Consumers Drive U.S. Recovery

On Friday I reported that the European Central Bank has downgraded its growth forecast for the euro zone. This wraps up a summer of bad economic news from Europe, all together showing that there is no recovery under way. At the same time, as I have explained in a series of blogs elsewhere (Ode to the American Economy, parts one, two and three), the United States continues its sleepwalk out of the Great Recession.

The differences between the U.S. and EU economies are striking. A review of the most recent Eurostat quarterly national accounts data shows that the American economy is not only outgrowing its European counterpart, but it is also in the healthier position of being dominated by consumer spending.

Let us begin with GDP growth (using the single-currency euro zone as the proxy for Europe):

LB 9814 GDP

Over the past 20 years for which Eurostat provides quarterly, inflation-adjusted data, there are three episodes where the United States outgrows Europe. The first episode was the heydays of the ’90s, when our unemployment was trending below four percent. Europe was struggling with twice as high unemployment rates and, in fairness, the remaining issues with Europe’s reunification. That said, with the right fiscal policies the 18 current euro-zone countries could easily have enjoyed the same forceful growth as the U.S. economy was producing.

The second episode of faster U.S. growth comes between the Millennium and Great Recessions. Many would attribute this to the housing bubble, and I am inclined to agree to some extent. However, it is important not to forget the Bush tax cuts, which in two phases – 2001 and 2003 – created a one-two punch of multiplier and accelerator effects on economic activity.

Unfortunately, this was also a period of excessive federal spending. The U.S. government grew its budget by 6.7 percent per year, on average, from 2001 to 2009, with the heaviest spending growth allocated to the latter half of that period. Indirectly, this drew resources away from private-sector growth, which partly explains the weakening of GDP growth from the top in early 2004.

As for Europe, the bump in growth right before the Great Recession is not easily explained. As shown in the two charts below, neither consumption nor exports were strong enough to produce that bump.

The third episode of American dominance is the one we are in right now. Amazingly, at a GDP growth rate mostly below 2.5 percent per year, we are leaving Europe in the dust. The difference is easily explained: after the serious dip early in the recession, U.S. fiscal policy has basically been neutral, with only marginal movements in taxes and spending. In fact, after the American Recovery and Reinvestment Act, President Obama has been the fiscally most frugal president since before Reagan. The states have also held back their spending, and even though most states still struggle with budget problems the overall trend in taxation is weakly in favor of lower taxes.

From this viewpoint the American economy has actually for the most part benefited from the Congressional deadlock and President Obama’s passion for playing golf. Our federal government is doing the American economy a favor by doing nothing. It would of course, be better if they cut taxes, reformed away entitlement programs and deregulated, but in lieu of that it is better that they continue to do nothing while we go about our business and slowly bring this economy back to something that resembles full employment.

Europe, on the other hand, is continuing to suffer from years of government-saving austerity. Their tax hikes and spending cuts have been motivated by a desire to keep as much as possible of the welfare state through the Great Recession, with little or no regard for what happens to the private sector. The European people and their businesses are now paying the price in the form of almost zero growth, eleven percent unemployment and a grim outlook on the future.

Adding insult to this national-accounts injury, the next chart shows the role of private consumption in each of the two economies:

LB 9814 Cons

There is a simple way to show the importance of private consumption in an economy. Subtract GDP growth from the growth rate of private consumption per period observed, in this case quarters. Sum up the difference per period and divide by the number of periods. If the resulting number is negative, it means that GDP grows faster on average than private consumption; if it is positive the opposite is true. An economy where consumption grows at least as fast as GDP is an economy where the consumer is the key economic agent, where he enjoys a high degree of economic freedom and where, therefore, the free market is a major player in the rest of the economy. In a consumption-drivene economy, the dominating end purpose of productive economic activity is to win over consumer spending on a free market, hence private businesses have to operate as free-market entities as well.

The U.S. consumption growth ratio is 1.3, meaning that for the period observed here, private consumption growth exceeds GDP growth by 1.3 percent per quarter, on average. By contrast, the euro-zone economy has a ratio of -0.7, showing that growth is driven by other variables than private consumption.

Is that “other variable” exports? Let’s take a look:

LB 9814 Exports

Interestingly, since the Millennium Recession there has been no major difference in the growth rate of U.S. exports and exports from euro-zone countries. The growth rates are high, especially compared to GDP growth, which means that for the slow-growing euro-zone economy the exports sector has helped keep growth up. This explains why GDP in the euro-zone countries outgrow their own private consumption, but since strong exports growth does not translate into household spending (if it did, private consumption would grow on par with exports) this means that the euro-zone economies are increasingly dependent on foreign markets to grow at all.

With its strong private-consumption growth, the U.S. economy has a big leg up on the European economy. We are, simply, a domestically dominated economy and are much less vulnerable to ups and downs of the international business cycle. Europe’s GDP, on the other hand, basically stands and falls with spending on other continents.

Furthermore, with as big a government sector as the Europeans have, their austerity policies which raise taxes – thus diminish the private sector – and cut government spending actually depress GDP in two ends.

The compounded effect on GDP is, as shown here, rather depressing. Pun intended.

12 comments

  1. Michael

    Several points I wish to make here:
    1- The European growth “bump” can be explained by the housing bubble.
    2- The size of the government sector is compatible between Europe and the USA – slighlty under 50% in Europe vs slighlty over 40% in USA.
    3- The real unemployment in USA is terrible – millions have given up hopes trying to find a job and are not registered as job-seekers, improving the statistics but not the economy. I believe its called “jobless recovery”.
    4- The huge debt massed by the USA in recent years is a burden that is not going to just disappear. Printing dollars to rescue the economy works – up to a point.

    • S R Larson

      Michael,

      Thanks for your comment. Quick responses:

      “1- The European growth “bump” can be explained by the housing bubble.”

      This is possible but unlikely. A housing bubble is more of a financial phenomenon than real-sector activity and would therefore not show up in GDP. It could however have had ancillary effects on investments, but I would be surprised if it explained that bubble. More research needed, though.

      “2- The size of the government sector is compatible between Europe and the USA – slighlty under 50% in Europe vs slighlty over 40% in USA.”

      Be careful what numbers you use. Income redistribution programs do not count toward GDP as they are pure financial transactions. Therefore you cannot have them in the numerator either.

      “3- The real unemployment in USA is terrible – millions have given up hopes trying to find a job and are not registered as job-seekers, improving the statistics but not the economy. I believe its called “jobless recovery”.”

      And that is not a problem in Europe?

      “4- The huge debt massed by the USA in recent years is a burden that is not going to just disappear. Printing dollars to rescue the economy works – up to a point.”

      Yes, which is why it is fortunate that the Federal Reserve is slowly tapering off QE. It is equally unfortunate that the Europeans over the past year have been expanding money supply and moving closer to a QE program. Today the ratio of money supply growth to GDP growth is higher in Europe than in the United States. It has been that way for most of this year, in fact.

      • Michael

        You have said yourself that you are inclined to agree to some extent with attributing USA growth bump to the housing bubble. So which one is it – does a housing bubble count towards GDP or not?

        I was trying to convey the point that things are not all roses and peaches for the USA and not all gloomy for Europe. The happiness about GDP growth is a) baseless b) useless. Baseless because the GDP growth can, as the housing bubbles and money printing demonstrate, be purely imaginative. Useless because the best thing that can happen to GDP is a terminal cancer patient going through an expensive divorce – not the best thing for the public, but a huge turn-on for GDP. As a policy guidance tool, I think that GDP has by and large outlived itself.

  2. S R Larson

    OK, I thought you meant the bump in European GDP growth. Yes, the U.S. housing bubble contributed to GDP because it increased construction and indirectly allowed people to mortgage houses to buy, e.g., new cars. So far I have not seen enough evidence of a similar event in the European economy as a whole, but there was somewhat of a similar phenomenon in Spain before their real-estate market crashed.

    Yes, everything is not roses and peaches with the U.S. economy – we could be growing faster and creating much more jobs. But given what taxes, regulations and government spending we have, this is the best we can do. And it is far better than Europe. And I do have to point out that you have greatly misunderstood the concept of GDP. If a person is sick with terminal cancer he is not working, in other words he is not producing any income to live on. He has to be supported by others (a merely factual statement, has nothing to do with the rights and wrongs of income redistribution) which reduces overall income and spending in the economy.

    It is an inescapable fact that a growing economy produces more opportunities for people to build their lives as they want them, than an economy that is standing still. If GDP growth meant nothing, there would be no problems in Greece which has lost one quarter of its GDP since the economic crisis began. More than half of the country’s young are unemployed – I am sure they would all prefer it if their GDP was growing instead.

    So long as we realize that GDP is a measurement of the size and composition of our economy, and nothing more, we can use it properly. There are people who are perfectly happy living on a very low standard of living, and there are those who happily strive to become millionaires. That is the beauty with a free society with a growing economy – there is room for all of us to build our own path through life.

    • Michael

      If you haven’t seen the evidence of a similar event in Europe then I don’t think you know European economy. Because the same bubble has been bursting all over the continent, with less dramatic consequences in Northern Europe, but the principle was the same.

      Jobless recovery – did I mention it? The growth in US economy has not created many new jobs so far. And the jobs get worse, generating less income, too. Longer hours for less salary – not very good way for people to build their lives as they want them, I’d say.

      My point is that a society can live perfectly well without GDP growth. As we all know, endless growth is not possible in any system. It will result in a catastrophic collapse. The big question is – can we be happy without GDP growth? I think we can.

      • S R Larson

        Anecdotes can prove anything. There is no evidence in national accounts of a bubble of that size throughout Europe. Spain, yes, and Sweden is very close to one bursting, but elsewhere it has not been of enough of a magnitude to register on the national accounts radar. And that is what matters when you want to compare economies. Sweden has enormous problems, and their central bank went to negative interest rates before ECB did, the result being a debt-to-income ratio that is far worse than it was here in the US before the bubble burst.

        The US economy is creating far more jobs than the European economy is. Yes, those jobs are usually not the best-paying kind, but that is because of the heavy tax-and-regulation hand that the federal government has placed over the economy. No president since Hoover has increased regulatory costs on the private sector like Obama has. Congressional deadlock has prevented tax increases and Obama has been very restrained on the spending side, for which he deserves recognition. That compensates to some degree for his regulatory carpet bombing. But if you lifted regulations, especially on health care and property (environment) the US economy would grow much more rapidly and create much more well-paying jobs.

        That said, would you rather live on European welfare with no job prospects or take a so-so job in the US with opportunities ahead of you?

        As for happiness and GDP growth, I suggest you ask the half of the young in Greece who have no job what they think about that.

      • Michael

        I happen to live in the Netherlands, where the housing bubble has exploded in full force. Same happened in Ireland, to name another country. And a look at the home prices in UK will show a dip of 25% between 2007 and 2009. If that’s not a bubble, I don’t know what is.

        Bottom line is – increasing numbers of Americans are working enormous hours in badly paying jobs and still don’t manage to make ends meet. As to your comment on the environment – it sounds as you’re lamenting the conservation of nature because it stands in the way of a couple more points to the GDP. If so, then we clearly have a different set of values and priorities.

        I’d rather live in a European country where if I lose my job, I get a second chance. Where if I get sick, I don’t end up bankrupted (most bankruptcies in the USA are due to healthcare costs). And the youth in Greece have a chance to go to other European countries and get a job. Many of them do. That is the primary achievement of the EU and the objective of removing trade and movement barriers.

      • S R Larson

        Again, the housing bubbles you refer to are not EU-wide. It’s like having a housing bubble in North Carolina and Ohio.

        GDP growth today is much more energy efficient than it was 50 years ago. The U.S. economy uses less than half as much oil per $100 of GDP today than we did in the 1970s.

        The income security systems you refer to have been the targets of major cuts in many European countries during the recession. In Sweden you now get about half your income if you have to be home sick, and unemployment benefits in Greece, Spain and Portugal are barely above the absolute poverty level. Your own country, Netherlands, has not been spared austerity either. (Search my blog for articles.) This is the entire point with my criticism of the welfare state: it is a massive conglomerate of promises that, when people actually try to cash them in, government cannot afford to provide. And let’s not even get started on socialized health care… You might want to read my book “Remaking America” which analyzes, among other things, the terrible crisis in the Swedish welfare state.

        In my new book “Industrial Poverty” I explain in great detail how governments in Europe have slashed, burned and chopped away at their welfare states during the Great Recession. If the welfare state cannot provide for people during a recession; if people cannot cash in on the entitlements government has given them when they really need to; then what are all those tax dollars you pay for it really worth?

      • Michael

        Your comment proves my point – Europe, the EU and even the Euro zone are not a single mass. They are different states, with radically different economies and traditions, and you just can’t make the comparisons to the USA. That said, most EU countries have experienced a housing bubble, some to higher some to lower extent (as I am sure is the case in different US states).

        I agree with you that the welfare states in Europe have grown skewed and that there is a need for massive reform. Some countries (like the Netherlands, in fact) have been pushing forward this reform, others like France are more reluctant to do so. Things will not return to what they were – that much is clear. But for the time being, I won’t be moving to the USA to escape the horrors of Europe, thank you very much.

        On a personal note – the system works pretty well for me, my family and my friends, who are supported and provided in difficult times by the community through our taxes. That’s a personal experience that does not “prove” wider effects. But I am cautiously optimistic about the (economic) future of the EU and Europe and I don’t see many reasons to be optimistic about the economic (and social) future of the USA in the long term.

  3. S R Larson

    I am glad to hear you are not moving to the United States. I don’t want to pay taxes to support sloth and indolence. Charitable welfare, yes, absolutely, because that is concentrated to those who are truly in financial hardship and sorts out those who are simply lazy.

    The bottom line here is that there is a very widespread misconception in Europe that people somehow have the right to other people’s money. They don’t. We all have the right to self determination, but that right comes with the obligation to try our very hardest on our own. If we end up in true financial hardship, no fault of our own, we can turn to charitable institutions. And before you go off on a rant about how egoism gets in the way of that, answer this question: if your neighbor starved through no fault of his own, would you deny him bread? If your answer is no, then ask yourself if your neighbor is less compassionate than you are. If your answer is no again, then you no longer have a case for government-provided welfare.

    • Michael

      Now you’re getting personal, by implying I am an indolent sloth. You somehow conclude that I live by munching off other people’s efforts. In reality, I live in a society that provides for its members in hard times. I am paying taxes (and quite a lot of them) to benefit from a social back-up system if I actually need it.

      The social security is a nationally structured insurance. How far does it reach and what should it cost is a matter of national debate. Like every system, this one has flaws. I think the flaws in (most) European social security systems have less dangerous long-term consequences and are more easilly corrected than the USA system – see the health costs and insurance example.

      And no, I have no idea what your neighbour and bread example actually means. But I think this debate has reached its end with you resorting to personal lines.

      • S R Larson

        If you are not ready to let your neighbor starve, then you have already provided the foundation for privately funded and provided welfare. There is no longer any need for a big, tax-funded and heavily bureaucratic welfare state. As for the differences in health care, I would recommend that you study the differences in wait lists, approved treatments and types of care you can get in the United States vs. Europe – and, I might add, most of Canada. Read my article on eugenics and the welfare state, which takes you through some of the most horrendous aspects of British, tax-paid medical “treatment”.