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Why Western economies have budget crises and China doesn't

By John Ross | | Updated: 2011-08-05 14:46

Economic news from the US and Europe is dominated by budget deficits and government debt. Countries are either trying to slash deficits (the US, Greece, Italy, the UK) or believe they will have to bail out those running unsustainable ones (Germany, France). While Japan is currently preoccupied with overcoming the consequences of the tsunami, it also will soon have to face the reality that, due to decades of budget deficits, it has the largest government debt as a percentage of GDP of any country – twice that of the US.

In contrast China in 2008 launched the world's largest state stimulus package to deal with the international financial crisis but has no substantial budget deficit – this year it will only be around 2 percent of GDP. Naturally China has economic problems to deal with, particularly food price inflation, but these are not on the same scale as the budget deficit crises gripping the US and Europe. Analysing why China has no comparable budget deficit is therefore illuminating.

The core of the difference lies in what occurred during the "Great Recession" after 2008. In the US and Europe this is dominated by an investment collapse. In the 2nd quarter of 2011 US GDP was still $56 billion below its 4th quarter of 2007 peak. However all major components of US GDP except fixed investment were already above their previous peak levels – inventories were $37 billion above, government consumption $51 billion above, personal consumption $66 billion above, and net exports $159 billion above. But US private fixed investment was $342 billion below its 4th quarter 2007 level. The entire decline in US GDP was due to the fall in fixed investment. These changes are shown in Figure 1. A similar pattern exists in almost every major developed country.

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