As US shoppers retreat, can world thrive?

Consumers were the biggest engine of global growth. But indebtedness prevents that now.

Buying stuff – it's been the American way. Free-spending US consumers for years have been a powerful engine for growth in the global economy.

But a hefty chunk of that cash outflow was borrowed. Drawing against home equity and credit cards, American households since 2006 have paid out some $400 billion more than they've earned.

Now the credit crisis, plus a recession, may push US consumers to live within their means. All signs indicate that for some time to come they'll be buying fewer domestic cars, Italian suits, and Taiwanese laptops.

Who, or what, might take up the slack? Can spending by governments, say, or Chinese consumers step in and replace open American wallets as the main motive force of world growth?

"We're going to test that proposition over the next year," says Brad Setser, fellow for geoeconomics at the Council on Foreign Relations.

The US economy is the largest in the world. Within that economy, consumers are the dominant force. From Main Street to the strip mall, retail activity accounts for about three-fourths of US gross domestic product (GDP).

Over the years, debt has become an increasingly important factor in US consumer culture. From the 1960s until the early 1990s, American households saved about 9 percent of their after-tax income. Then, cheap credit plus good economic times encouraged even faster spending, and the savings rate dropped to about 3.5 percent.

Since 2005, the spending has become even more frenetic, in the sense that the savings rate has sunk to about 1 percent, according to US government figures.

"We spend too much. We save too little. And I suspect those trends are going to change," said Timothy Adams, a former undersecretary of the US Treasury for international affairs, at an Oct. 16 Council on Foreign Relations symposium.

Experts have long predicted a slump in levels of US consumer spending, only to be proved wrong as flat-screen TVs, designer back-to-school outfits, and fried burrito stackers continue to march out the door.

This time may be different. Levels of consumer confidence are as low as they have ever been, in the face of unprecedented credit turmoil and a slumping economy. Plus, the collapse of home prices has stripped owners across the country of paper wealth.

Since 2007, US households have lost nearly $7 trillion, or 12 percent, of their net worth, according to a new report from the financial analysis firm Global Insight.

Thus, it's unlikely consumers are going to pull the US, and the rest of the developed world, out of its current downturn with a fresh burst of spending.

"They're going to have to rebuild their balance sheets," says Peter Morici, an economics professor at the University of Maryland. "Savings will go up."

Real consumer spending declined in the third quarter of this year for the first time since 1991. It may resume growing again in the first quarter of 2009, but only just. Then it may wobble forward at an anemic 1.7 percent in the second quarter, predicts the Global Insight forecast.

So, if the US consumer isn't going to be the spark that lights a recovery, what will? In the long term – can anything replace the role American consumer spending now plays in the global economy?

The short answers here may be "governments" and "yes."

"Government spending will have to play a big role in bridging the deleveraging of US consumers to the next global demand generator," says Mr. Setser of the Council on Foreign Relations.

That is why Washington is now talking about a second stimulus package as a follow-on to the $100 billion in tax rebate checks sent out this spring. Ben Bernanke, chairman of the Federal Reserve, came out in favor of the idea on Oct. 20.

Any such move should be "significant," among other things, Mr. Bernanke told the House Budget Committee.

The US isn't the only country mulling over a stimulus move. The German government could propose measures to boost its domestic economy, the largest in Europe, as early as next week.

But even advocates acknowledge that a stimulus package would provide only a quick short-term boost. Longer-term balance in the world economy might require another development: growing consumer demand in the emerging economies of Russia, Brazil, India, and China. Especially China.

"An expanding middle class in emerging economies will over time alleviate the traditional reliance on the US consumer to propel global economic growth," says Sabina Dewan, associate director for international economics at the Center for American Progress, in an e-mail message.

The rise of new consumers "will at the same time generate additional demand ... for US products and services, leading to improvements in living standards in America," says Ms. Dewan.

Again, that's long term. Today, the consumption spending of China's 1 billion consumers, plus some 1 billion Indian consumers, is $600 billion – or about one-sixth of US consumption spending.

But growth rates in developing nations are much higher than in the industrial world. China's GDP, for instance, is about one-quarter to one-third the size of that of the US. But its growth rate in the past two years has been more than 11 percent.

That's been cooling in recent months due to slumping demand for Chinese exports. But Chinese industrial spending, plus its existing consumer sector, should help maintain a growth rate of over 9 percent for the next two years, according to new International Monetary Fund projections.

"The gap in growth rates is so big it can quickly offset the larger base [of the US economy]," says Setser.

By 2030, the size of the economies of the G7 industrialized nations and those of Brazil, Russia, India, and China should be about equal.