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The American Consumer's Roller Coaster

As previously shown in Exhibit 1.1, the American consumer is by far the largest driver in the GDP Growth Equation. In fact, in developed countries such as the United States, the European nations, and Japan, personal consumption expenditures typically account for fully two-thirds of economic activity. That's why a strong consumer with robust purchasing power is critical to any long-term American recovery.

Right now, the American consumer is anything but strong and robust. A large part of the problem is a frayed and tattered household "balance sheet" that remains as a leftover from overconsumption during much of the last decade. It was precisely this pattern of overconsumption (and a collateral low level of saving) that helped fuel America's housing bubble and eventually helped trigger the consumer-led 2007–2009 crash.

In fact, much of the overconsumption that occurred during the past decade was driven not by rising income and wages but rather by rapid home price appreciation. As housing prices rose during the bubble years, millions of Americans relied more and more on the black magic of mortgage refinancing for their spending needs rather than on rising wages and income.

By refinancing their mortgages and removing equity from their homes in the form of cash payouts, consumers effectively turned their homes into automatic teller machines. Collectively, this "house as an ATM" phenomenon provided a tremendous short-term consumption boost to the economy.

However, with consumers spending beyond their means and stretching their balance sheets, that kind of economic boom would inevitably go bust. Once the housing bubble burst, the "house as an ATM" consumption stimulus for the economy went into reverse, and consumption spending slowed dramatically.

Today, as the American economy attempts to resume its robust long-term growth pattern, a big brake on that growth remains a chastened consumer being squeezed on at least four fronts.

First, with housing prices stagnant and foreclosures an ongoing problem, the houses of many consumers are worth less than their mortgages. This "negative equity" problem puts a severe crimp on spending, and using one's home as an ATM is no longer an option.

Second, persistently high unemployment constrains future GDP growth in both an obvious and subtle way. Most obviously, all the people in unemployment lines, who aren't bringing home a paycheck, are by definition spending far less than they otherwise would. More subtly, a high unemployment rate puts strong downward pressure on the wages of those who are employed, further suppressing consumption.

In still a third dimension of the problem, inflation has vitiating effects on America's purchasing power. Not only are oil and gasoline prices in a long-term upward trend, but so are the prices of imported goods ranging from foreign cars to toys and electronics as the value of the American dollar declines.

Finally, income growth has actually been negative since the beginning of the nought decade—in contrast to very robust growth in the preceding two decades. This is illustrated in Exhibit 1.3 using one of the best measures of income growth—real, inflation-adjusted average median household income.

Exhibit 1.3. Real Median Household Income Over the Past Three Decades


Total Growth Rate for the Period

Average Annual Growth










You can see that during the 1980s, real median household income grew a total of 18% over the decade, or 1.8% annually. Similarly, during the 1990s, the total growth rate was 16%, or 1.6% annually. However, during the nought decade through 2008, income growth actually went negative—to a growth-vitiating minus 1.4% over the nine-year period.3 As we shall explain, there are at least two reasons for this—one obvious and one more subtle.

The problem is not so much one of insufficient productivity growth, though an increasingly hostile tax, trade, and regulatory environment is harmful to income growth. A more subtle part of the problem, however, is rapidly rising health care costs. These out of control costs (which we squarely address in Chapter 9, "Why ObamaCare Makes Our Economy Sick") have taken an ever increasing share out of the total compensation paid to workers by employers in our employer-based health care system.

It follows from these observations that restoring the strength of the American consumer as an important driver of long-term economic growth is a complex and multidimensional task. Any broad rebalancing solution will incorporate at least five components.

First and foremost, it will mean putting unemployed Americans back to work. Second, it will mean stabilizing the housing market and housing prices. Third, it will mean more rapidly increasing the productivity of the American worker and making U.S. industry more competitive in international markets so that wage and income growth can once again boost purchasing power. Fourth, it will mean reducing America's dependence on increasingly expensive oil. Finally, it will mean creating a strong and stable dollar so that our import bill remains manageable.

Two final points on the consumption driver in the GDP Growth Driver equation are worth noting. First, nothing we have said about the falloff of consumer spending in this new decade should be construed as exhorting consumers to "go to the mall and help spend their way to prosperity." We tried that strategy in the 2000s, and what we got was initially a housing bubble, and then a housing bust, and then a bad balance sheet hangover.

Second, nothing we have said about the 2000s being a decade of overconsumption should be construed as an anticonsumption, moralistic judgment. Quite the contrary: We advocate a strong and robust consumer who generates sufficient income and wealth to enjoy a rising standard of living without going deeply into debt. Only with such a strong and robust consumer will we regain our path to prosperity.

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