Economics While the U.S. Is Only Showing Essay

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Economics

While the U.S. is only showing the first signs of recovery from the global economic crisis, other nations such as Australia and China have recovered much more quickly. There are a number of factors that have contributed to the disparity in economic performance in the past three years in these different nations. In particular, three factors will be considered. The first is the situation in each country at the outset of the crisis. As the crisis was largely precipitated by a credit crunch, the differences between the structure and regulation of the banking sectors in each country will be given particular attention. The second factor will be the response on the part of each federal government to the crisis. The third factor will be the nature of the different economies -- the degree to which different structures have impacted the recovery process. Lastly, policy implications will be drawn for the United States with respect to the steps it should take now to bring about economic recovery./

The Crisis and Recovery

The following chart compares the GDP figures for the U.S., China and Australia between 2008 and 2010.

2007

2008

2009

2010

United States

+2.1%

+0.4%

-2.4%

+2.8%

China

+11.4%

+9.6%

+8.7%

+10%

Australia

+3.8%

+3.7%

+1.3%

+3.3%

These figures point to a few different trends. The United States saw a recession that brought GDP growth in 2008 and 2009 well below the long-term trend line. China also saw its GDP growth slow, but overall this growth remained high. It is worth noting, however, that China's GDP figures are unreliable. They are widely considered to be works of fiction (Reuters, 2010). Figures provided by various Chinese authorities often do not reconcile (Zitan, 2011). So while most observers believe China's economy is growing rapidly and did not suffer significantly as the result of the economic downturn, the precise degree of this success is unknown. For its part, Australia saw a slight downturn, but never slipped into prolonged recession. That country has seen its economy rebound almost fully at this point in time, although the economy is expected to take a hit in Q1 of 2011 as the result of the natural disasters plaguing Queensland this summer (SMH, 2011).

What these results show is that the economic downturn was different in each country. The early years point to the impact that the financial crisis had on each country's economy, and this in turn reflects the policy inputs. The degree to which the factors that precipitated and exacerbated the financial crisis were present impacts on the depth of the recession initially. By 2009, the nations have had an opportunity to prepare and implement a policy response to the crisis. The timing and intensity of the recovery therefore reflects the policy outputs, that is the response to the crisis. The underlying structure of each of these economies cannot be ignored, and they impact on both the initial depth of the crisis and the outcomes associated with the response and recovery.

Inputs

There are no clear-cut causes of the crisis that are universally agreed upon. The most reasonable (albeit oversimplified) explanation holds that the crisis is related to a housing bubble that impacted not only the United States but many countries in Europe as well. Repackaging of risky securities as safe ones allowed for the crisis to go global, as American and European mortgage underwriters spread the risk associated with their real estate holdings around the world. When the bubble burst, a credit crunch ensued and thereby spread beyond the financial sector. This situation was especially prevalent in the United States, where a number of major financial firms faced bankruptcy as the result of their extensive holdings of bad real estate debt. In China, the real estate boom did not happen to the same degree. Thus, Chinese banks were not as susceptible to a decline in real estate prices. Without this exposure, and with strict government control, Chinese banks not only did not face the same downside risks but were compelled to keep lending to domestic firms. Australia was one of the western nations (along with Canada) that largely avoided the banking crisis because its banking system is heavily regulated and its banks were simply not able to make the same risky investments that undermined the health of American and European banks (Maiden, 2009).

Government response to the crisis differed in the three nations. The American government expended significant political and financial capital to merely stabilize its banking system and major industries.

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This left it unable to enact a sufficient stimulus package; what it did enact arguably only offset the declines in state government spending (Jones, 2011). Moreover, the money pumped into the banking system via both monetary and fiscal policy was not put to use by the banks. Lending did not improve dramatically, meaning that the credit crunch lingered longer than the government intended. Consumers, meanwhile, spent less and this provided incentive for businesses to withhold investment of their own from the economy.

In China the banks are closely tied to the government, and continued to lend. This allowed Chinese businesses to recover more quickly. This policy was facilitated in part by China's healthier balance sheet, but also by the country's currency manipulation, which propped up foreign demand for Chinese goods. Australia responded to the crisis with a relatively minor stimulus package, but the country did not experience the same credit crunch that the U.S. did. So while Australia faced a slowdown, its economy continued to grow because domestic demand was not as suppressed and business investment was higher than what the U.S. experienced.

Related to these factors is the structure of these different economies. The U.S. economy is based largely on consumer spending. In recent years, this has been fueled by borrowing. Consumers became less able to borrow as the result of the credit crunch, and fear over job prospects spurred an increase in savings rates. With demand down, businesses had no reason to invest in additional capacity. China's economy is export driven and with currency manipulation and easy credit, China's firms were able to continue to build their export-based businesses. Without a domestic real estate bubble and with historically high savings rates, Chinese consumers were in a better position to consume than were American consumers, so domestic demand did not fall as far. For its part, the Australian economy is a commodity economy. Its slump in 2009 reflected a decline in commodity prices as major economies purchased less. The rebound in Australia's economy is related to commodity price increases. The country was primed to rebound when the global commodities markets rebounded, which occurred as China and other major emerging markets began to exit the slowdown.

Policy Prescriptions for the U.S.

Australia makes a much better point of comparison for the U.S. than does China. Where the American and Australian economies share similarities there are opportunities to make improvements to U.S. policy. There are also areas where there is no real convergence. Australia's relatively small stimulus may appear to contradict Keynesian calls for increased stimulus in the United States, but the nature of the Australian economy must be taken into consideration. The commodity-driven nature of that economy has played a significant role in the Australian recovery. That recovery is only slightly faster than the U.S. economy at this point, but it began earlier. The U.S. does not have the luxury of a commodities boom to fuel its recovery, so the U.S. must be more active with its fiscal and monetary policy.

On the monetary policy front, the U.S. already has low interest rates and has engaged in the so-called quantitative easing to put more money into the economy. There are a few monetary policy moves left, such as reducing reserve requirements, but at this point monetary policy appears to have created ample money supply. Banks are not investing what money they have right now. Thus, action needs to be taken on the fiscal policy front in order to stimulate demand. This can come in the form of stimulus spending or in the form of tax cuts. Stimulus spending is far more immediate and has demonstrated to be more effective than tax cuts, particularly as tax cuts put substantial amounts of money into the hands of the wealthy, where it sits on the sidelines awaiting investment opportunities. The investment opportunities will not come without the prospect of growth. Tax cuts would not be much more effective than addition monetary stimulus at this point. A further stimulus package carries with it the risks associated with increasing federal debt. These risks are low according to current interest rates.

Today, however, the economy is showing signs of life. The most important policy prescription right now is to stay out of the economy's way. The private sector is beginning to expand again, so more stimulus would send the wrong message about economic recovery. It may help in the short run but it also may discourage private sector investment......

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