Aftershock: The Next Economy and America's Future (9 page)

Nor will households be able to borrow as before. Banks and other lenders that got burned will be far more careful in the future. In addition, lending standards will have tightened, and new bank regulations and overseers will require prudence. Gone forever are many of the loan products of the wild years—credit cards awarded to anyone who could stand up straight, regardless
of credit history; mortgages requiring no down payment; home equity loans for the asking. Housing values will not regain their speculative peak for a long time, which means homeowners cannot use their homes as sources of easy money through home equity loans and refinancing deals.

Meanwhile, a large number of Americans must get out from under the huge pile of debt they amassed. With shrunken family budgets and precarious jobs, they can’t afford the interest charges. Even those who are better off are wary; the Great Recession served as a traumatic reminder that good times don’t last forever. The result is that Americans are paying off, paying down, or walking away from trillions of dollars of outstanding loans—in a vast “deleveraging” of household finances that is likely to continue for years. Even as the economy returns, people won’t want to be burdened by much additional debt.

At the same time, tens of millions of boomers are approaching retirement with nest eggs that have shrunk considerably, and it will take years until the values of their 401(k) plans catch up to where they had been expected to be by retirement time.
In 2009, some 50 million workers lost a total of at least $1 trillion in their 401(k) plans, according to the Center for Retirement Research at Boston College. Even when (or if) the stock market returns to its 2007 levels, boomers will have lost years of gains they were counting on to boost their savings. These boomers must now save like mad. Many will have to put off retirement, which means fewer opportunities for younger people looking for work.

All this means relatively less middle-class consumption than before the Great Recession. Although consumers have to replace cars, appliances, and other things that run out or wear out or finally break down, and businesses have to replace inventories that become so depleted they have nothing left to sell or ship, a lasting and vigorous recovery cannot be based on replacements.

In mid-2009, analysts from Bank of America Merrill Lynch
reported that the wealthiest 10 percent of Americans “should have enough spending power to fuel a recovery.” The report’s authors reasoned that before the Great Recession, the top 10 percent had accounted for more than 40 percent of consumer spending. And the recession hadn’t battered this group nearly as badly as it did the middle class because the top 10 percent had most of its assets in the stock market, while the major assets of the middle class were their homes. The value of their homes had plummeted more than the Dow, and would recover more slowly.

Specious analyses like this are consistent with those produced by the much-vaunted Wall Street “talent” that plunged the nation into financial crisis. Apparently it never occurred to the authors that the only reason the top 10 percent accounted for some 40 percent of consumer spending before the Great Recession is they were taking home about 50 percent of total income, and that no “recovery” can be “fueled” by just 40 percent of prior spending.

Where will sufficient demand come from without a buoyant American middle class? Absent their spending, companies have less incentive to buy new equipment or software, or acquire new commercial buildings or factories. Without enough demand, entrepreneurs won’t embark on new research or develop new products and services. It is possible, of course, that someone will introduce a new product or software application so revolutionary as to require that every business in the world buy it, thereby electrifying the economy and creating a great gush of new jobs, as did the Internet and the dot-com booms of the 1990s. But without a change in the fundamentals, a positive jolt like this is unlikely to alter the economy’s long-term trajectory, as we saw when the dot-com bubble burst. Government can fill the gap for a time, but government cannot continue indefinitely to stimulate the economy with deficit spending or by printing money.

Some experts and policymakers believe the answer will be
found in consumers outside the United States, especially in China. But they are wrong.

September 24, 2009. As world leaders arrive in Pittsburgh for the Group of Twenty summit, President Obama speaks of the urgency of “rebalancing” world growth, especially between the two economic colossi of the United States and China.
“We cannot go back,” he says, “to an era where the Chinese … just are selling everything to us, we’re taking out a bunch of credit card debt or home equity loans, but we’re not selling anything to them.” The president slightly exaggerates for effect, but his meaning is clear: Americans, he asserts, can no longer keep buying from China on credit supplied by China. The long-term fix is to get Americans to save more, and Asians—especially the Chinese—to spend more.

By this view, Chinese consumers will make up for the incapacity of American consumers to keep the U.S. economy going. In 2010, China was on the verge of overtaking Japan as the world’s second-largest economy, after the United States. The Chinese market is potentially huge, we are told, and its middle class is growing. Inevitably, the U.S. dollar will decline. So eventually everything we buy from them will cost us so much more and everything they buy from us so much less that we’ll start exporting to them big-time. Detroit may even reemerge as the world’s automobile capital. Our steel mills will be humming again. Appliance
manufacturers will be resurrected on American soil. New technologies for energy efficiency and noncarbon fuels will be produced in the United States for export abroad.

This is wishful thinking.

True, the Chinese market is growing at a fast clip.
By 2009, China was second only to the United States in computer sales, for example, with a larger proportion of first-time buyers. It sold more desktop computers than were sold in the United States. It had more cell-phone users. Excluding SUVs, the Chinese bought more cars than Americans did (as recently as 2006, Americans bought twice as many), more refrigerators, and more washing machines. If the Chinese economy continues to grow at or near its current rate, and the benefits of that growth trickle down to 1.3 billion Chinese consumers, the country will become the largest shopping bazaar in the history of the world. By 2050, they’ll be driving over a billion cars—almost 50 percent more than the current world total—and will have become the world’s biggest purchasers of household electronics, clothing, appliances, and almost everything else produced on the planet.

But the benefits of China’s growth are not trickling down nearly this fast. Consumer spending there is growing far more slowly than the overall economy. The share of national income going to households in the form of wage and investment incomes continues to drop, while the share going to Chinese companies increases. In 2009, total personal consumption in China amounted to only 35 percent of the economy. Ten years earlier it was almost 50 percent. Investment, by contrast, rose from 35 percent to 44 percent of the economy. Most new jobs were in production and not, as in the United States, in retail sales or services.

Chinese companies are plowing their rising profits back into more production—additional factories, more equipment, new technologies. In 2009, the Chinese government jolted the domestic economy with a whopping package of government spending
equal to $585 billion, almost as large as America’s stimulus but far larger as a proportion of China’s economy. But most of it was also directed at further enlarging China’s capacity to produce—railways, roads, power grids, sewers, and factories. China’s capital spending is on the way to exceeding that of the United States. Its consumer spending is barely a sixth as large.

China is heading in the opposite direction of “rebalancing.” Its production of goods keeps soaring, but China’s own consumers are taking home a shrinking proportion of the output. The destinations for what China makes are other nations, especially the United States and Europe.

Many explanations have been offered for the parsimony of Chinese consumers. Social safety nets are still inadequate, so Chinese families have to cover the costs of health care, education, and retirement. (China recently doubled its spending on these services, but the total is still low by international standards—around 6 percent of the Chinese economy, compared with an average of 25 percent in most developed nations.) Young Chinese men outnumber young Chinese women by a wide margin, so households with sons have to save and accumulate enough assets to compete successfully in the marriage market. Chinese society is aging quickly because the government has kept a tight lid on population growth for three decades. That means households are supporting lots of elderly dependents and must save in anticipation of supporting even more.

The larger explanation for Chinese frugality is that the nation is oriented toward production, not consumption. Production gives meaning and purpose to the Chinese economy. China wants to become the world’s preeminent producer nation. It also wants to take the lead in the production of advanced technologies.

The United States would like to retain the lead, but our economy is oriented toward consumption rather than production. Deep down inside the cerebral cortex of our national consciousness
we assume that the basic purpose of an economy is to provide more opportunities to consume. We grudgingly support government efforts to rebuild our infrastructure. We want our companies to invest in new equipment and technologies, but we also want them to pay generous dividends. We approve of government investments in basic research and development, but mainly for the purpose of making the nation more secure through advanced military technologies. (We regard spillovers to the private sector as incidental.)

China’s industrial and technology policy is unapologetically direct. China especially wants America’s know-how. The best way to capture know-how is to get it firsthand. So China continues to allow many U.S. and foreign companies to sell their wares there on the condition that production take place in China—often in joint ventures with Chinese companies. Even as the U.S. government was bailing out General Motors and Chrysler, the two firms’ sales in China were soaring—in 2009, GM’s sales there were up 67 percent from the year before, and it sold more cars in China than in the United States—but almost all the cars are made there. Procter & Gamble is so well established in China that many Chinese think its products (such as green-tea-flavored Crest toothpaste) are local brands. They might as well be. P&G makes most of them there.

In 2009, other American firms were helping China build a “smart” infrastructure, tackle pollution with clean technologies, develop a new generation of photovoltaics that convert solar radiation into electricity and wind turbines, find new applications for “nanotechnologies,” and build commercial jets and jet engines. General Motors announced that it was planning to make a new subcompact in China designed and developed with its Chinese partners at the Pan-Asia Technical Automotive Center. General Electric was producing wind turbine components in China. Massachusetts-based Evergreen Solar, a leader in the production
of solar panels, revealed that it was moving its plant from Devens, Massachusetts, to Wuhan, China. Applied Materials, the world’s largest supplier of equipment to make solar panels, moved both its chief technology officer and its newest research lab to Xian, China.

In addition to becoming the world’s center of high-tech production, China wants to create more jobs in China. That means it will continue to maintain the yuan’s fixed relationship to the U.S. dollar rather than allow the yuan to rise freely against the dollar. China will allow its currency to rise a bit from time to time in order to deflect foreign criticism, but will keep it undervalued. (If the yuan rose, Chinese exports would become more expensive for us and we’d buy fewer.) This is costly for China. Not only does it keep the prices of everything China might want to import artificially high, but it also requires that when the dollar drops in international currency markets, China has to sell yuan and add to its pile of foreign assets. Yet China is willing to bear these costs because its export policy doubles as a social policy, designed to maintain order. Each year, tens of millions of poor Chinese stream into China’s large cities from the countryside in pursuit of better-paying work. If they don’t find it, China risks riots and other upheaval. Massive disorder is one of the greatest risks facing China’s governing elite. That elite would much rather create jobs, even at the high cost of subsidizing foreign buyers, than allow the yuan to rise against the dollar and thereby risk job shortages at home.

For all these reasons, the task of “rebalancing” trade between the United States and China is far more complicated, and less likely to succeed, than is commonly admitted. The awkward truth that’s not openly discussed on either side of the Pacific is that both the United States and China are capable of producing far more than their own consumers are capable of buying. In the United States, the root of the problem, as we’ve seen, is a growing
share of total income going to the richest Americans. Inequality is also widening in China, but the root of the problem there is a declining share of the fruits of economic growth going to average Chinese and an increasing share going to capital investment. Both societies are threatened by the disconnect between production and consumption. In China, the threat is civil unrest. In the United States, it is a prolonged jobs and earnings recession, which, when combined with widening inequality, could create a negative political backlash.

To be sure, citizens of other nations might respond to a declining dollar by buying more from the United States and thereby generating more American jobs—if the dollar were to drop far enough. But this could lead to fewer jobs in these nations, which would not be politically popular there. It is risky for any nation, especially one as large as the United States, to rely on currency adjustments as its major jobs policy; this approach can unleash competitive devaluations. Moreover, even if Americans were to gain some jobs through a weakening dollar, our export sector would have to become far larger than it has been in recent memory before American exports could make up for a big portion of the jobs already lost. And even then, the consequence would be for most Americans to become poorer as everything we purchase from the rest of the world costs that much more. It is no great feat to create jobs by growing poorer. In one way or another—through pay cuts, losses of high-paying jobs, and the substitution of lower-paying ones—we have been doing that for years.