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Saturday, February 20, 2016

Growth Limits (Again)

The "limits to growth" debate is continuing. Ramanan has written a good article discussing the role of the external constraint in this debate. I agree with what he says, but I am less troubled by the fact that it is not heavily discussed by others.

There's been a few article about this; the Mike Norman Economics web site is keeping up with the links. For example, this MNE article links to the article by Ramanan, and 'Detroit Dan'.

As I discussed earlier, I do not know whether Bernie Sanders (or Jeb Bush's) economic plans will drive economic growth to 4-5% over any particular horizon. I am just arguing that there is no reason to say that such a growth rate is impossible.

External Limits To Growth?

In Limits to Growth? Ramanan argues:
But things are not easy. What surprises me is that in none of these discussions from either side, is there any discussion of the U.S. balance of payments. [emphasis mine] The U.S. does not have exports of just a couple of hundred billions and a GDP of some $16 tn. It has exports of about $2.5 tn and GDP of about $16 tn, meaning the GDP is a few multiple of exports. The United States is a net debtor to the rest of the world. So a rapid rise in growth by any means will come at the expense of terribly deteriorating balance of payments which cannot last long. 
Of course the above doesn’t mean that things are as pessimistic. It depends on what is going on in the rest of the world and the United States being the economic center of world activity can convince others to boost their economies and there is no reason to assume that it cannot. if there is rapid growth in other economies, the U.S. balance of payments is not something to worry about.
I will start by saying that I agree with Ramanan's analysis (although my article did have a glancing mention of external trade, so technically such a discussion did appear somewhere...). However, I am less concerned about the absence of the discussion of the external constraint.

From a U.S.-centric analytical viewpoint, the "external constraint" shows up as trade drag, since the American "establishment" has given up on the idea of the U.S. Treasury facing an external "financing constraint." (As I discussed in this article, financing risks were treated more seriously pre-2008, and remain a point of discussion in other countries.)  This trade drag acts an ever-present automatic stabiliser, in much the same way the progressive income tax system. That is, if the U.S. economy grows quickly, there is an increasing trade deficit that acts to slow growth.

Theoretically, what should matter is relative growth: if the rest of the world is growing faster, there is less of a constraint on U.S. growth. However, that really only matters if your external trade account is near balance; U.S. imports are larger than exports, and so it takes a lot of export growth to catch up with import growth, if those imports are growing at all. Correspondingly, U.S. economists can get away with largely ignoring what the rest of the world is doing when discussing domestic growth. All we need to do is keep in mind that there are automatic stabilisers, which can be seen in historical data. (The effectiveness of those automatic stabilisers is why it is reasonable to be skeptical about GDP growth projections that deviate too far from trend.)

In any event, the U.S. could get away with strong GDP growth without causing external difficulties right now. There is plenty of spare global manufacturing capacity, so rapid U.S. growth would be accommodated by exporters. After awhile, there would be a self-reinforcing global growth spurt, which will reduce the pressure on the U.S. trade balance. The only way that the growth train goes off the rails is if we start hitting supply constraints for raw materials (particularly oil).

Moreover, there is no reason to believe that GDP growth must drive a worsening of the trade balance. One could imagine policies that cause a rebalancing towards the consumption of domestic goods and services. In fact, this rebalancing is probably necessary if one wanted to generate strong job creation, and hence GDP growth. However, I am unsure which policies could cause such a rebalancing within our current policy framework.

(c) Brian Romanchuk 2015


  1. Is one assumption that if the US grows quickly, it will increase imports relative to domestic spending because growth in disposable income will very likely be more rapid than growth in industry to provide domestic alternatives? Thanks. :)

    1. Even if imports grow at the same pace as domestic incomes, since imports are larger than exports, the trade deficit will increase. That acts to reduce growth, since net imports subtract from GDP. The faster domestic demand grows, the larger this effect is (which is why it is a form of "automatic stabilizer").

      This external drag would have to be limited if policy makers wanted to push for very fast growth rates. However, it should be noted that increased reliance upon imports reduces inflationary pressures, so it might be a bad idea to try fight against it too much. It's probably better politically to have 3.5% annual real growth and contained inflation than 5% growth and higher inflation.

    2. Thanks, Brian. :)

      "since imports are larger than exports,"

      What I was trying to get at was that if the local economy grows by producing alternatives to imports, then the ratio of imports to exports might shrink, but I think that that is unlikely to happen in a short period of time; i.e., a time of rapid growth.

    3. It would be possible to generate rapid growth by replacing imports ("import substitution"), although that tends not happen in our current economic structure (the U.S. private sector would shy away from head-to-head competition with low cost Asian exporters). Something would have to shift to induce the private sector to launch such competition.

      Otherwise, what would tend to happen is that growth is being driven by some form of fixed investment that is not directly related to import substitution, such as the big telecom investment binge of the late 1990s. In this case, the new capacity was not producing the goods directly demanded by new consumer incomes, and the trade deficit widens (that is, trade drag).

    4. Thanks again, Brian! :)

  2. The key point here is that exporters to the US are not really exporting goods and services. They are importing demand from the US into their domestic economies. That is the purpose of 'export led growth'.

    Since pretty much all the world economies are gripped with neoliberalism and therefore won't use government spending to augment their domestic demand, their only option is to import it from somewhere that appears to have some spare.

    Spending on the level Sanders is proposing is likely to cause a boom anywhere where they have some mechanism to discount USD financial assets in the local currency. It may even happen in the Eurozone with the US Treasuries being collateral for Euro loans - which would then bring the Eurozone out of the doldrums.

    The external constraint is real, not nominal. Which is why talking in numbers is silly.

    Ramanan's problem is that he thinks the numbers are limiting. They are not. The external balance is always balanced if it exists. The current and the capital account match. The current cannot exist without the capital.

    So those that desire the US's demand have to provide the capital mechanism as well as the current one. Discounting and sovereign wealth funds do that job.

  3. Neil,

    The current and capital accounts match is hardly an argument. The same is true about the domestic private sector as a whole. Suppose the private sector runs a huge deficit. It is matched by the financial account in national accounts.

    So according to your own logic private sector deficits can't be bad. Which is absurd.

    Brian thanks. Will reply in another small post, although IMO the full argument is more involved.

    1. I will take a look. I realize that I am justifying analytical sloppiness ("let's just ignore the external sector!"), but at the same time, there's quite a few effects that are all aligned in the same direction (stabilizing growth rates). Analysis of historical data is going to have a hard time disentangling the different effects.


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