Monday, September 13, 2010

The Myopic Squirrel and $7 trillion worth of Missing Nuts

It is well-known that a major part of our difficulties today is that like the myopic squirrel, we ate all the nuts in the Fall and didn’t put enough away for the Winter. In other words, residents of the US spent like there was no tomorrow. The spending and the leverage that accompanied it contributed to problems in real estate which spread to the financial sector and then to Main Street. Did we really spend thatmuch? What will it take to restore some balance?

I deal with those questions in this blog. It is sobering to see what Karma has wrought. Can we trim the US consumer’s appetite by $840 billion per year in the coming decade? It won’t be easy but that’s what I think it will take to return to something normal. My calculation is that the US household would have to trim its annual consumption by approximately 42 billion bottles of Jack Daniels. While that seems tough, another calculation finds that if there are approximately 300 million people in the US, then per capita consumer spending would have to fall by about $2,700 per year.

To draw these conclusions I found data on the website of the Bureau of Economic Analysis – http://www.bea.gov/ . I chose to use real (chain-weighted) GDP and Personal Consumption Expenditures (RGDP, RPCE). Using real figures means that the Commerce Department has removed price change from these figures. To examine how consumer spending changed over time, I look at both the value of the amount of RPCE as well as its share of GDP (Share=(RPCE/RGDP)*100). For the year 2009, RGDP was $12.9 trillion. RPCE in the same year was 71% of that amount, or $9.2 trillion. RPCE includes the spending in the US on consumer durable goods (like cars, and furniture), nondurable consumer goods (like food and clothing), and consumer services (like financial transactions and transportation). RPCE does not count goods or services that businesses buy (like plant construction business computers) nor does it count goods and services purchased by foreigners or the government. It also does not include housing construction. Because of the latter, it does not include any of the spending of households on new houses or condominiums. Clearly, if I added the latter, the numbers would get bigger.

So what about this 71% figure for 2009? The table below shows the average of Share over selected periods of time. Notice that for the 18 year time period stretching from after World War II until 1963, Share was a little less than 63%. In the next 16 years – call this from President LBJ to Carter – the ratio increased to about 64%. Share in the 1980s rose to 66%, in the 1990s to 67% and then the last decade it averaged about 70%. At the end of that period it hung in at 71%. Very clearly, household spending has not only increased in absolute terms but it has become an ever larger part of the nation’s output and income – that is, RPCE has been growing much faster than RGDP.

Share of Real PCE to Real GDP for selected time periods from 1946 to 2009
46-63
64-79
80-89
90-99
00-09
62.53
63.91
65.90
66.63
69.63

Okay – so Share is rising, but what else can we say? Let’s make a big assumption about normality. Let’s take the 44 year period from 1946 to 1989 as a norm. Share averaged about 64% during that time. Let’s calculate how much RPCE would have been IF SHARE HAD REMAINED AT 64% IN THE FINAL 20 YEARS. Applying the normal Share of 64% to the years between 1990 and 2009 gives us a normal RPCE estimate of about $8.2 trillion in 2009. The actual RPCE in that year was $9.2 trillion. Subtracting the normal estimate from the actual value, we find that above-normal RPCE was about $910 billion dollars in 2009. Notice that in terms of 2009 figures, RPCE was about 10% higher than if SHARE has been normal. That is, if we want RPCE to return to a more normal share of the national economy, consumers should have spent about 10% less than they did in 2009.

That’s just one year. What if we look at the whole decade from 2000 to 2009? The total RGDP produced over the period was $123.2 trillion. RPCE totaled $85.8 trillion. If RPCE Share was 64% during the whole 10 years, RPCE would have summed to $78.8 trillion – or about $7 trillion less than what was actually spent. In other words – households spent $7 trillion more than normal for a decade. Now that’s starting to look like money! US consumers overspent more than half of a full year’s RGDP in the last 10 years.
What about the future? I estimate that at current trends we will overspend approximately $8.4 trillion in the next 10 years from 2010 to 2019. In other words, we need to trim spending by roughly $840 billion per year for the next 10 years to restore the PCE Ratio to 64% of Real GDP. During that time period RGDP will average $14.7 trillion per year (if it grows at the same rate as the past decade – a lowly 2% per year). If Share remains at 71% then Real PCE will average $10.3 trillion per year. With a normal Share of 64%, Real PCE would average $9.4 trillion. Thus over-consumption would average approximately $840 billion per year from 2010 to 2019.

Let’s add an important perspective. Cutting out this $840 billion each year from 2010 to 2019 does not mean that RPCE has to decline. What it says is that as a nation if we want to return the share of consumer spending back to something normal, then we will have to increase our spending at a lower rate. Notice that should RPCE grow at a more normal rate it will average about $9.4 trillion per year; it will GROW! But it must grow by somewhat less than the $10.3 trillion average if Share is to return to some sense of normalcy.
You can’t have your Jack Daniels and drink it too. We have a clear choice. We can continue to spend like a drunken hooligan or we can try to put our house back in order. Chopping $840 billion per year out of consumer spending will not be easy – noting that if we apply this same analysis to residential construction we will have to tighten the future belt even more – and the result will be slower growth of both output and employment. But not tightening has its price too. Clearly all this spending reduces the nation’s saving and its ability – like the squirrel – to do what’s best for the future. There is no way to return to normal economic health without a return to normal spending. Let’s get on with it.  To set an example, I had breakfast this morning without my usual JD.

11 comments:

  1. As a drunken hooligan.....I am quite sobered by this post.
    Hope I can sill breathe after planned belt-tightening.

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  2. Hi Larry,

    I am really confused about your post.

    First off I do not understand how there can be "normal" portion of the GDP allocated to consumer spending; or a normal portion for saving or any other bucket you choose to name. Why is a lot of GDP devoted to consumer spending a bad thing, or a good thing?

    While historical data can provide a picture of past consumer spending why should that be considered normal.

    It seems to me that if you have a large portion of "poor" people in the population then consumer spending as a portion of GDP should increase since "poor" people tend to save less of their income and spend more on necessary goods and services. If you have a larger portion of unemployed peeps the RPCE would be even higher since unemployed peeps usually do not save at all.

    Another concern I have is countries like Japan which traditionally have a much higher saving rate than the US (and presumably lower RPCE) do not always seem to benefit from the higher saving rate.

    Perhaps most important the current administration seems hell bent on increasing consumer spending, which makes it unlikely we will quickly reduce the RCPE.

    Finally I will leave you with a musical refrain.

    "lord preserve and protect us, we been drinking whiskey for breakfast"

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  3. Many economists seem to agree that saving is important for the long-term growth of a country. Too little saving can be detrimental. The declines in the US economy in the last decade are often attributed to too much spending and leverage. One can only make assumptions about what is normal. I decided to use a historical definition -- a long term average. If one disagrees with that approach then clearly they won't like my results. As for Japan and some other countries -- it is possible to save too much. It's like the Goldilocks story -- you don't want the porridge too hot or two cold. Cheers....

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  4. Lewis, What's a trillion here or there? I am glad I could help you. Cheers.

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  5. I agree with the basic concept that personal consumption in the US should be reduced in order to regain balance in the economy. But the tough question is what is the 'correct' level, and how in the world is it accomplished?

    The current recession would seem to be forcing a reduction in consumer spending, but we constantly hear from the U.S. government that restoring consumer confidence is one of the keys to getting the economy to grow again. Echoing the sentiments of 'Only Thing We Have to Fear Is Fear Itself' from FDR’s first inaugural address in the height of the depression.

    But, the capitalistic model is based on growth. I think striving for a sustainable level of growth is a holy grail. How does a government know what is the proper growth target for consumer spending. And if it did, the tools it can employ to hinder/spur consumer spending seem a bit crude and have a serious lag effect.

    I think most people secretly wish for the 'good old days' of irrational exuberance. And, in the developing nations, their rising middle classes are hoping for their own chance to spend, spend, spend. The estimates of 300 million Chinese being lifted out of poverty into the middle class by 2050 scare me a lot regarding how on earth that can be sustained financially and also via the natural resources required.

    It is basic human nature to want more, more, more. So, bring on the whiskey for my corn flakes please!

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  6. Brad,

    Thanks for the comments. I am not sure we need to have new policies to restrain consumption in the USA. More than anything we need to go back to sane monetary and fiscal policies and regulations that do not create the incentives for excessive expansion and spending.

    For your worry about the developing nations -- I can imagine that people said similar things 100 years ago. How could anyone ever have imagined a supply response that created the goods and services that were produced worldwide in the last 100 years. Not only are there billions of people who want more goods -- but they are the billions of people who have the potential to be employed much much more productively. Now they produce almost nothing. I remain optimistic that if we let markets work we will have plenty of output for the Chinese middle class and more.

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  7. Dear Crash,

    I read Atlas Shrugged when I was at Georgia Tech and it changed me forever. It is forever fresh and relevant. This morning I read that Geithner and the Auto companies have teamed up to get mad at China about exchange rate policy. Gee -- and we were suspicious that those bailouts might send the wrong signals about corporate/government alliances....hmmm

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  8. It is refreshing to hear a optimistic economist! I agree that education and innovation will lead to gains in productivity to meet the needs of future generations.

    It is tough to stay optimistic with the negative tone in the news media. For example, The Guardian newspaper had a recent stories, 'UN calls special meeting to address food shortages amid predictions of riots' (http://www.guardian.co.uk/business/2010/sep/05/commodities-food-drink-industry),
    and "Artificial meat? Food for thought by 2050" (http://www.guardian.co.uk/environment/2010/aug/16/artificial-meat-food-royal-society)

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  9. There's always good news and bad...

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  10. Funny how it works out that way! Once had a friend who said, "Cheer up, things could be worse!" So I cheered up, and sure enough, things got worse.

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