The Great Recession' is Actually 'the Great Investment Collapse"

8/9/2019 The Great Recession' is Actually 'the Great Investment Collapse"

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'The Great Recession' is actually 'The Great Investment Collapse'

By John Ross, Li Hongke and Xu Xi Chi

Much analysis of the international financial crisis, since it began to unfold, has been focussedin the wrong place. It has been projecting an alleged exhaustion of the US consumer,

centring attention on US consumer deleveraging etc. In fact, as this blog has consistentlypointed out, the real core of the Great Recession is a fixed investment collapse.

Nearly two years into the financial crisis it is possible to show clearly in figures which ofthese two contrasting analyses is correct they evidently lead to different conclusions asregards policies. As will be shown below the overwhelming driving force of the GreatRecession is a collapse in fixed investment, not a decline in US consumption - orconsumption in other economies. This also casts clear light on why China has been thecountry which has come the most successfully through the financial crisis. To summarise thestatistical conclusions below:

'Decline in fixed investment accounts for approximately 96% of the fall in GDP in the OECDarea as a whole and for 76% of the decline of GDP in Europe. In three countries - the US,Spain, and Portugal - the decline in fixed investment was greater than the decline in GDP. InJapan, France and Greece the proportion of the fall in GDP due to the decline in fixedinvestment was over 70%, 80% and 90% respectively. In every country except Germany thefall in fixed investment was the single biggest component of the decline in GDP. In short thedecline in fixed investment entirely dominates the Great Recession'

The focus of this article is therefore a detailed factual account of what has actually occurredduring the Great Recession. These facts leave no doubt. The Great Recession is actually

The Great Investment Collapse. Policies for dealing with the Great Recession musttherefore primarily address reversing the investment decline.

The OECD as a whole

Taking first aggregate changes in the components of GDP in the OECD area as a whole, i.e.all advanced economies, Figure 1 shows these since the beginning of the economic downturn

after the first quarter of 2008 up to the latest available aggregated OECD data. As may beseen the GDP fall is entirely dominated by the decline in fixed investment.

During the period from the first quarter of 2008 to the fourth quarter of 2009 OECD GDP fellby $1.04 trillion dollars in constant parity purchasing power (ppp) terms - the form in whichthe OECD aggregates data. Of this fall $0.99 trillion, equivalent to approximately 96 percent,was accounted for by a decline in fixed investment. In contrast the decline in personal

consumption expenditure was $0.25 trillion, only one quarter of the decline in investment,government consumption rose by $0.23 trillion and the balance of trade of the OECDeconomies improved by $0.23 trillion.


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Figure 1

The US

Turning to the US, the changes in the components of GDP in the downturn after the secondquarter of 2008 to the first quarter of 2010 are shown in Figure 2. Again, as may be seen, thefall in US GDP is entirely dominated by the decline in fixed investment. During this periodUS GDP in constant price terms, 2005 dollars at annualised rates, fell by $177bn. Howevermost components of US GDP actually rose over the period as a whole consumerexpenditure by $8bn, government expenditure by $58bn, inventories by $78bn, and net trade

by $108bn.

The entire decline of US GDP is therefore due to the $420bn decline in fixed investment.


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Figure 2

In order to avoid any suggestion that this investment decline is due simply to the fall inresidential investment, propelled by the sub-prime mortgage crisis, Figure 3 divides thedecline in US fixed investment in the period into residential and non-residential. The declinein non-residential fixed investment is $310bn and the decline in residential fixed investmentis $110bn i.e. the decline in US fixed investment is overwhelmingly accounted for by thefall in non-residential investment.

Figure 3


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Europe

Taking Europe as a whole, the changes in the components of GDP in the downturn after thefirst quarter of 2008, up to the latest available OECD data, are shown in Figure 4. The fall in

GDP is again dominated by the decline in fixed investment.

In constant price ppp dollars, the form in which the OECD calculates aggregated data, theGDP of the OECD area in Europe fell by $583.5bn. Of this $445.7bn, or approximately 76%,was due to the decline in fixed investment. Personal consumer expenditure fell by $145.6 bn,while government consumption rose by $123.3 bn and net trade improved by $47.4bn.

Figure 4

Japan

Turning to Japan, the changes in the components of GDP in the downturn after the firstquarter of 2008, up to the latest available OECD data, are shown in Figure 5. The downturnin almost all components of Japan's GDP, except government consumption, is severe.However by far the largest decline is accounted for by the fall in fixed investment.

During the period since the start of the economic downturn Japan's GDP, in constant priceterms, fell by 8.3 trillion. Government consumption rose by 0.3 trillion while personalconsumption fell by 1.1 trillion, and net trade worsened by 2.2 trillion. However fixedinvestment fell by 5.7 trillion - i.e. approximately 69% of the fall in Japan's GDP was due to

the decline in fixed investment.


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Figure 5

Germany

Turning to the individual major European economies, the components of GDP in thedownturn in Germany's economy after the first quarter of 2008, up to the latest data for thefirst quarter of 2010, are shown in Figure 6. Germany is specific in that, as will be seen, it isthe only major economy in which the worsening of the net trade balance is greater than thedecline in fixed investment in terms of its impact on GDP. The combination of the fall ininvestment plus the worsening of the net trade balance accounts for the severity of the

German recession - GDP in Germany in the first quarter of 2010 was still 5.3% lower than inthe first quarter of 2008.

In constant price terms German GDP fell by 30.4bn between the first quarter of 2008 andthe first quarter of 2010. Government expenditure rose by 6.0bn, personal consumption fell

by 5.6bn, fixed investment fell by 14.7bn and net trade worsened by 21.6bn.


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Figure 6

France

For France Figure 7 shows the changes in the components of GDP in the downturn after thefirst quarter of 2008 up to the first quarter of 2010. As may be seen, the fall in GDP isdominated by the decline in fixed investment. During this period France's GDP in constant

price terms fell by 11.7bn. Net trade worsened by 1.0bn while personal consumption roseby 3.6bn and government consumption by 4.6bn. However fixed investment fell by11.7bn - i.e. approximately 87% of the fall in France's GDP was due to the decline in fixedinvestment.

Figure 7


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The UK

Figure 8 shows the changes in the components of UK GDP in the recession after the firstquarter of 2008 up to the first quarter of 2010. Again, as may be seen, the largest component

of the fall in GDP is fixed investment.

In constant price terms UK GDP fell by 18.6bn. Net trade improved by 2.0bn, governmentconsumption rose by 3.6bn, and personal consumption fell by 8.3bn. However fixedinvestment fell by 10.5bn - i.e. approximately 56% of the fall in UK GDP was due to thedecline in fixed investment.

Figure 8

Italy

Turning from the major north European economies to the southern European states, the socalled PIGS (Portugal, Italy, Greece, Spain), the situation is equally clear. Figure 9 shows thechanges in the components of GDP in Italy in the recession following the first quarter of 2008up to the first quarter of 2010. In constant price terms Italy's GDP fell by 19.6bn.Government consumption rose by a marginal 0.3bn, net trade worsened by 4.4bn and

personal consumption fell by 4.8bn. Fixed investment however fell by 10.0bn - i.e. 51% ofthe fall in Italy's GDP was due to the decline in fixed investment.


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Figure 9

Spain

Turning to Spain the changes in the components of GDP in the downturn after the firstquarter of 2008, up to the first quarter of 2010, are shown in Figure 10. The fall in GDP isdominated by the decline in fixed investment.

During this period Spain's GDP in constant price terms fell by 9.2 billion. Governmentconsumption rose by 3.0 billion and net trade improved by 10.6 billion as Spain began toreverse its wide balance of payments deficit. There was a significant fall in personalconsumption of 7.1 billion but by far the dominant element was the 13.7 billion fall infixed investment. The fall in fixed investment in Spain was greater than the entire decline inGDP.

Figure 10


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Portugal

Figure 11 shows the changes in the components of GDP in Portugal in the recession after thefirst quarter of 2008 up to the first quarter of 2010. In constant price terms GDP fell 0.8bn,

net trade improved by 0.2bn while personal consumption increased by 0.3bn andgovernment consumption by 0.4bn. Fixed investment however fell by 1.5bn - more than

the entire decline in GDP.

Figure 11

Greece

Finally Figure 12 shows the changes in the components of GDP in Greece from the beginningof its recession, which commenced in the third quarter of 2008, up to the first quarter of 2010.In constant price terms Greece's GDP fell 2.0bn. Net trade improved by 0.2bn while

personal consumption fell by 0.1bn and government consumption by 0.3bn. Fixedinvestment fell by 1.8bn - i.e. approximately 90% of the fall in GDP was due to the declinein fixed investment.


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Figure 12

China

It is evident from the above data that whether considering the advanced economies as a whole,or looking at individual economies, the overwhelmingly dominant element in the economicdownturn is the fall in fixed investment. Decline in fixed investment accounts forapproximately 96% of the fall in GDP in the OECD area as a whole and for 76% of thedecline of GDP in Europe. In three countries - the US, Spain, and Portugal - the decline infixed investment was greater than the decline in GDP. In Japan, France and Greece the

proportion of the fall in GDP due to the decline in fixed investment was over 70%, 80% and90% respectively. In every country except Germany the fall in fixed investment was the

single biggest component of the decline in GDP. In short the decline in fixed investmententirely dominates the Great Recession. The policy conclusions which follow from this are

evident. The decisive question is to reverse the decline in investment.

It is equally clear from this data why China has come most successfully through the financialcrisis. China's government carried out its stimulus package not via an increase in the budgetdeficit, which has remained at less than 3% of GDP, but by a major increase in infrastructuraland other fixed investment.The comparative paths of fixed investment in China and the USunder the impact of their stimulus packages in 2009 are shown in Figure 13. Whereas in theUS fixed investment fell by twenty percent China's urban fixed investment rose by more thanthirty percent due to the stimulus package. The impacts, in terms of the changes in US and

China's GDP in 2009, are shown in Figure 14.

China's stimulus package dealt directly with the central issue in the Great Recession. Chinafocussed on investment - rather than attempting primarily to influence this indirectly via thehope that a stimulus to personal and government consumption, maintained by a large budgetdeficit, would induce a reversal of the investment decline. Consequently China was able tolaunch a large stimulus package without running a large budget deficit. The GDP growthinduced by the investment rise in turn produced large scale tax revenue - China's fiscalincome in 2009 rose by 11.7%, compared to major declines in tax revenue in the US and


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European economies. China therefore currently does not face the choice faced by the US andEuropean governments of whether to maintain large scale budget deficits, to attempt to

sustain economic stimulus, or whether to engage in fiscal consolidation. In light of the actualcharacter of the Great Recession China's stimulus package was therefore significantly better

designed than those in the US and Europe.

Understanding what has been the real core of the Great Depression will therefore better aidthe policy response in recovering from it.

Figure 13

Figure 14

* * *This article originally appeared on the blog Key Trends in Globalisation on 29 June 2010.


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The views expressed in this article are solely those of the author of this blog. The statisticalcalculations are those of the Research Group 'China and the International Financial Crisis' at

Antai College of Economics and Management, Shanghai Jiao Tong University.

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The Great Recession' is Actually 'the Great Investment Collapse"