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| Actually this post was just an excuse to post a picture of T-Pain. |
IMF officials “underscored the urgency of reforms to rebalance the economy toward more consumption-led growth,” the lender said.Or this:
Why hasn’t China done more to rebalance? The scale of the adjustment necessary to switch from an investment-led to consumption-led growth machine is so monstrous that the country would likely experience a lower rate of growth while it is taking placeOr this:
The transition from export- and investment-led growth to domestic consumption-led growth based on technology innovation, and from lifting tens of millions out of abject poverty to satisfying a more demanding middle class will be even harder for the party to execute.What the heck is "consumption-led growth"? What does it even mean for a sector to "lead growth"?
Recall that GDP = consumption + investment + government spending + net exports.
Does "consumption-led growth" just mean that the consumption share of GDP should be higher than it is? If so, fine. Then why not just say "consumption-led GDP"?
Or does it mean that consumption should rise faster than the other components of GDP? Fine, but consumption's share of GDP can't increase forever. Eventually, consumption's share will hit a ceiling, and the "consumption-led growth" - if this is what it means - will be gone.
Or does it somehow mean that the shocks to GDP become shocks to consumption preferences, instead of shocks to productivity? That GDP grows because people want more stuff, not because people figure out how to produce more stuff? If so, it's a bit confusing as to how it would work. You can want more stuff til you're blue in the face, but only if you figure out how to make more stuff will you actually get what you want. Sure, you can work harder to get more stuff, but that kind of "growth" will pretty quickly hit a wall.
So what does "consumption-led growth" mean? I am a bit at a loss. Can someone explains what it means?
That GDP grows because people want more stuff, not because people figure out how to produce more stuff?
ReplyDeleteClose, but not quite. Just because you want more stuff and because people know ways to make more stuff that you want doesn't mean you get more stuff. You need to have sufficient income, and to feel reasonably secure in it that you won't lose something you want more tomorrow if you lose your job.
China may have a harder time running a trade surplus. If so they will need to consume themselves what they are currently exporting (stuff they already know how to produce lots of, and presumably plenty of Chinese want) to keep their economy going. That sounds like it should be easy, but if it actually were they wouldn't be manipulating their currency to increase their exports.
Consumption led growth is when GDP grows because those who don't have everything they want gain the capacity to get it, giving reason to put more people to work producing stuff and making it profitable to build more productive capital allowing the production of more stuff.
The can 't gain more capacity unless they have the income to buy it, and that means producing more stuff
DeleteIt's political speak for "people are afraid for the future so they are hoarding money and other relatively safe stores of value, and since the economy is way under capacity, we really need them to consume more to support employment."
ReplyDeleteIn other words, it's a real problem if for whatever reason don't want most all of the stuff that the economy can already make. When people are trying to "fix their balance sheets" this problem arises.
"If so, it's a bit confusing as to how it would work. You can want more stuff til you're blue in the face, but only if you figure out how to make more stuff will you actually get what you want."
ReplyDeleteIf this was true, no-one would make money off a stock-market *crash*. If you are (for example) America, you get to have more stuff without making more stuff, because any stuff you can't buy you can forcibly go and steal (Iraq, for example), so people will lend stuff to you until you can't afford your army any more. Eventually, the music stops and you realise they have come and repossessed your chair, but with the evidence of the 112th Congress in front of us, one must argue many of the players have plugged their ears with money, and can't even *tell* when the music stops.
Try to reason in terms of an accelerator model for investment, and you will hint at an answer. It's actually a very Keynesian-Structuralist idea. The concept of "something-led" growth refers to what the main source of demand is, not in terms of its share of GDP, but in terms of the orientation of the productive structure. For instance, a consumption-led growth strategy may well require a higher share of investment/GDP, because given the technological coefficients you may require more investment to supply more goods. With a capital/output ratio of 3, and 3% gdp growth, to maintain that ratio would require an investment share of GDP greater than 3%. But still, if China for instance instead of relying on exports and low wages as the main orientation of its productive structure, turns into domestic demand relying on higher wages (or pension benefits), then you can say that's a consumption-led growth strategy.
ReplyDeleteThere is a demand side to the economy, in case you haven't paying attention the last five years.
ReplyDeleteIn China's case consumption is a historically low percentage of GDP, estimated at 35%. With positive public investment opportunities growing scarce and export markets stagnating they need to rebalance the economy towards consumption meaning that consumption growth needs to grow faster than overall GDP on sustained basis, which
Given the financial structure of the Chinese economy, with financial repression that dwarfs Japan's, rebalancing will be difficult.
DeleteAlso, to echo JW Mason, thinking of a developing country like China as having a 'given set of productive endowments' is not a good model. Catch up growth means that the productivity frontier of the economy is well beyond current production and supply can be expanded at tremendous rate (theoretically)leading demand to be an even more important feature in steering growth.
It should mean consumption is the ultimate end to all economic exchange while the other components are the means to consumption in one way or the other.
ReplyDeleteAlthough annual GDP is constructed with mutually exclusive components to avoid double counting added value while representing total output, across total future years necessary to capture full depreciation of all components, the present value of current consumption should be the same as the present value of C+I+G+(X-M).
OK, I'm not sure this is the right answer, but let's try it. Suppose you have a model of the macroeconomy. Typically when things are going well, there will be growth. Typically there will be a shock that drives any particular simulation of the model. That shock, or rather, the direct demand-side effect of that shock, is what "leads" growth. So if your shock is a central bank purchase of foreign exchange, the direct demand-side effect is an increase in exports, and you have "export-led growth." If the shock is a change in household preferences, say an decrease in the subjective discount rate, the direct demand-side effect is an increase in consumption, and you have "consumption-led growth." Also, in the real world the shock won't typically happen all at once: the central bank will keep purchasing foreign exchange over time, or household preferences will shift gradually, so it makes sense to talk about a "period of export led-growth" or a "period of consumption-led growth."
ReplyDeleteOf course eventually if you stop shocking the model, a typical model will get to some kind of equilibrium that involves growth, so I suppose you end up with "nothing-in-particular-led-growth." But maybe that's what we call "balanced growth."
I think a realistic model also ought to allow for some sort of secular demand-side stagnation, so you might get an equilibrium with little or no growth, where there is broad tendency to hoard cash and government bonds rather than spending. In that case you need some kind of shock to drive the model to a better equilibrium that involves a non-negligible growth rate: you need something to "lead" growth.
Yes, any kind of "X-led growth" implies a very Keynesian, demand-side view of the world. If you really think the supply side is driving things (as perhaps Noah Smith rather than Ryan Avent looking at Japan) then the concept doesn't make much sense.
does it somehow mean that the shocks to GDP become shocks to consumption preferences, instead of shocks to productivity? That GDP grows because people want more stuff, not because people figure out how to produce more stuff? If so, it's a bit confusing as to how it would work. You can want more stuff til you're blue in the face, but only if you figure out how to make more stuff will you actually get what you want
ReplyDeleteNever heard of aggregate demand, have we? or some guy named Maynard?
Never heard of aggregate demand, have we? or some guy named Maynard?
DeleteI feel that the quality of your commentary has suffered of late, my dear Mr. Mason. I understand that you probably have a lot of other demands on your time...
...ah, I see you have another comment further down. I'll respond to that one, then.
Well consumption is pretty much always greater than investment, so it isn't necessary to speak of "consumption led GDP". The growth rate here can tell us more than the level.
ReplyDeleteAnd I think it's often (usually?) the case that shocks to GDP are from shocks to consumption, rather than production. Think of negative shocks here. If you have a shock due to insufficient production, you should then have lines and shortages; think of the late 1970s and gas lines. But most recessions instead occur with inventory buildups, but low capacity utilization. Thus not from too much production, but too little demand.
Of course, you are right that growth led by increased consumption will hit a wall. That wall is loosely called "full-employment". At that point, long term growth models which focus on production functions become much more relevant.
But it is also relevant how you get to that wall. If you get there with an economy consuming more than it is producing, you are going to have a problem of chronic trade deficits, like the US over most of the last decade. If you get there with an economy producing more than it consumes, you are going to end up like China in the last decade. For a small country with little global impact, this may not matter as much. For two of the worlds largest economies, there is an interdependence there; one imbalance can't exist without the other. If you unilaterally try to "correct" only one side, you might end up lowering overall growth.
Less snarkily: the Keynesian economics that underlies national accounts is based on the idea that aggregate output is determined by desired expenditure. It is always the case that how much is produced depends on how much economic actors choose to spend. At the same time, desired expenditure depends largely on current income.
ReplyDeleteThe economics that you learn in graduate school doesn't look like this at all. You have a known endowment of production possibilities that you allocate between investment, consumption, etc. -- or rather between consumption now and consumption at various dates in the future if this is your vision of the economy, then terms like consumption-led growth don't make sense. But people who use those terms aren't confused, they just have a different vision than you do. They think that output depends on desired expenditure, and expenditure is largely determined by current income. You have to get out of the Walrasian box for it to make sense, you have to forget about endowments and intertemporal optimization and all that.
Concretely, the question is which component of demand is varying relatively autonomously. In the US, net exports depend mainly on current income, so they fall relative to GDP when growth is high and rise (toward zero) when growth is low. In a country with export-led growth, it would be the other way round. Housing in the US behaves the opposite -- it's relatively autonomous. The increased income from housing booms raises consumption and business investment when housing investment rises, but less than proportionately, so the housing share is higher when growth is high and lower when growth is low. Demand here is housing-led.
the Keynesian economics that underlies national accounts is based on the idea that aggregate output is determined by desired expenditure. It is always the case that how much is produced depends on how much economic actors choose to spend. At the same time, desired expenditure depends largely on current income.
DeleteYes, yes. Now, if I recall correctly, consumption and investment are both types of expenditure. So, using this framework, how should we differentiate between "consumption-led growth" and "investment-led growth"? Do you mean to say that "consumption-led growth" is when desired consumption moves upward relatively autonomously - people keep deciding they want more stuff - and desired investment responds by moving upward as well (possibly with a lag, possibly contemporaneously)?
That sounds like something similar to what people might call "shocks to consumption preferences". Or do you mean something other than this?
Now, keep in mind, Keynesian theory is a theory of business cycles, and generally holds technology fixed. But in the long run - what we usually call "growth" - increases in wealth require improvements in technology, institutions, or some other thing like that. So over the long run, it's interesting to ask how autonomously moving desired consumption would interact with technological and institutional changes in a Keynesian framework. I don't think existing Keynesian models address that question, but it is interesting, wouldn't you agree?
"So over the long run, it's interesting to ask how autonomously moving desired consumption would interact with technological and institutional changes in a Keynesian framework."
DeleteGreek prime-minister, former econ professor (at Harvard and Berkley), and John Kenneth Galbraith's friend A. G. Papandreou tried in the 1980s a Keynesian "if you built it (demand) they (production) will come" strategy as a recipe for long run growth. We all see how well that worked out!
I notice that my comment never received a reply. I guess this means that Mr. Mason's standard line of "Oh, I guess you never heard of this guy named Maynard something-or-other?" has reached the end of its useful lifespan. Perhaps it could not survive an encounter with someone who actually knows Old Keynesian models. Hmm.
Deleteit's often (usually?) the case that shocks to GDP are from shocks to consumption, rather than production.
ReplyDeleteSorry, this is confused. On the one hand, there is expenditure or demand on the one side, and supply or productive capacity on the other. On the other hand, expenditure is divided into consumption, investment, government expenditure and net exports. So you can ask whether changes in output (levels or growth rate) are determined more by changes in desired expenditure, or changes in productive capacity. And, if you think they are determined by changes in desired expenditure, you can ask which specific category of expenditure -- consumption, investment, etc. But it does not make any sense to counterpose "consumption" and "production."
Also, let's refrain from talking about "shocks." There's a lot of unexamined assumptions packed into that word.
Hmm. Not sure if I want to step into this, but: Everything that is produced must be consumed. If it isn’t consumed, you end up with a surplus, prices go down, and your factories can’t make a profit, and they shut down. So in the long run, or even the medium run, consumption, or perhaps more accurately the ability to consume, has to grow at a rate at equal to the growth of your rate of production.
ReplyDeleteWhat about government spending? A form of consumption. Exports: Somebody else consuming what you produce.
What about investment? Investment causes a growth in future production, so future consumption has to grow, too.
The problem, the problem in distributional economics, is that consumers have to spend their money for what the producers produce, so eventually, unless there is some social mechanism that transfers the money back to the consumer, the producers end up with all the money. (Producers, by definition, produce more than they themselves can consume. Consumers, by definition, consume more than they produce.)
Without any money, the consumers can’t buy anything, and with the collapse of the producers’ market, the producing sector then implodes: Lots of cash, but no market for their surplus. Factories shut down, further contracting their market, etc. in vicious spiral.
So the problem is how to get the money out of the producers hands, and into the hands of the consumers. Lending doesn’t cut it, because eventually the money has to be paid back, and the consuming sector then contracts, etc.
See: anamecon.blogspot.com/2011/11/morality-and-debt.html
for a more nuanced discussion.
With the enormous productive capacity of the modern economy, a large government sector and progressive taxation has been found necessary to maintain an economy’s demand.
This comment has been removed by the author.
ReplyDeleteThis comment has been removed by the author.
DeleteOne problem that I have with this discussion (I am not an economist) is that the distinction between investment and consumption as far as I can tell cannot be made at the time of the expenditure. Spending on an asset (fixed or financial e.g. factory, housing, bonds) that later on has less economic value than anticipated would seem to count as consumption. And purchases that may have been anticipated as consumption (collectables) may wind up with more economic value than anticipated hence an investment.
ReplyDeleteIn health care, expenditures that lead to increased economic productivity, either of the patient or the family/caregivers of the patient, might be an investment or consumption depending on the rate of return.
So Greg is quite wrong saying that government expenditures are consumption. Sometimes they are, sometimes they are investments. Roads to nowhere are probably consumption, while the general interstate highway was probably investment.
DeleteI simplified in haste and for brevity. Sorry. The Interstate, bridges and dams, all investment. DARPA. Etc.
DeleteBut the line isn't so clear. What is a Wall Street office building? From a 'real' point of view, is it consumption, or an investment? Nothing substantial is produced, society's resources are consumed to build and operate the thing, but the 'investment' will likely 'pay' for itself in a few years. It's not a factory, but what if the factory produces toys? Is that factory an investment, or more consumption of precious, often irreplaceable resources that our future depends on, both in being built and in what it consumes for what it produces?
And is not the very term consumer, a misnomer and a canard,
when referring to a worker, who, in the eyes of his employer at least, produces more than he consumes, and so by definition is a producer? If not, his employer would let him go.
But the distinction is valuable because it highlights problems. It is a tool.
So: "Consumption-led-growth" would seem to require that the market expand for producers to be motivated to expand their production. In the end, producers will expand to exactly fill the market. This requires that the consumers have more money. But that's the problem. I suppose everything can, and should, expand at the same rate, and in balance.
But I think the point of the excerpt was that if they (the Chinese) are so intent on producing so much, they should give their consumers/workers the salaries to pay for what they produce. So, yes, a larger 'consuming' sector. But the Chinese government probably just considers labor overhead in their trade war with the US.
'Does "consumption-led growth" just mean that the consumption share of GDP should be higher than it is? [...] Or does it mean that consumption should rise faster than the other components of GDP? Fine, but consumption's share of GDP can't increase forever...'
ReplyDeleteWhen consumption share of GDP should be higher than it is (ignoring for a moment why that might be), then consumption should rise faster than other components for a while. So there is no conflict between your first two "or's." Just combine them both in the most sensible way. See, not so hard. :-)
'That GDP grows because people want more stuff, not because people figure out how to produce more stuff?'
International macro -- the context in which the phrase "consumption-led growth" usually appears -- does not admit so blithely of that binary choice. Who are the people who want more stuff, as compared to the people who produce more stuff? As long as we have "countries," there will exist a long-run balancing constraint between trade partners, and deviations from balance create risk (as short-term balance can be demanded by various events/parties).
So if you want to talk about what to do to reduce risk caused by lack of balance, the phrase "consumption-led growth" might be useful.
I think they are using the word "led" to imply that something happens first and then causes other things to follow. This is probably not a familiar concept since most economists tend to ignore the passage of time as if Newton never invented calculus. If you just look at Y=C+I+G+X as a static identity, as many do, you can use it to prove that economic growth is impossible. (I'm not making this up. You see this argument all the time.) If you use it in a dynamic analysis, Y is just a sum of varying components, not a fixed limit, so economies can grow and shrink just fine.
ReplyDeleteThere are many ways to grow an economy. For example, you can encourage investment by offering tax breaks to companies, cutting interest rates, building infrastructure or simply building productive capacity. This could make the overall economy grow because I is part of the GDP, and a bigger I would mean a bigger GDP. Ideally, the growth in I would also increase wages, so that investment might actually provide some return to those parties who care about such things. This is usually called the supply side approach or producer led approach, because the idea is that if you produce more stuff, people will magically have more money to buy it. You see this in the business press all the time: arguments that the big problem in our economy is that people just have too much money to spend but nothing to spend it on.
Another approach to growth is to get more money to consumers by raising wages, cutting taxes at the low end, providing benefits for children, hiring people to do things, increasing transfer payments, providing free land and so on. The idea being that one of the things preventing spending is the lack of money or fear of lack of money. This is an exotic idea that runs counter to most economic thinking, but a study of lottery winners and people who got raises showed that people with more money tend to spend more than when they had less. Higher spending encourages producers to produce more and to build productive capacity as they now have a realistic chance at a positive ROI. (The business press discounts this idea because most businesses are run as charities.) This is sometimes called demand side growth, but usually in a quiet voice so the speaker usually doesn't get shouted down by people who cannot conceive of someone's spending being limited by income. Given that the first move suggested is getting money to the consumers, the idea is that the consumers will "lead" the economy into further growth, hence "consumer led".
Michael Pettis has been blogging about this for some time, I recommend his blog.
ReplyDeleteI believe the thesis is that consumption share of GDP fell from an already low level of 50% to now about 1/3. Such a low consumption share is unprecedented, particularly in an aging economy that has great need of social services for the elderly.
So the first order of the day is to stop the consumption share from declining. The second order would be to have the consumption share grow. Preferably as a result of consumption growth outpacing GDP growth rather than consumption declines being less than GDP declines.
Underlying this is the belief that China has a policy of subsidizing investment and taxing consumption, together with another policy of preventing a growing share of income from reaching the household sector in the first place (as China is not a private ownership economy, it is not true that households own all of the assets or take delivery of all income).
So there is a dynamic in which state owned enterprises take out loans to build monorails and replicas of nice swiss villages, and then default on the loans. Banks grant the loans because they are risk free, in the sense that the losses are socialized via negative deposit rates.
Therefore even though total GDP is growing very rapidly, much of that growth corresponds to investment in the form of monorail investment decided by local governments rather rather than growth of firms that are able to profitably sell goods and services to Chinese households in a voluntary exchange.
A shifting to this second form of more sustainable development that is what I interpret "consumption led growth". It is called consumption led growth because it was the state's suppression of consumption that allowed real resources to be diverted towards the monorail construction, so this would be a reversal.
I doubt that this is what anyone is referring to, but could consumption-led growth arise if an economy is dynamically inefficient, and consuming some of the capital brings it closer to the "Golden rule" level (in a Diamond model say?)
ReplyDeleteOr maybe something along the lines of Jan DeVries "Industrious Revolution" (book from 2008, I highly recommend), would classify as consumption-led growth. He describes how the changing availability of consumer goods in early modern Europe changed the aspirations of households and led to an increase in market-oriented labor, which further altered consumption patterns. Again, not likely what is being referred to in the links you post.
The second link in your post makes it seem like "consumption-led growth" is just a euphemism for less growth.
I think when people say consumption led growth they probably just mean demand. Right now most people say that the recovery is slow because of a lack of demand for services and goods. The banks and corporations have plenty of cash right now but what is missing demand. In the case of china growth is primarily through exports instead of consumer demand in their own country.
ReplyDeleteHmmm...How about this as an example of consumption-led growth? If I continue to consume Twinkies, then I will continue to grow.
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