C = Private Consumption
I = Business Investment
G = Government Demand
(X-M) = Net Exports
With government spending being very liberal and effective in creating growth there is a need for the other components of GDP to do their part – Private Consumption, Business Investment and Net Exports.
Exports in the US have been disappointing equaling 14% of GDP compared to the euro zone’s 26%.
Business investment has also been subdued as lower profits mean less investment.
Private consumption hasn’t been as strong as anticipated even with the windfall gain of the significant fall in oil price and the growth of outstanding consumer credit. The biggest barrier to increasing private consumption is the level of pay to employees. Across the US median inflation-adjusted wages are not higher today than they were pre GFC.
Why are wages so low?
The Economist identified three things that have been behind the slow growth of wages in the US.
1. America’s Unemployment-Insurance
With the US government cutting back on unemployment benefits the wage expectations of workers fell. Businesses took advantage of this cheaper pool of labour and in 2014 a significant proportion of the 31 million jobs created wherein poorly paid industries.
2. The Behaviour of Firms
When the GFC hit firms found it difficult to reduce the wages of their staff but fired their least productive workers keeping the most productive happy. To compensate for the higher wages paid to the most productive firms were willing to offer new recruits only low wages.
3. Persistent Labour Market Slack
As there are worker available to fill jobs that become available firms are able to offer paltry wages. The number of part-time workers who would rather be full timers – called part-time for economic reasons (PTER) – fell much more slowly than the official unemployment rate following the GFC. The same can be said for discouraged workers i.e. the number of those wanting a job but say there is no point in looking. Research has found that a 1% fall in the PTER rate is associated with 0.4% fall in real wage growth. When the PTER is high, workers may feel unable to ask for higher wages, since what they really want is more hours.
It seems that the US economy lives and dies by what happens to consumer spending.
Here is an excellent webinar by Geoff Riley of Tutor2u on the multiplier and accelerator. This is part of Unit 5 in the CIE A2 course. Although the examples that he talks about are UK based he explains the theory very well. Worth a look especially with mid year exams approaching.
Over the Easter break I heard a very good interview on Kim Hill’s Saturday morning programme. The interview was with Bronwyn Hayward Associate Professor of Politics and head of the Department of Political Science at the University of Canterbury, who will lead one of nine research teams for the new international Centre for the Understanding of Sustainable Prosperity (CUSP).
In short, “Sustainable prosperity” would come as a result of sustainable development that enables all human beings to live with their basic needs met, with their dignity acknowledged, and with abundant opportunity to pursue lives of satisfaction and happiness, all without risk of denying others in the present and the future the ability to do the same. This means not just preventing further degradation of Earth’s systems, but actively restoring those systems to full health. Source: Worldwatch.org
Here is the link to the interview
Radio New Zealand – Bronwyn Hayward Interview
The accelerator theory states that investment is determined by the RATE AT WHICH INCOME, AND HENCE OUTPUT, CHANGES OVER TIME. The principle states simply that unless the rate of increase in consumption is maintained, the previous level of investment will not be maintained.
This theory assumes that firms try to maintain some constant relationship between the level of output and the stock of capital required to produce that output. In other words, we assume a constant capital-output ratio which can be expressed in either physical terms or money terms. The accelerator helps us to understand how small changes in demand in one sector can be magnified and spread throughout the economy. The example below assumes that the firm starts with 8 machines each year and 1 machine wears out each year and that each machine can produce 100 units of output per year. In the second year, demand rises for capital goods rises by 200% (from 1 to 3). When the rate of growth of demand for consumer goods slows in year 4, demand for capital goods falls. In year 6 demand drops and they is no requirement for any investment.
Limitations of Accelerator:
* Firms can meet output with stocks – may not need investment
* Changes in technology may mean firms don’t need to invest in as much capital as before
* Firms need to be convinced that demand is long-term to warrant investment
* Limited supply of technology available
The recent drop in oil prices from $115 per barrel in June last year to $58 per barrel today (10th March) has asked the question why don’t oil producers cut back on supply? This would seem to be the logical policy to pursue as the revenue of oil producers has been cut significantly. However Saudi Arabia has allowed big oil surpluses to grow and as a result the price has fallen. As Saudi Arabia can extract the oil from the ground at a much lower cost than its oil producing counterparts they have a greater ability to absorb the lower oil price. Those that have a high cost of extraction – US shale producers, the tarsands of Canada, Russia, Venezuela – are now finding the return from oil is much lower. Therefore, the plan being to force high costs producers out of the market leading to an increase in the market share of the Gulf states.
Excess Oil Supply
There has been a growing amount of oil in storage which is absorbing the glut. World stocks have increased by approximately 265m barrels last year and is suggested to increase by a further 1.6m-1.8m barrels a day in the first six months of 2015 which adds about 300m barrels to the total. Oil producers are hoping that the demand for oil will increase next year and that the accumulated stock will satisfy that demand. However the restocking cannot continue for long as storage facilities in Europe and Asia are already at 80-85% capacity. Companies are going as far as renting oil tankers to store the excess oil. And what happens if storage facilities start to reach full capacity, then producers will be forced to dump supply onto the market dropping the price even further. There is the belief that oil prices will drop in the long run which will mean a restructuring of the industry.
Source: The Economist February 21st 2015
Here is an image from the recent Westpac Economic Overview. As New Zealand is the world’s largest exporter of dairy products any disruption in the supply from New Zealand can impact on the global dairy prices. The last few droughts saw world dairy prices increase considerably as milk supply from the rest of the world was unable to adjust to market conditions. However supply capacity in the US and the EU has increased and with Russia’s import ban there is a much greater supply on the global market. Nevertheless, this doesn’t disprove the possibility that prices rise when supply falls short. The overall signs are that supply and demand are coming into line as Chinese buyers run down stocks. The drought in New Zealand will further boost prices from current low levels. Westpac expect the milk price to rise to $6.40/kg for the next season. Below is a useful video clip from Dominick Stephens – Chief Economist at Westpac – about the primary sector in New Zealand. It is very good on fundamentals – supply and demand.
Just been going through this part of the course with my A2 class and came across a table from some old A Level notes produced by Russell Tillson (ex Epsom College Economics and Politics Department) to help them understand the principal differences.