The Dull Compulsion of the Economic (xv)
A series of blog postings by D&S collective member Larry Peterson
Raghuram Rajan's Ineffective Demand
As investors and policymakers in the west have become disheartened by the marked failure of the western consumer to resond to the heroic stimulus and recapitalization measures taken by their governments this year, there has been a tendency amongst observers of the economic scene to look for transgenic varieties of the already withering green shoots taking root in the--in many ways--far more forbidding soil of emerging markets. The latest to succumb to this tendency is former IMF chief economist Raghuram Rajan, who, in an op-ed in today's Financial Times (here's an indirect link to the article, courtesy of ninemsn Money), tries to find the magic formula that will result in a robust form of Asian consumption to pull the global economy out of its doldrums (and in a more balanced way, no less).
Rajan's basic idea is to reconfigure the global supply netorks such that emerging markets will, rather than providing lower value-added manufacturing for products designed with western consumers in mind, as is the predominant model now (Rajan uses the example of an iPod, in which 3/4 of the value added is provided in the rich world, while only 1/4--corresponding to the manufacture of the item--takes place in emerging markets), involve higher value-added design, marketing, advertising and even financial (he doens't mention legal; I wonder why...) capacities. He goes further in saying that such a move would create much economic value, precisely because such a transfer would orient production toward pent-up emerging market consumers, whose stifled consumption is to a great deal due to the failure of western multinationals (hopelessly tied by the umbilical cord of rich-world demand) to meet or anticipate their needs. Accordingly, Rajan refers to the example of the Tata Nano, which wilfully "leapfrogs" the temptation to penetrate western markets (which demand sturdier family vehicles like SUVs) to fill a widening niche in India: as a cheap form of transport, but one that, given India's poor roads, does not need to emphasize safety, both because of the congestion that slows all vehicle transport down, but also because the vehicle is cheap enough to serve as a substitute for more dangerous family forms of transport, like single motor-scooters (he speaks of the perils of fitting driver, wife with baby, and number two son on the seat of one scooter), anyway. So, according to Rajan, the more the higher value-added cacities involved in anticipating local demand are transferred from rich-countries to the developing world, the greater local demand will grow, which will, in turn, generate greater local employment, both in higher- and lower-value-added jobs, which will increase demand all the more, and so on. Thus will the emerging country consumer save an over-indebted and demand-constrained world from itself.
So what's the big problem? To my mind, there are two. First, Rajan assumes that companies, politicians and voters in the west will just sit back and allow this to happen. In fact, the only thing he says at all on this score is that rich countries will benefit as poorer countries grow rich. But growth in employment in many western societies is focused in two areas: one involves many of the the very sorts of activities Rajan focuses on. And these industries hardly compete with manufacturing (used to do) where job creation potential is concerned anyway. But many more workers cast off from acccelerated technological change and further losses among traditional employers (especially in manufacturing) find theuir way into lower-end service industries, in which demand is becoming now becoming more elastic as labor conditions decline precipitously: luxury services catering to the (shrinking ranks of the) affluent (especially as the high-end of the housing market languishes even behind the low-end one) or which play on the hidden costs of the celebrated worker flexibility in the US (day-care is the best example). In the latter case, other arrangements are replacing employed day-care, especially as more unemployed people are able to provide that care. In other cases, such as beauticians, such services are completely substitutable by nonmonetized activities. Moreover, as Dean Baker has consistently maintained, considerable obstacles to the replacement of service workers exist in the US already; and given the political power of those holding these jobs, any movement to liberalize services at a pace required to make Rajan's scheme truly effective would seem to be a pipe dream at present.
But there is another shortcoming, involving the developing countries themselves. Though savings rates in these countries are often extremely high, much of the savings, especially in China, come from the corporate sector, and even in the household sector, savings need to be kept at a high level because health care, education and social security benefits are scarce or nonexistent. China has rammed through reforms in its health care provision, but these will take some time to implement, and considerable doubt has been cast on their comprehensiveness or even potential effectiveness. So consumption will continue to be constrained in these countries by poorer employment outlooks than those that held for the hypercharged years that have just ended. Beyond this, the lack of consumer finance in these countries is a factor. And though some would this is precisely an argument to open these countries up to the services of western financial institutions, I would argue that rapidly leveraging-up rural consumption in China, say, could lead to the development of a kind of unsustainable triangle like that which is plaguing Europe now, which has seen peripheral (Baltics, Greece, Italy and Spain) consumption, dependent on central customer-finance (Germany), except on a far more massive scale. And we have the example of South Korea, hobbled by a wave credit card debt the last time consumer finance was supposed to come to the rescue of a bubble-economy in Asia to serve as a warining on this score.
Ultimately, the the double squeeze on labor worldwide that is the source of the problem. Workers in the rich world have been pitted against workers being paid far less in other parts of the world, but copious amounts of consumer credit have disguised this somewhat, and increased demand in the poor world to such an extent that rapidly rising wages there could offset somewhat cutbacks in social provisions demanded by of macroeconomic planners hell-bent on transformational, if haphazard, global integration. So ramping up demand in one part of the world to the exclusion of the other is a fool's game. The US (and UK) economically requires a heroic deal of capacity to be re-sent to it to re-balance its current-account deficit, while emerging countries continue to covet whatever rungs of the value-added ladder they can get a foot on, and sink huge amounts of capital on the rungs (China's stimulus program, which involves far more money per head that any western stimulus) currently unoccupied. This stickiness means that both high levels of debt and the lure of protectionist temptations will be inevitable in the medium-term, regardless of the economic case that can be made for a vast transfer of capacity of the sort Rajan is arguing for. And this will only be extended as the cost of ignoring climate change becomes ever higher, as the costs are set to rise precipitously if the problem isn't tackled. Only a solution involving workers in all markets, more or less simultaneously, will be capable of defusing the kind of medium-term social unrest that will lead to the derailment of recoveries by protectionism, the accumulation of debt, or inactivity regarding climate change. Unfortunatel y, it looks like labor itself is at present unable to bridge this gap.