How important is saving?

Tyler Cowen of

Marginal Revolution
(along with a number of my own readers) has asked about
"http://www.businessweek.com/the_thread/economicsunbound/archives/2005/09/why_savings_is.html">
this statement by Michael Mandel
:

Let’s do the calculations. Over the past 10 years, the U.S. has run up an accumulated goods and services trade deficit of roughly $3 trillion. Sounds like a lot of money, doesn’t it?

Now let’s suppose those dollars had been used for good rather than evil. That is, rather than buying imported cars, toys, and handbags, thrifty Americans would have saved their money. It’s reasonable to believe that about half of that $3 trillion would have gone into financing productive purchases here in the U.S.–new factories, power plants, office computers and the like–$1.5 trillion worth.

So what would be the payoff from all that thriftiness? A reasonable rate of return on investment, after depreciation, is roughly 7%. So $1.5 trillion in extra assets would have a return of about $100 billion a year.

That $100 billion is roughly 1% of an $11 trillion economy. Over ten years, then, complete elimination of the trade deficit might–might–have added a tenth of a percentage point to growth.

That’s a good measure of the size of the virtues of savings–roughly a tenth of a percentage point on growth. That’s 0.1 percentage points.

Let me begin with a clarification about the question that "http://www.businessweek.com/the_thread/economicsunbound/archives/2005/09/why_savings_is.html">
Michael Mandel
is asking here. I would start with the accounting identity that national saving equals investment plus net exports. One question that we might consider is what would happen if U.S. national saving were to rise by just the amount needed to bring net exports from their current big negative value up to zero, thereby eliminating the trade deficit but keeping the value of investment unchanged. This thought experiment would have no effect on investment and construction of factories (by definition), but would mean that we would not have to borrow or sell off assets each year to pay for the net imports. The amount by which such asset transfer would be reduced if the trade deficit were eliminated would be the full amount of the trade deficit, not one-half. The annual flow consequences of this would depend on which assets were being used to finance the trade deficit. To the extent that America is simply borrowing from foreigners to pay for the imported goods, each $100 billion reduction in imports would mean $100 billion less borrowing for that year. Using the 2% real interest rate on Treasury inflation-indexed securities, each $100 billion in lower borrowing means we will owe $2 billion less in interest every year thereafter. To the extent that the deficit is financed by selling off U.S. companies such as Unocal or Maytag to foreign bidders (as appeared likely this summer, though neither of those highly publicized deals went through), a higher rate of return for calculating the burden should be used.

Another way one might want to modify the raw numbers would be to note that for 2005, analysts are expecting a current account deficit of $800 billion for 2005, at which rate in just four more years we’ll have further doubled the burden acquired under the last ten.

Leaving aside these qualifications about the precise nature of the change we’re seeking to evaluate, let me get to the heart of what Mandel is addressing, which is whether changes in investment flows really make any difference for living standards. If we’re interested in living standards, what we care about is the level of income per person. Let b denote the fraction of GDP that goes to compensating owners of capital. For a country like the U.S., b is about 1/3. If we increased the capital stock per person by a percentage amount %ΔK, economic theory predicts that output per person Y would go up by a percentage amount given by

%ΔY = b%ΔK.

The basis for this prediction is similar to that used to predict the economic effects of changing energy use that I exposited here.

With the additional output that this generates, we would have the income to invest even more, and there is the possibility of a compounding effect of the original added productivity. The effect of this is fundamentally limited, however, by the fact that we’ll also be needing more and more dollars of each year’s output devoted to keeping up with such factors as depreciation and a growing work force. It turns out when you work through the math that if we were able to permanently increase the fraction s of income that’s devoted to saving, we’d succeed in increasing the capital stock per person by an amount

%ΔK = [1/(1-b)]%Δs.

This equation is associated with the theory of economic growth proposed by Nobel laureate Robert Solow in the Quarterly Journal of Economics in 1956, though it really is simply the accounting implications of the calculations that I just described. Putting the two equations together, a permanent rise in the saving rate is expected to result in a permanent increase in output per person given by:

%ΔY = [b/(1-b)]%Δs.

If b = 1/3, this elasticity [b/(1-b)] would be about 1/2. If the U.S. were to increase annual investment spending by $400 billion from the current $1.9 trillion, that would represent about a 20% increase in s, implying eventually 10% higher real income per U.S. resident. If one looks at the correlations across countries, one finds that countries with 20% higher values of s do indeed have on average at least 10% higher real income per person; (see for example Table 2 in “A Contribution to the Empirics of Economic Growth,” by Greg Mankiw, David Romer, and David Weil in the Quarterly Journal of Economics in 1992).

Is 10% more income per person a big deal? I would say that it is, though Mandel is certainly correct that, if we had some policy that could make even a modest change in the productivity growth rate, it could potentially have a much bigger effect over time. The problem is that I’m not sure what such a policy would be. Certainly insofar as productivity gains result from firms’ investments in new technology, the way to get those gains is through additional investment, which Pro-Growth Liberal logically sees as another reason why saving can indeed matter a great deal. In Mankiw, Romer, and Weil’s regressions, 80% of the variation across countries in output per person was explained statistically by differences in countries’ saving rates, population growth rates, and educational commitments. In a subsequent study published in the Quarterly Journal of Economics in 1995, Alwyn Young found that much of the phenomenal growth rates of several of the countries of southeast Asia could be accounted for by their high rates of capital accumulation.

Mandel is correct that we should not attempt to oversell the magnitude of the benefits that might be obtained from raising the U.S. national saving rate. But I also believe that for purposes of discussing policy options, it makes sense to focus on the variables that we can actually do something about. The U.S. budget deficit is something we could control, and I believe that we should.

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30 thoughts on “How important is saving?

  1. pgl

    As usual – very well done. Mandel’s post really did not formulate a well defined question. But you did – and provided a very good example. Maybe not exactly the answer Mandel wanted to convey to his readers – but then maybe he’ll reply with a clearer question and set of definitions of the terms he tosses around.

  2. Movie Guy

    Naturally, improving U.S. national savings is important, particularly household savings for future consumption. And reducing the U.S. fiscal deficit is also important. But let’s look at the rest of the picture from which Michael Mandel pulled his subject matter.
    The basis for Mandel’s September 28th discussion flows back to Mark Thoma’s September 27th review of the Economist article, ‘Rebalancing act’ – September 22nd. The Economist travels down the well worn path of discussing U.S. fiscal deficits, Bernanke’s global perspective on savings, and then addresses the lack of U.S. household savings and foreign lack of domestic investment and consumption. Mark Thoma also kindly refers his readers back over to Econbrowser in search of Menzie Chinn’s September 26th post, ‘On the origin of American current account deficits’. So, we have gone full circle in discussing the various aspects of global trade, global savings, U.S. savings, and U.S. domestic investments.
    It is apparent that some do not have sufficient background in production operations to appreciate the losses and related impacts that the U.S. is undergoing currently or will likely undergo in the future. U.S. GDP growth is declining as a result of offshoring or outsourcing. That’s a principal issue and growing danger for the United States.
    The Economist lead survey series article below (for the article cited by Mark Thoma) is worth noting. It’s publicly available. Hat tip to Brad Setser.
    The great thrift shift, September 22, 2005
    http://www.economist.com/displaystory.cfm?story_id=4418328
    The attention that Bernanke received for his ‘global savings’ remarks is partially misplaced in my judgment. He demonstrates no principal knowledge of current global production sourcing, its cumulative impact, or why such is occurring. He doesn’t appear to understand what happens when FDI is concentrated on large production operations, large enough to handle global demand of certain products. Under current arrangements with China, for example, everything related to the production of such finished goods, parts, components, or subassemblies is flowing to the production source. This includes R&D in a growing number of cases. Lean manufacturing.
    Bernanke and some others do not appear to understand the ramifications of consolidated large scale offshore production. It results in a downward focused economic hit that results in a growing absence of all forms of investment. personal and corporate. Focusing instead on the supposed global saving glut misses this point. Other nations are dealing with the same production consolidation and related economic hits within their own economies. So, at best, Bernanke (and Snow/Greenspan) can waste time arguing if not demanding that peoples of developing nations shouldn’t try to save up for a rainy day, but should adopt the American ‘shop til you drop’ consumer model. But few people overseas are that foolish, at least in the early stages of further developing and transitioning their local economies. So, this brings us back to the global production source problem.
    Bernanke doesn’t quantify the large hit that global production shifting is placing on U.S. GDP growth. But Peter Morici, former director, Office of Economics, U.S. International Trade Commission, 1993-1995, quantifies the U.S. GDP loss.
    US current account deficit $195 billion, choking growth – - Dr. Peter Morici
    Sep 16, 2005
    http://www.finfacts.com/irelandbusinessnews/publish/article_10003302.shtml
    “The ballooning trade deficit is the most significant factor slowing U.S. growth. Over the last year, GDP growth has slowed from 4.5 percent to 3.5 percent. Federal Reserve interest rate increases, by failing to affect mortgage interest rates and other long bond rates, have had little impact. Whereas the current account deficit has taken a lion’s bite out of growth.”
    “Longer-term, U.S. import-competing and export industries spend at least 50 percent more on R&D and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from these trade-competing industries, the trade deficit is reducing U.S. investments in knowledge-based industries and skills, and slashing more than one percentage point off economic growth each year.”

  3. Movie Guy

    Denial is not an option
    I think some of you might benefit by reading Krugman’s latest column.
    Excerpt:
    “When corporate executives say that they have to cut wages to meet foreign competition, workers have every right to ask why we don’t cut the foreign competition instead. I hope we don’t have to go there. But denial is not an option. America’s working middle class has been eroding for a generation, and it may be about to wash away completely. Something must be done.”
    Paul’s correct. Denial is no longer an option.

  4. Rich Berger

    Regarding Professor Hamilton’s comment about controlling those things we can control (the US budget deficit), it is important to note that the deficit just came in at $318BN, or 2.6% of GDP. It was originally estimated to be $427BN or 3.5% of GDP. If the attempts to cut Federal spending continue to gain momentum, I expect that the budget situation will continue to improve until it ceases to be a source of such handwringing.
    As a final note, the US savings rate has been in decline since the early 1990′s (at which time it was in the 9-10% range, I believe).

  5. Bill Ellis

    A Reuters news story today headlines “American Dream at stake in Delphi-UAW showdown.” In examination this headline, and the topic on JDH’s blog both are dealing with the same subject.
    First, it is the US dream to be an economically dominant society, to have the power of almost unlimited consumption and wealth. Indeed, many of our ancestors came to the US in search of economic opportunity. Whether the flight was from a potato famine, a move from Mexico in search of high wages, or a move because there was cheap land available in North America, economics was a significant motivating factor. The Dream is the opportunity to be economically successful.
    A basic economic tenet is that price is a result of the balance between supply and demand. For most of the US’s history, labor supply was provided by immigration, both voluntary and forced. In the twentieth century the Country began limiting immigration significantly, and the birth rate declined to a maintenance level. The results are predictable in the development of a labor shortage that resulted in high US wages.
    The US however, is not immune from world forces. The population growth in Asia has created a large pool of under-utilized workers, and it is inevitable that we must compete with this pool. While we can impose tarrifs and trade restrictions, these are like the levees around New Orleans. Sooner or later the pool outside of the levees will breach them.
    The UAW won a contentious labor negotiation in 1958, and it is no coincidence that the ’60s saw the beginnings of large scale importation of automobiles. Importing products is simply a proxy for importing labor. We refused to import labor, so product importation is what got.
    It is not a lack of capital that keeps US business from growing at a faster rate. It is not a lack of markets that keeps US business from growing at a faster rate, and it is not a lack of technology.
    The US also enjoyed a rich base of raw materials such as coal, iron ore, forests, farm land, oil, fresh water, etc. The abundance of these resources also provided a support for an extra-ordinary success.
    Now we are faced with a consumption level that exceeds our resources, both labor and natural resources. While we can hope to limit consumption to preserve wealth, that is a temporary Band Aid. Long term, we must become more productive or become less wealthy.
    The conumdrum of increased productivity is that either we expand the labor base, or that we become engaged in activities of a greater value. Activities of a greater value are those that require a higher skill set, or that cannot easily be performed off-shore. With a limited labor force, in order to engage more people in higher value activities, we must transfer the low value activities to some other source. Thus, the rise of Asia is a product of our own need to improve, but the by-product is also a large population that is also dramatically improving their abilities racheting up the competition to ever higher levels.
    Our dream lasted maybe seventy years, but it began to crumble fifty years ago. Dreams are illusions. World competition is a reality, and FAIR is a four letter F word.
    If we are to prevail in maintaining world economic leadership it is because we have an economic system that attracts and inspires entreprenuers and a system that encourages and rewards hard work.
    If the American Dream is to work forty hours a week for forty weeks a year while earning $100,000 per year, then it will perish. If the American Dream is having the opportunity to succeed on your own efforts and merit, then it persists.
    Bill

  6. TI

    Mandel is obviously one of those “deficits don’t matter” people who mix up external and internal economic problems. Investing more might very well increase imports (capital goods and raw materials etc.) and widen deficits – this is well known in Europe. External deficits and domestic investments have no direct connection.
    Rich noted quite right that the US Federal deficit is not so high and is not the real cause of lacking investments and savings or external deficits.
    The real problem is there where Bill points – there are deep going structural reasons why the investment and savings levels are so low in the US. Everybody knows what JDH says, investments make growth. Everybody would gain from a higher domestic investment levels. Before we start accusing profit-hungry corporations we should ask the simple question: is it really possible to maintain a higher investments level in the US (or in the OECD)?
    I think the answer is no. There are constraints, as Bill says. But the main constraint is obviously not labor but energy. The US energy efficency has diminished over the years – and this is not only good news. It tells that energy-intensive industry has moved away. The Rust Belt heavy industry is not vanished altogether but running high in China on Chinese coal. Natural gas -depenedent industry (fertilizers) are relocating to Middle East.
    Like it or not but it is a fact that the US energy supply is in trouble. The US energy self-sufficiency is under 70%. Its primary domestic energy production has been stagnant a quarter century now. From 1981 to 2004 it uncreased altogether only 5%. And it has been declining since 1998 and is now 4% lower than in that year. All the increase in energy consumption comes from rising energy imports. It is not possible to increase the domestic supply – it has been difficult enough to keep up the present levels. And worse, it is even very difficult to increase the volume of energy imports. It is not possible to make huge new investments in this environment.
    Compare this with China. It has 94% energy self-sufficiency and its domestic primary energy production has grown 194% between 1981 and 2004. The growth 1998 – 2004 was 52%. The years 2000 – 2004 saw an increase of 72%. See some pattern here? And the volume of Chinese overall domestic energy production is nearing rapidly the US volume and will overtake it in 2 – 3 years. The expansion of Chinese industry has been enabled by this. There is no possibility that the US or any European country could match this. This is the real reason why productive investments are not made in the US but in China.
    The R&D, know-how, marketing and brands will eventually go where the production is. The Japanese experience tells this. Outsourcing will end when the outsourcing companies are gone or Chinese owned.
    Not a nice perspective. But no problem. The US is an important exporter of food and raw materials and will get along as a low cost producer.

  7. Miracle Max

    O.K., I’ll be the skunk at the picnic. I don’t quibble with Professor Hamilton’s arithmetic.
    It may not be obvious to all that higher GDP per person later resulting from more saving now is really trading consumption today for consumption tomorrow, or maybe the day after tomorrow. This raises the fascinating question of just who will consume less today?
    The most readily accessible policy lever here is the budget deficit, as Prof. Hamilton says. So whose ox will be gored, and how socially desirable will that be? The discussion here basically glosses over that question.
    The other detail missing in this rosy full-employment setting is the macro consequence of chopping down consumption spending. Or looked at another way, what are the benefits of a policy focus on very tight labor markets, approaching the impossible levels of the late 90s, as opposed to imagining the conversion of the trade deficit into a pile of new plant and equipment in the U.S.?

  8. Economics Unbound

    More and more and more savings!

    I don’t care much about the savings rate. I don’t think it’s a good indicator of future growth, and I’ve said so repeatedly, with lots of charts and graphs, including here. James Hamilton, the fine UCal San Diego economist, responds…

  9. Barkley Rosser

    Rich Berger,
    Yes, the deficit is lower this year than expected. This is due to higher tax revenues than expected, which have not been fully explained by anybody yet, although some of the supply-side folks are saying that “dynamic accounting” is right and that tax cuts reduce deficits. That those folks are in charge means that even if spending is cut, which remains questionable despite the changed attitude in the House (yes, they want to cut medicaid and food stamps), does not mean it will happen. Also, my understanding is that a fairly large chunk of those unexpected revenues are due to a one time pass forward in corporate taxes from some past writeoffs.

  10. Movie Guy

    TI — “The US is an important exporter of food and raw materials and will get along as a low cost producer.”
    Here’s the story on U.S. food products exports and imports.
    USA FOOD EXPORTS AND IMPORTS
    USA – Exports 1999-2003
    http://www.intracen.org/tradstat/sitc3-3d/er842.htm
    USA – Imports 1999-2003
    http://www.intracen.org/tradstat/sitc3-3d/ir842.htm
    Clicking on each product group in either reference above will link to the specific rankings and data for all nations listed.
    2003 U.S. Food Exports and Imports by Product Group:
    (x) – global ranking
    Product group: 001 – LIVE ANIMALS EXCEPT FISH
    Exports – (3) – $ 1,894,007,000
    Imports – (1) – $ 1,654,356,000
    Product group: 011 – BEEF, FRESH/CHILLD/FROZN
    Exports – (1) – $ 3,036,103,000
    Imports – (1) – $ 2,461,100,000
    Product group: 012 – MEAT NES,FRESH/CHLD/FROZ
    Exports – (1) – $ 3,522,901,000
    Imports – (7) – $ 1,365,565,000
    Product group: 016 – MEAT/OFFAL PRESERVED
    Exports – (6) – $ 133,202,000
    Imports – (4) – $ 203,524,000
    Product group: 017 – MEAT/OFFAL PRESVD N.E.S
    Exports – (4) – $ 568,720,000
    Imports – (4) – $ 544,210,000
    Product group: 022 – MILK PR EXC BUTTR/CHEESE
    Exports – (9) – $ 465,505,000
    Imports – (18) – $ 230,713,000
    Product group: 023 – BUTTER AND CHEESE
    Exports – (20) – $ 17,387,000
    Imports – (10) – $ 66,911,000
    Product group: 024 – CHEESE AND CURD
    Exports – (14) – $ 152,092,000
    Imports – (5) – $ 930,574,000
    Product group: 025 – EGGS, ALBUMIN
    Exports – (3) – $ 164,096,000
    Imports – (17) – $ 23,512,000
    Product group: 034 – FISH,LIVE/FRSH/CHLD/FROZ
    Exports – (2) – $ 2,034,182,000
    Imports – (2) – $ 3,808,839,000
    Product group: 035 – FISH,DRIED/SALTED/SMOKED
    Exports – (12) – $ 58,432,000
    Imports – (6) – $ 166,371,000
    Product group: 036 – CRUSTACEANS MOLLUSCS ETC
    Exports – (7) – $ 660,289,000
    Imports – (1) – $ 5,251,412,000
    Product group: 037 – FISH/SHELLFISH,PREP/PRES
    Exports – (10) – $ 330,728,000
    Imports – (1) – $ 2,361,503,000
    Product group: 041 – WHEAT/MESLIN
    Exports – (1) – $ 3,954,539,000
    Imports – (32) – $ 143,992,000
    Product group: 042 – RICE
    Exports – (2) – $ 1,027,014,000
    Imports – (8) – $ 242,313,000
    Product group: 043 – BARLEY GRAIN
    Exports – (9) – $ 102,468,000
    Imports – (12) – $ 52,539,000
    Product group: 044 – MAIZE EXCEPT SWEET CORN
    Exports – (1) – $ 4,962,882,000
    Imports – (17) – $ 169,604,000
    Product group: 045 – CEREAL GRAINS NES
    Exports – (1) – $ 612,333,000
    Imports – (3) – $ 248,880,000
    Product group: 046 – FLOUR/MEAL WHEAT/MESLIN
    Exports – (7) – $ 86,958,000
    Imports – (2) – $ 77,134,000
    Product group: 047 – CEREAL MEAL/FLOUR N.E.S
    Exports – (1) – $ 105,052,000
    Imports – (1) – $ 54,673,000
    Product group: 048 – CEREAL ETC FLOUR/STARCH
    Exports – (5) – $ 1,481,645,000
    Imports – (1) – $ 2,501,886,000
    Product group: 054 – VEGETABLES,FRSH/CHLD/FRZ
    Exports – (5) – $ 1,769,293,000
    Imports – (1) – $ 3,905,917,000
    Product group: 056 – VEG ROOT/TUBER PREP/PRES
    Exports – (5) – $ 1,076,540,000
    Imports – (1) – $ 1,706,893,000
    Product group: 057 – FRUIT/NUTS, FRESH/DRIED
    Exports – (2) – $ 4,101,756,000
    Imports – (1) – $ 5,260,713,000
    Product group: 058 – FRUIT PRESVD/FRUIT PREPS
    Exports – (3) – $ 524,080,000
    Imports – (2) – $ 1,274,572,000
    Product group: 059 – FRUIT/VEG JUICES
    Exports – (3) – $ 651,038,000
    Imports – (2) – $ 925,682,000
    Product group: 061 – SUGAR/MOLLASSES/HONEY
    Exports – (8) – $ 390,125,000
    Imports – (1) – $ 1,121,722,000
    Product group: 062 – SUGAR CONFECTIONERY
    Exports – (6) – $ 293,136,000
    Imports – (1) – $ 1,172,465,000
    Product group: 071 – COFFEE/COFFEE SUBSTITUTE
    Exports – (8) – $ 284,455,000
    Imports – (1) – $ 2,075,051,000
    Product group: 072 – COCOA
    Exports – (13) – $ 121,188,000
    Imports – (1) – $ 1,418,404,000
    Product group: 073 – CHOCOLATE/COCOA PREPS
    Exports – (6) – $ 502,876,000
    Imports – (2) – $ 1,105,881,000
    Product group: 074 – TEA AND MATE
    Exports – (9) – $ 63,100,000
    Imports – (1) – $ 283,580,000
    Product group: 075 – SPICES
    Exports – (15) – $ 54,097,000
    Imports – (1) – $ 679,572,000
    Product group: 081 – ANIMAL FEED EX UNML CER.
    Exports – 1() – $ 4,109,475,000
    Imports – (11) – $ 744,264,000
    Product group: 091 – MARGARINE/SHORTENING
    Exports – (8) – $ 90,565,000
    Imports – (15) – $ 30,815,000
    Product group: 098 – EDIBLE PRODUCTS N.E.S.
    Exports – (1) – $ 3,304,062,000
    Imports – (1) – $ 1,941,996,000
    Product group: 111 – BEVERAGE NON-ALCOHOL NES
    Exports – (6) – $ 396,876,000
    Imports – (1) – $ 1,056,125,000
    Product group: 411 – ANIMAL OIL/FAT
    Exports – (1) – $ 544,367,000
    Imports – (10) – $ 66,636,000
    Product group: 421 – FIXED VEG OIL/FAT, SOFT
    Exports – (5) – $ 1,069,271,000
    Imports – (3) – $ 930,342,000
    Product group: 422 – FIXED VEG OILS NOT SOFT
    Exports – (6) – $ 154,026,000
    Imports – (6) – $ 485,817,000
    Product group: 431 – ANIMAL/VEG OILS PROCES’D
    Exports – (5) – $ 288,646,000
    Imports – (5) – $ 193,525,000

  11. TI

    Mandel and Hamilton talk about different matters and so does pgl. Savings don’t make the economy grow. Only investments can do that. Savings are for paying those investments. More savings don’t automatically create more investments – the “puhshing with a rope” problem. Investments don’t necessarily need domestic savings to finance them, so basically nobody has to cut consumption. But as this means indebtness and growing CAD, we need some savings.
    Saving can be voluntary or forced – for instance taxes. Voluntary saving means that somebody cuts consumption voluntarily. Savings don’t basically affect the demand level – investment demand covers the difference.
    The real problem here is that while we could calculate that increased investments would be good this cannot be realized. The US domestic savings rate is low exactly because saving is unnecessary to pay investments – there is no shortage of capital, domestic or foreign. Instead there are a shortage of domestic real productive investment opportunities.
    I suspect strongly that in the US (and many other OECD economies) we have in fact disinvestment going on. Infrastructures crumble (there are some official data on this) and production is relocated abroad. Exactly this has made consumption the driving force in the economy. About a couple decades ago every economist knew it was the investments. This was self-evident.
    This is also the reason why inflation pressures have been relatively weak. During strong investment activity there easily appears an imbalance between growing investments and lacking savings which causes inflation. Now we have an opposite imbalance and deflationary tendencies. The Fed has nothing much to do with this.
    The reason behind all this is the energy supply. Productive investments are real. They mean buildings and machines and energy and raw materials to make and run them. This is the link between the physical reality and the world of economics. We all se that hurricanes affect the economy. The overall energy situation in China or the US affects it, too. I gave above some numbers on it. I would like to add here that we should take account also the structure of energy consumption in the US and China. Because the Chinese use a bigger share for productive activity their advantage is still bigger.

  12. John F. Opie

    Hi -
    Nice analysis, but doesn’t go far enough.
    The inverse, of course, of increasing the savings rate is to decrease consumption. Given the fact that the US imports more than it exports and that the majority of these imports are consumer goods, then the increase in savings means that net exports will move more quickly to balance than would be the case based merely on the flows within the economy.
    However, the question is whether this is a rational decision. If I were to save 10%, as in the example ut supra, in order to have a higher level of income at a later date, I replace foreign suppliers of consumer goods and services now – ceteris paribus – with domestic suppliers at a later date. Given, however, the fact that the foreign suppliers are now providing me with much less expensive goods and services than can be reasonably expected at a later date – domestic in this case being driven out by low-price foreign competition – than it is a rational choice by the consumer (! and not by economists trying to get a nice equilibrium state) to consume lower-cost goods and services now instead of saving and purchasing higher-cost goods and services later with a higher level of income (upon which taxes, etc. must be paid).
    Just tossing my 2 cents in…
    John

  13. Thomas Wood

    TI,
    Good posts. I always find your comments very insightful.
    I have a question about your conclusion, that the driving cause of disinvestment in the US economy is diminishing supplies of cheap energy. We’re talking about a relative shift in investment, whereas I would expect that the bigger effect would be a global decline in investment (due to diminishing energy supply). Or perhaps I have misinterpreted your point. It seems to me very plausible that labor is playing a role as well.
    I’d also be interested in hearing your view on where all this ends. My own view is that there’s no reason the US economy cannot continue to find its relative advantage – beyond agriculture – even if absolute growth rates take a hit from diminishing world energy supplies.

  14. Adrian Nicolici

    Mr. Opie brings up a good point, to which I would add the example of Germany circa 1960. During that time Germany had a very import-restrictive trade policy such that national savings were large. But the overall effect was that the rest of the world (the US, Japan, Taiwan, etc.) left Germany behind in terms of technological and economic development and eventually forced Germany to abandon its import restrictions. It seems like trade barriers (ala Warren Buffet) would certainly raise national savings, but would the average American be better off under them? History argues against it. I bring this point up because trade barriers are the politically expedient thing to try.
    One further point: the US demographic situation is such that the population is aging, meaning that those who are in retirement are burning their assets as they approach death – a perfectly logical thing to do. This tidal wave will tend to skew the trade balance/national savings picture because our population is consuming more than it’s producing by virtue of our ‘age’ relative to the ages of younger nations, like those in Asia.

  15. TI

    The problem is that there is no simple connection between savings, consumption, current account deficit and investments. The low level of productive real investments in the US and elswhere in the OECD area cannot be directly connected to decreasing savings. The low rates tell that there is no shortage of capital. Corporate earnings are sufficient for financing replacement investments. It is reasonable to ask why should the savings rate be higher. There seems to be no need for that.
    Increasing savings would now mean mainly paying off debts, domestic and foreign. This should free capital to investments but not necessarily. If the savings would transform to investments they would probably be in China and elsewhere abroad. I see it quite difficult to direct increasing savings to domestic investments.
    Trying to decrease consumption and imports by braking the economy to recession would of course not increase savings volumes, not even imports as much as expected if a lot of petrodollars and Asian financing is available.
    Increasing domestic investments would probably increase imports: more imported energy is needed and energy-intensive capital goods also. High investments levels lead often to worsening imbalance in foreign trade.
    I have pinpointed the energy problems as the main constraints that explain the low investment levels. It think the numbers are quite convincing. It is difficult to see labor as a major constraint in the US or Europe. Real unemployment levels are quite high, in Europe they are persistently at considerably higher levels than 15 – 20 years ago, during the period of high investments. There is a lot of immigration, legal or illegal. Manufacturing is shedding people, not employing. I cannot see labor shortage anywhere. Ageing population is not a real problem.
    The energy problem is not only about cheap energy. It is about all energy and mainly about coal. This seems odd but the point here is that coal is by nature quite local. Transporting huge amounts of it (hundreds of millions tons) is not feasible or profitable. The nearly 2 billion tons of Chinese coal produced in a year must be used in China. There it generates power and makes energy-intensive capital goods (cement, steel).
    The only way the US could increase its energy consumption conserably would be to use more coal. Check the statistics (http://production.investis.com/bp2/ia/stat/). It is easy to see why natural gas and oil cannot provide the necessary extra energy. Not even nuclear. The share of coal of the US energy consumption is 24%. To increase the the energy consumption by 5% using coal would mean increasing the coal production by 20% or 200 million tons a year. This is not possible. This is why oil import is so important, not only for driving and transporting but for overall energy. Compare the US situation with the Chinese numbers and you see where the problems are. Europe is in still worse shape with lower self-sufficiency in energy.
    The US economy seems unsustainable. It has of course relative advantages, but this is not the same as maintaining the present level of GDP. I see that the investments will go to China and elswhere as long as they can maintain their energy production growth – and even after that because of their high self-sufficiency. This is basically the same that happened to the US a century ago. World growth will continue as long as the Chinese coal production can keep the pace. The US economy is not collapsing but stagnating (but no real stagflation).

  16. The Reconstruction

    Business Economists Are Strange

    Last Thursday, Tyler Cowen posed an exam question for his macro class, consisting of a passage from a Michael Mandel column in Business Week, and the inquiry, “True, false, or uncertain?” The passage in question read as follows:
    “Let’s do the calcul…

  17. Thomas Wood

    That coal is essentially a local energy source makes sense. And to the extent this is a major driver of geographic differences in production cost structure, then certainly investment would tend to move accordingly.
    So then I would ask, are energy cost differences between countries a major source of overall production cost differences? I don’t have any data or facts. My naive view would have been that wages & benefits would be a bigger source of cost differentials across geographies, but TI’s view is different. Are there any data / facts?

  18. Movie Guy

    TI,
    I agree with many of your positions. But we have to part company on coal and, to some extent, other energy sources. Information that I reviewed in the past year doesn’t provide similar conclusions as you have reached. In terms of energy supply to industry and the nation, EIA DOE doesn’t forecast major obstacles through 2025. That is not to say that such will not occur, but there is little evidence that current rates of energy demand growth can not be accommodated. And the cumulative demand growth projected over the next twenty years is fairly substantial.
    TI — “The energy problem is not only about cheap energy. It is about all energy and mainly about coal. This seems odd but the point here is that coal is by nature quite local. Transporting huge amounts of it (hundreds of millions tons) is not feasible or profitable.”
    “The nearly 2 billion tons of Chinese coal produced in a year must be used in China.”
    “The only way the US could increase its energy consumption conserably would be to use more coal.”
    “It is easy to see why natural gas and oil cannot provide the necessary extra energy. Not even nuclear. The share of coal of the US energy consumption is 24%. To increase the the energy consumption by 5% using coal would mean increasing the coal production by 20% or 200 million tons a year. This is not possible. This is why oil import is so important, not only for driving and transporting but for overall energy. Compare the US situation with the Chinese numbers and you see where the problems are. Europe is in still worse shape with lower self-sufficiency in energy.”
    First, the U.S. is presently a small net exporter of coal. It is affordable to water transport coal to various parts of the world. By 2015, the U.S. will probably be a major importer of coal, as the net export trend is projected to reverse by 2008 or so. As such, coal supply isn’t the principal constraint. The issues are emissions and emission credits.
    China was an exporter of coal until recent years. China has been importing some coal from the U.S. in the past few years, according to EIA.
    U.S. energy demand projections from EIA DOE, as outlined below, do not support the notion that the U.S. can only increase its energy supply considerably by consuming much more coal. While coal production and usage is projected to grow moderately per year through 2025, growth in the provision of crude oil and natural gas appears to be much greater. Note the second graph on the first link, as an example. There is no evidence that EIA or industries anticipate huge growth in coal production and consumption. In fact, future U.S. coal consumption will involve a greater shift to low sulfur coal due to the regulation of emissions.
    Annual Energy Outlook 2005 with Projections to 2025
    January 2005
    http://www.eia.doe.gov/oiaf/aeo/
    Annual Energy Outlook 2005
    Market Trends – Coal Production
    http://www.eia.doe.gov/oiaf/aeo/coal.html
    Annual Energy Outlook 2005
    Market Trends – Energy Demand
    http://www.eia.doe.gov/oiaf/aeo/demand.html
    Projected Change in World Hard Coal Consumption through 2010
    http://www.abareconomics.com/research/energy/globalenergy_graphs/globgrapghs.html
    Energy – the Global Outlook
    Philip Aiken?s Address to the KPMG Global Energy Conference,
    Houston, May 2004
    http://www.bhpbilliton.com/bbContentRepository/Presentations/KPMGspeech21May.pdf
    The Outlook for Coal Utilization in the United States
    Richard Bonskowski, Energy Information Administration
    January 2005
    http://www.eia.doe.gov/cneaf/coal/page/f_p_coal/apec_jan2005_coal_outlook.pdf
    Coal
    EIA DOE
    http://www.eia.doe.gov/fuelcoal.html

  19. Movie Guy

    USA AGRICULTURAL EXPORTS AND IMPORTS
    TI — “The US is an important exporter of food and raw materials and will get along as a low cost producer.”
    Thomas Wood — “My own view is that there’s no reason the US economy cannot continue to find its relative advantage – beyond agriculture – even if absolute growth rates take a hit from diminishing world energy supplies.”
    Let me try this again.
    In 2003, U.S. agricultural imports exceeded U.S. exports by over $4 billion. Agricultural imports exceeded exports by roughly $4,025,874,000 in the above tabulated data analysis.
    As agricultural subsidies are reduced and eliminated, the likelihood that U.S. agricultural exports will exceed imports is very slight. Covering a $4 billion deficit in such production and moving to a surplus situation will be difficult, particularly if relying on any key crops and related production yields supported by unsustainable irrigation sources.

  20. Ragout

    So why the different results? As I see it, Mandel says that investing an extra $150 billion makes us 1% better off after ten years. Hamilton says that investing an extra $400 billion a year permanently would leave us 10% better off in the long run.
    So Hamilton is considering a change 2.7 times bigger per year, and he’s implicitly pointing out that for every extra dollar capital gets, labor gets two due to higher wages. So that accounts for an 8-fold difference in results: most of the 10-fold difference.
    So the rest is that Hamilton has the change being permanent and a certain amount of compounding, while Mandel has neither. The surprising thing is how little these last two factors matter. Of course, the unimportance of compound interest is just another way of saying that in the Solow model, higher savings raises income but doesn’t raise the growth rate in the long run.

  21. TI

    EIA projections are not realistic. I know them but the present facts tell a different story. I thought that everybody had already understood what is going on in the US energy sector.
    1) The domestic oil producton has been decreasing since 1970 and will go on decreasing – so this is negative. The world oil supply is tight and no experts (even in the oil companies) project significant increases any more. Prices are rising as we all know. And look: if somebody don’t believe in the Peak Oil it doesn’t matter here because this is about the US domestic production. The facts are really hard: only decrease ahead.
    2) The North American and US domestic natural gas production is now decreasing (hey, the $13-14 dollar natgas – and this not only hurricanes) and will go on decreasing (probably rapidly). The EIA projections are not realistic. Negative domestic energy impact here. There is not enough LNG terminals and shipping capacity for increasing imports at present. Increasing imports is possible in the future but not by huge amounts.
    3) The US coal production has been growing a little and there is some growth potential – how much is difficult to say. Coal is a common name for wide variety of products. Coking coal (and coke) is a special one and is commonly exported and imported. And all US coal is not the best energy coal, bituminous coal – a large share is lignite. Lignite is very local and used only for power generation.
    4) The possibilities to increase nuclear energy are limited for various reasons – the main one being shortage of fuel. Half of the fuel used by the world nuclear power plants is from stockpiles – it is made from weapons uranium. The world uranium production is not sufficient.
    5) The renewables volumes are just too small to make any difference here.
    So we see that the possibilities to increase the US energy supply by domestic energy production or by imports are very limited. And we should compare this with China. I gave the numbers in an earlier post here. China and the US live in different worlds in energy. The US can somewhat increase its energy production and consumption but it cannot match China any way. This is the point.
    Now some positive news. The US has still a fairly high energy sufficiency – 70%. It has coal and oil shales (shales are not for making oil but generating power – they are a substitute for coal. This can be profitable – they do this in Estonia).The US can keep up its energy production level by coal and coal substitutes. This is an environmental problem but I am cynical and expect that in the end this will be ignored.
    The level is not the problem here and now – the growth is. And exactly this affects the investments. Therefore I see mostly stagnation in the future for the US economy.
    I am interested in coal because it is more important for industry and investments than oil. Coal (and natural gas) is used for electricity and making steel and cement and other very energy-intensive products that are important raw materials for manufacturing, building etc. We could simplify: coal is for making goods, oil for transporting them.
    I know that the US is today a net importer of food. But food trade is not at all free. It is very subsidized and regulated and it is difficult to see here the real advantages. But what about cutting some of the overweight of the Americans?

  22. Robert Sczech

    TI, you made a very convincing case regarding energy as the main constraint for maintaining growth of the US economy. Regarding China, you say that the higher Chinese economic growth rates are simply the result of higher coal production growth rates in comparison to the US. I find that puzzling given that the coal reserves in the US are significantly higher than in China. One would therefore expect that it would be much easier for the US to increase coal production than for China.
    A second point: The US is the worldleader in energy consumption, not only on absolute basis but also on a per capita basis. One can therefore not say that the US suffers from energy scarcity – the opposite seems to be true. It is more a matter of economic decision on how we prefer to allocate energy usage in our economy. We prefer to invest more energy into consumer conveniences than into the productive capacity of the country. I believe that it is no exaggeration to say that the efficiency of the US economy is much smaller than that of its main competitors. Even if we can not increase total energy consumption anymore, we have more to gain from increasing energy efficiency than any other country. (My favorite example is waste of energy in heating and airconditioning of buildings – huge amonuts of energy could be saved here. Rebuilding the railroad network would decrease energy usage in the transportation sector). I feel that your analysis does not properly reflect this area of potential growth of our economy. This has much to do with the true meaning of savings – the topic this thread started with.

  23. pat

    Rich Berger and Barkley Rosser,
    Here are a few numbers according to Ried Thunberg:
    For the fiscal year ending in September, outlays grew 7.9 percent, but receipts grew 14.6 percent. In particular, corporate income tax surged 47 percent, partly attributed to the temporary tax amnesty for repatriated foreign earnings.
    Almost all forecasts I am aware of are predicting higher fiscal deficit for 2006.
    A side point: payroll tax did grow 8.4 percent last year, an indication that the labor market may not have been as weak as some people think?

  24. TI

    The US and Chinese coal reserves are in reality about equals. The US reserves are usually given as 275 billion tons, but only 46% of this is “real coal”, i.e. bituminous and anthracite. That makes 126 billion tons. The rest is lignite. The Chinese reserves are 126 billion tons and almost all bituminous (source: EIA country briefs).
    And we have an important difference: the US has a very long history of coal production. The US production reached 600 million tons level already in the 1920s but the Chinese only about 1980. This means that the easiest fields in the US are already used but the Chinese have only begun to use theirs.
    The US total energy production growth has once been at “Chinese” levels – between 1850 and 1903 – 1910. It was almost all coal then. This was also the period of most rapid economic growth in the US history. The Chinese are just experiencing the same as the Americans did about a century ago, “The Golden Age”
    It is true that the structure of energy consumption is very different in the US and China. In fact the energy use has diminished only in industry but increased everywhere else in the US. The decreasing use in industry is mostly a result of relocating hevy and other energy-intensive industry elsewhere. Without this the US energy imports would be far higher and the problems really big.
    May be the US could reallocate its energy use and make room for new productive investments. But of course this would be a temporary help even if it would be possible. If the total domestic energy production don’t grow there is only so much room for reallocation and industrial growth. It must be taken into account that industrial investments have usually very long life-cycles – at least 20 -30 years , often 50. This means that the long time resource forecasts influence heavily the investment decisions. I think this is the real problem.
    The importance of low labor and other costs in China cannot be dismissed. But there are also other low-cost countries. Only China can provide all: very rapidly growing supply of cheap, price-regulated energy, abundant skilled labor and developing infrastructure (build with that energy and labor!). And the Chinese have the newest factories and hence the most modern machinery. This is really an unbeatable combination. Just as unbeatable than the US once was!
    The US is not a basket case. But it has to adapt to the new reality.

  25. Matt

    There is a problem with the evidence from Mankiw et al. on the cross-country relationship between investment shares and growth. The explanatory variable there is I/Y evaluated at PPP. However, there is essentially no correlation between I/Y and incomes evaluated at national price levels. It is the latter that is relevant in discussing how much a given rise in the national investment rate might raise incomes over time.
    Other research shows that prices for investment goods don’t vary too much by country income level. Rather, poor countries have low values for I/Y evaluated at PPP because consumption goods are cheap by international standards; rich countries have high values for I/Y at PPP because consumption goods are dear. Absent other evidence, the positive association between I/Y at PPP and real incomes looks like an artifact of the relationship between real incomes and consumption goods prices.

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