Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AmericasJanuary 8 2007

The consumer-led US boom is a myth

Strong business profit performance lies behind the upswing in the US economy, writes Yusuke Horiguchi.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

There are many who hold pessimistic views about the US growth outlook, with some even predicting a recession (see Nouriel Roubini’s article, page 38). A large part of their pessimism comes from their characterisation of this whole upswing as one built on an artificial foundation. They say the upswing was kick-started by an ultra-easy monetary policy that fuelled a housing bubble that, in turn, boosted personal consumption as well as residential construction.

With the housing bubble popping now, the pessimists say the US economy is heading for major trouble. Economist Paul Krugman summarises his view of the current situation nicely in one of his regular columns in the New York Times: “The Federal Reserve successfully replaced the tech bubble with a housing bubble. But where will the Fed find another bubble?”

I do agree with some parts of these observations. In particular, the slowdown under way, the sharp negative turn in housing markets, and the risks this entails for consumption and future growth cannot be denied.

Foundations of expansion

However, I do not agree with the notion that the US expansion since 2002 has been based on an artificial foundation, and its implication that the economy is in particularly troublesome shape. To explain, let us first look at whether this upswing has really been based on a consumption boom propelled by a housing bubble.

Personal consumption has surged as a ratio to disposable personal income (DPI) during this expansion, from 93% in 2002 to the current 98%. The personal savings rate has plummeted into negative territory. An upswing founded on this kind of household behaviour cannot be sustained, argue the pessimists. Yet in the course of this upswing, the ratio of personal consumption to gross domestic product (GDP) did not rise. It was 70% in 2002 and has not moved since. Given this flat performance, it is difficult to argue that consumption has been the main engine of growth.

The contradictory movements of these two consumption ratios can be reconciled by the fact that the DPI/GDP ratio has declined sharply in the past several years. So, although personal consumption surged in relation to DPI, this was offset by the decline in the ratio of DPI to GDP, with the net result of a flat personal consumption/GDP ratio.

Why did DPI decline so sharply in relation to GDP? The reason is that labour income share has fallen sharply since 2002. Correspondingly, there has been a strong rise in profit share, which is continuing despite the mature stage of the upswing. The proximate factor behind profit share increase and labour share decline has been the persistent excess of productivity growth over real wage growth.

Corporate profits

Compare corporate profit share performance during this upswing with that during the previous upswing. In the second half of the 1990s, when the economy was booming with growth averaging 4.25% per annum, corporate profit share fell precipitously after peaking in 1997. Being almost mesmerised by the apparent strength of the economy, we all overlooked a key development pointing to potential problems ahead. This time around, when growth has averaged 3.25%, corporate profit share has continued to rise sharply and now stands at historically high levels. When business profit performance is this strong, it is highly unlikely for the economy to experience a protracted weakening.

Together with the current relatively elevated capacity utilisation rate, the high profit share is the basis for strong business investment. To translate this structural solidness of the US economy into sustained growth, a key catalyst is a carefully calibrated monetary policy that avoids an over-tight stance. The current US situation is one that allows implementation of such policy without an undue risk of a lingering inflation problem.

Yusuke Horiguchi is first deputy managing director and chief economist at the Institute of International Finance.

Was this article helpful?

Thank you for your feedback!

Read more about:  Bracken , Americas , US