Imbalances between Consumption and Investment (2) — Michael Pettis on Crises of Imbalance

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Continued from here.

Michael Pettis seems to suggest that most of the great economic crises (of the 1870s, 1930s, 1970s, as well as the present one of 2007/2008) are under-consumption crises. That is, the amount of economic resources consumed is insufficient to justify the amount of resources saved (S) or invested (I), where I = S.

More is produced than can be absorbed by the consuming public. The cause of this imbalance may be interpreted to be a case of inequality. Low(er) income members of the public—always the largest aggregate contributors to consumption—are insufficiently wealthy and/or command too little income to sustain a level of consumption commensurate with the present amount of investment/savings. The economic meaning of inequality then is: those with the highest propensity to consume have less means at their disposal for consumption compared to the wealthier, who have a lower propensity to consume, and compared to investment/savings. Thus, equality is defined in terms of an optimal relationship between the spending power of high-propensity-consumers and low-propensity consumers. Incidentally, defining equality in this sense does not necessarily imply equality in an absolute sense, where everybody has the same level of wealth and income.

Economically speaking, inequality denotes a situation of excess savings/investment.

(1)  increasing the level of debt incurred by consumers to compensate for their lack of means to effect consumption. This, however, is not a sustainable strategy, as it will hit a ceiling, sooner or later, where debt capacity is fully stretched. And there are two sustainable scenarios of adjustment:

However:

There are, it turns out, two sustainable responses to a forced increase in the savings rate in one part of the economy. The first is an equivalent increase in productive investment. The second is an increase in unemployment. (p.198 here)

That is:

(2) unemployment, which builds as supply is reduced to square with the low level of disposable income/wealth, and

(3) more productive investment, which ultimately puts more money in the pockets of everyone, thus counterbalancing the initial imbalance.

Writes Pettis:

Rising income inequality reduces total demand. It does so in two ways. First, it directly forces down the consumption share of GDP, and second, it reduces productive investment by reducing, as Eccles says, “the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants.”

But—and here is where I will presume to add something new to the historical debate about income inequality and underconsumption—there is another very important form of rising income inequality that also forces up the savings rate in a very similar way, and this has been especially important in the past two decades. A declining household share of GDP has the same net impact as rising income inequality.

We have seen this especially in places like Germany and China during the past decade. In both countries policies were implemented that, in order to spur growth and, with it, employment, effectively transferred income from households to producers of GDP (the state or businesses). (p.199 here)

What I do not yet quite grasp is how forcing down "the consumption share of GDP" need not be tantamount to “a declining household share of GDP”—households being the big driver of consumption? How does one force down the consumption share in GDP without forcing down the household share in GDP?