In economic theory, one of the ways output is defined is by the expenditure method. According to this approach the GDP of an economy is the sum of expenditures by the households, by the governments, by the corporations, and the net exports of a country. Symbolically the equation is Y= C+G+I+(X-M).
However, this equation seems to be getting pruned in the aftermath of the Global Financial Crisis (GFC). Most of the developed world is suffering from a sobering phase where the households that were so far consuming as if there was no tomorrow are drastically cutting back their spending and instead focusing on deleveraging. In UK, harsh economic conditions actually led to a decline in real disposable income in March 2011. Such a phenomenon has occurred after about 30 years.
Similarly heavy public debt burdens in most of the developed world have led to severe austerity cuts that comprise of budget freezes and job cuts. UK is already undergoing a four year spending review which would see decline in real expenditures, and USA has frozen discretionary spending. Greece recently witnessed loss of some 15,000 public sector jobs and this number of course is just a harbinger of what is likely to come.
So the developed world has basically ruled out any growth in the contribution of (C) and (G) to (Y) in the output equation. Instead they are banking on (I) and (X-M) to offset the loss of growth in two of the erstwhile leading engines of growth.
The growth plan broadly reads as follows: make private sector invest more by reducing the crowding out by the government sector, and leverage and redirect this investment so as to be able to serve external markets and external demand in emerging economies by way of exports. Given the rising cash surpluses with developed world corporations and the rising middle class in emerging economies the plan seems perfect on the face of it.
However, this plan runs on big assumptions about the feasibility of such a large structural change in the developed world economies as well as the appetite of the emerging economies for such exports and investments. Only time will tell if this experiment around a pruned output equation would do the job.
