Great Graphic: Surplus Capacity Is Not The Same As Insufficient Aggregate Demand

Many economists argue that the key challenge is that of insufficient aggregate demand. That is why world growth is slow. Hobbled with debt, households have pulled back. Business investment is weak. Government dissavings has been offset by household and business savings. The solution offered by some economists is a large public investment program. 

The G20 encouraged members not to rely on monetary policy, which even some central bankers are concerned, has reached a point of diminishing returns. China has already indicated intentions on providing some fiscal stimulus.

Japan, whose debt to GDP is the largest in the world, also sees scope for more spending. A supplemental budget for the current fiscal year has been approved, and there is talk in the face of weak growth impulses, the Abe government is considered to offer another supplemental spending program front-loaded at the start of the new fiscal year (April 1). Japan’s budget deficit is around 6% of GDP.  

We wonder if the problem is being misdiagnosed. To be sure, consumer demand is soft. Earlier today Japan reported overall household spending contracted 3.3% in the 12-months through January. It is the fifth year-over-year contraction, and this is ahead of the planned sales tax hike in April 2017. The eurozone will report retail sales Thursday. It is expected to have slowed to a 1.3% year-over-year rate. That would be the lowest since November 2014. It would be the fourth month that the year-over-year pace has slowed. This appears to be the longest declining streak since the aggregate data began in 2001. 

While weak demand is part of the problem, excess investment seems to be more intractable. Business investment is weak because there is still excess capacity in many, if not most, sectors. Summers has argued that new business require is less capital intensive than older industries, but capex in the older industries is poor too.