Mon, 08 Nov 1999

Wealth effects, myths about America's boom

HONG KONG (JP): The U.S. is currently enjoying what has become the longest economic boom in peacetime history. Two misguided interpretations of this phenomenon seem to dominate public opinion with one being as fallacious as is the other. On the one hand, it has become commonplace credit household spending for the record growth. On the other hand, many citizens and even a few economists believe that Bill Clinton was the architect of the current growth cycle.

Concerning the role of household consumption, it may seem logical to focus on its role in the current expansion since it accounts for two-thirds of total economic activity. The presumption is that increases in the value of household assets, especially home and stock market portfolios, have generated a "wealth effect'' that are motivating record levels of consumer spending.

However, this logic is flawed on several counts. First, consider that as of 1993, 3.6 percent of households had wealth worth over $500,000 and controlled nearly 60 percent of the country's household wealth. With the wealthiest Americans owning the largest share of stocks, increases in their wealth would not translate into increased spending at the same rate as lower income groups.

Looking at the Forbes 400, the 1982 list identified 12 billionaires whereas in 1998 nearly half on the list were billionaires and wealth of the top person on the list increased from 2 to 58 billion dollars. To paraphrase the old song, the rich are getting rich a whole faster than are the poor (who are not getting poorer!). It takes a healthy imagination to conclude that US growth is caused by robust household consumption based upon a wide distribution of increased wealth. Come on. Bill Gates and his pals can only build so many $25 million homes. Forget that story.

Second, claims that spontaneous increases in household consumption can be the source of sustainable growth are on weak theoretical grounds. Such logic arises from discredited Keynesian economic theory that claimed that manipulations of overall demand would stabilize economies and promote growth. If consumer-led growth were a practical reality, business cycles would not exist since recessions could be easily remedied through expansion of government deficits or loose monetary policy. The experience of the 1970s proved conclusively that these results are not possible.

More cogent explanations can be found to describe Americas economic expansion. Certainly the restructuring during the 1980s contributed to American firms becoming leaner, meaner and more competitive. (I now admit, without the least amount of embarrassment, to owning an American-made automobile!)

However, most important to the achievement of high and steady growth of the U.S. economy is the increased efficiency in its capital markets. Steps in this direction were taken during the Reagan administrations. These gains in efficiency have initiated a virtuous cycle of low unemployment and stable prices joined by the seemingly irrepressible rise in stock prices. Increased capital market efficiency allows growth despite a sharp decline in personal savings because funds are attracted from countries with less efficient markets and/or higher risks.

Neither rising consumer spending nor increased government expenditures financed by larger deficits can drive long-term economic growth. Market economies rely upon entrepreneurs that have ready access to capital to finance their ventures to be the engines of economic growth.

Some of the gains in productivity have also been driven by a revolution in information technology. Falling risk premiums combined with an increase in economies of scale in the collection and processing of information have lowered capital costs in the U.S. In the end, this means that global financial resources are being utilized more efficiently.

The role of the so-called wealth effect in the U.S. economy is somewhat ambiguous since there is no clear line of its cause and effect. Willingness to spend today is a complex combination of factors that include changes in ones' future position. This is certainly influenced by changes in the stock of wealth, but it also depends upon the anticipated flow of future income. Consumer confidence is also shaped by expectations relating to job security and prospective pay packages.

It is misleading and misinformed to suggest that the U.S. is experiencing a consumer-led boom that is being driven by a wealth effect. Regardless of the existence or the extent of a wealth effect on America's economy, it was observed only after the growth phase was well underway. Not only was it not a mainspring of recovery, it seems to have been only one factor providing momentum for robust growth.

The writer is an independent corporate consultant and Visiting Professor at Universidad Francisco Marroqumn in Guatemala.