Thursday, October 4, 2007

Reasons not to be Concerned by Consumer Led Growth

In this post: I suggested several problems of relying on consumer led economic growth. However, there are some reasons Not to Be Concerned by Consumer / Service Sector Led Growth

1. Changing Comparative Advantage.

Due to lower labour costs in China and other parts of Asia, it is much cheaper to produce labour intensive manufactured goods in China and not the US. Therefore, there is no reason why the US should feel obliged to try and compete with low labour cost countries. Countries should specialise in goods where they have a comparative advantage. For the UK and US this is no longer in manufactured goods but in industries like finance, insurance and education.

2. Increased Export Revenue from the Service Sector.

It is a mistake to feel that manufacturing is the best source of export revenue. Increasingly the UK and US achieve net foreign income flows through foreigners coming to study at American and British universities. This counts as a positive item on the current account. Therefore, there is nothing intrinsically wrong with relying on a service sector based economy. It is just that in the US consumer spending grew too fast and was unsustainable.

3. Self Correcting Mechanisms

If a country experiences a growing current account deficit it is not necessarily a problem. Firstly for many years Asian investors were willing to balance the current account deficit by buying US securities - causing a surplus on financial account, Balance of Payments. Now that these funds are drying up, it is causing a devaluation in the dollar. A devaluation should help correct the imbalances. It makes imports more expensive so reduces demand for imports. Over time it should help reduce the current account deficit.

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