In a piece for Project Syndicate , Michael Pettis , professor of finance at Peking University, reminds us that the act of rebalancing in Europe requires the work of both debtor and creditor economies. Most global financial crises, Pettis notes, "were the result of strains created by the recycling of capital from countries with high savings to those with low savings." A country’s overall consumption rate is, of course, the flip side of its savings rate. Apart from demographics, which change slowly, three factors largely explain differences in national consumption rates. First and foremost is the share of national income that households retain. In countries like the United States, where households keep a large share of what they produce, consumption rates tend to be high relative to GDP. In countries like China and Germany, however, where businesses and the government retain a disproportionate share, household consumption rates may be correspondingly low. The second factor is income inequality. As people become richer, their consumption grows more slowly than their wealth. As inequality rises, consumption rates generally drop and savings rates generally rise. Finally, there is households’ willingness to borrow to increase consumption, which is usually driven by perceptions about trends in household wealth. In Spain, for example, as the value of stocks, bonds, and real estate soared prior to 2008, Spaniards took advantage of their growing wealth to borrow to increase consumption. But this is not the whole story. Consumption rates can also be driven by foreign policies that affect these three factors. For example, an agreement in the late 1990’s among the German government, corporations, and labor unions, which was aimed at generating domestic employment by restraining the wage share of GDP, automatically forced up the country’s savings rate. Germany’s large trade deficits in the decade before 2000 subsequently swung to large surpluses, which were balanced by corresponding deficits in countries like Spain. Pettis uses Germany and Spain as examples here. While the situation in Europe may be more pronounced at the moment, Pettis's point is a larger, more global one, about the nature of the relationship between high-saving and low-saving economies. Read The Saver's Dilemma here .
Filed under: jobs, consumption, debt, Germany, Europe, Euro Zone, Spain, EU bailout, root causes of the crisis, project syndicate, michael pettis, rebalancing, recycling capital, high savings rate, low savings countries, savings rates, consumption rates