government sector seems set to hit political or economic limits. This combination of factors might make these countries’ performance look a little like that of Japan in the 1990s, with chronically weak aggregate demand.
Second, the US and UK have run substantial current account deficits in recent decades. Andrew Smithers of London-based Smithers & Co argues that this has allowed the relative shrinkage of manufacturing, a capital-intensive sector. That, in turn, has permitted the two economies to grow quite fast, despite relatively low rates of investment in physical capital. In the coming decade, this process is likely to be reversed. Savings and investment would then have to rise substantially to sustain given rates of overall economic growth. Should this not happen, growth would slow further.
Bubbles induce severe over-estimates of underlying economic performance. Will the same prove true of the US and UK? I would guess so. Might the next decade belong to Germany or Japan, instead? That would not surprise me either. Expect the unexpected. It is a good rule.
