Friday, November 28, 2014

Stagnation by Design

NEW YORK – Soon after the global financial crisis erupted in 2008, I warned that unless the right policies were adopted, Japanese-style malaise – slow growth and near-stagnant incomes for years to come – could set in. While leaders on both sides of the Atlantic claimed that they had learned the lessons of Japan, they promptly proceeded to repeat some of the same mistakes. Now, even a key former United States official, the economist Larry Summers, is warning of secular stagnation.

The basic point that I raised a half-decade ago was that, in a fundamental sense, the US economy was sick even before the crisis: it was only an asset-price bubble, created through lax regulation and low interest rates, that had made the economy seem robust. Beneath the surface, numerous problems were festering: growing inequality; an unmet need for structural reform (moving from a manufacturing-based economy to services and adapting to changing global comparative advantages); persistent global imbalances; and a financial system more attuned to speculating than to making investments that would create jobs, increase productivity, and redeploy surpluses to maximize social returns.

Policymakers’ response to the crisis failed to address these issues; worse, it exacerbated some of them and created new ones – and not just in the US. The result has been increased indebtedness in many countries, as the collapse of GDP undermined government revenues. Moreover, underinvestment in both the public and private sector has created a generation of young people who have spent years idle and increasingly alienated at a point in their lives when they should have been honing their skills and increasing their productivity.

On both sides of the Atlantic, GDP is likely to grow considerably faster this year than in 2013. But, before leaders who embraced austerity policies open the champagne and toast themselves, they should examine where we are and consider the near-irreparable damage that these policies have caused.

Every downturn eventually comes to an end. The mark of a good policy is that it succeeds in making the downturn shallower and shorter than it otherwise would have been. The mark of the austerity policies that many governments embraced is that they made the downturn far deeper and longer than was necessary, with long-lasting consequences.

Real (inflation-adjusted) GDP per capita is lower in most of the North Atlantic than it was in 2007; in Greece, the economy has shrunk by an estimated 23%. Germany, the top-performing European country, has recorded miserly 0.7% average annual growth over the last six years. The US economy is still roughly 15% smaller than it would have been had growth continued even on the moderate pre-crisis trajectory.

But even these numbers do not tell the full story of how bad things are, because GDP is not a good measure of success. Far more relevant is what is happening to household incomes. Median real income in the US is below its level in 1989, a quarter-century ago; median income for full-time male workers is lower now than it was more than 40 years ago.

Some, like the economist Robert Gordon, have suggested that we should adjust to a new reality in which long-term productivity growth will be significantly below what it has been over the past century. Given economists’ miserable record – reflected in the run-up to the crisis – for even three-year predictions, no one should have much confidence in a crystal ball that forecasts decades into the future. But this much seems clear: unless government policies change, we are in for a long period of disappointment.

Markets are not self-correcting. The underlying fundamental problems that I outlined earlier could get worse – and many are. Inequality leads to weak demand; widening inequality weakens demand even more; and, in most countries, including the US, the crisis has only worsened inequality.

The trade surpluses of northern Europe have increased, even as China’s have moderated. Most important, markets have never been very good at achieving structural transformations quickly on their own; the transition from agriculture to manufacturing, for example, was anything but smooth; on the contrary, it was accompanied by significant social dislocation and the Great Depression.

This time is no different, but in some ways it could be worse: the sectors that should be growing, reflecting the needs and desires of citizens, are services like education and health, which traditionally have been publicly financed, and for good reason. But, rather than government facilitating the transition, austerity is inhibiting it.

Malaise is better than a recession, and a recession is better than a depression. But the difficulties that we are facing now are not the result of the inexorable laws of economics, to which we simply must adjust, as we would to a natural disaster, like an earthquake or tsunami. They are not even a kind of penance that we have to pay for past sins – though, to be sure, the neoliberal policies that have prevailed for the past three decades have much to do with our current predicament.

Instead, our current difficulties are the result of flawed policies. There are alternatives. But we will not find them in the self-satisfied complacency of the elites, whose incomes and stock portfolios are once again soaring. Only some people, it seems, must adjust to a permanently lower standard of living. Unfortunately, those people happen to be most people.

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    1. CommentedClaude Simon

      Capitalism sucked probably too much our ecosystems. It's time for existentialism instead.

    2. CommentedHardik Udeshi

      To guage the effectiveness of the response based on the uni-dimensional criteria of the length of the downturn overlooks the crucial economic and political choices that the governments and political actors of the day had to undertake.

      In the immediate aftermath of the financial crises, governments all across were trying to stop the contagion to spread - true, some of the reactions were knee-jerk, but they had to be made on a relatively short notice. As the crises unfolded, underlying political considerations of the Euro-zone also played a role in determining European nation's responses. IMHO, it would be wrong to question the effectiveness of the response overlooking the above factors.

      Even from a strictly economical point of view, a good policy should make 'full use of the crises' and usher in the structural reforms whose needs were hidden in the glittery shine of pre-recession boom. The policies proposed by Dr. Stiglitz indeed work in those direction.

    3. CommentedFabio Souza

      About 2 years ago the industrial production in US came to the pre-2008 level, but with less worker, about 2 million laid off. Some of that change came also about transfering productions to areas with lack or weak unions, where workers can make their representantion. It may not be all the cause of inequality income and distribution, but sure it helps to worsen.
      Another debate about inequality.

    4. CommentedRoger McKinney

      "Markets are not self-correcting."
      How would Stiglitz know? We don't have a free market. The Federal Register has added over 3 million pages of new regulations since 1970. Markets cannot work with such massive government intervention. Yet Stiglitz, the old unreformed socialist blames the market.

        CommentedROBERT BAESEMANN

        I wonder what would prompt anyone to count pages in the Federal Register, but the scope and severity of Federal Regulation has greatly declined since 1970. Over the last 43 years, the US has abolished the CAB and ICC, feed telecomm companies to compete, eliminated the Nixon COLC price controls and the Carter CWPS Price and Wage Standards, modified EPA standards, and abolished Glass-Steagall.

        Left to their own devices markets might have never turned toward high mileage automobiles, mandatory airbags, etc. Unregulated markets produced AAA ratings CDOs and Credit Default Swaps issued by companies with no reserves and $62 Trillion in potential liabilities.

        CommentedAlan Luchetti

        Roger, all the liars loans and junk derivatives flowered under repealed and ignored regulations. I'll take a free marketeer seriously when he stands up for global removal of all immigration controls in order to ensure a free labor market.

    5. Commentedkiers sohn

      So True! QE is a joke. Everytime QE is mentioned on the Tele, the video shows pictures of money being printed off the press! A completely opposite is in fact true. QE was a time out....a freeze on economic expansion. QE was deflationary! It must have served some geopolitical purpose but it did not help the common man. It certainly helped the US government get free money by not having to repay those bonds that the Fed purchased and lie in its cupboards. Meanwhile overall effect of QE was a TIME OUT on the conomy! totally the opposite of what the news shows

    6. CommentedGary Palmero

      The trend towards most labor becoming commoditized in the US was underway in the mid-2000s but was likely accelerated by the 2008 downturn and subsequent events. Fighting the last war is not going to move the needle appreciably. The education system in the US has to become more responsive to the new reality--especially that part oriented to middle class children--by aiming the cirriculum more towards innovative thinking and problem solving and away from standardized testing in a one size fits all environment. Many economists are excellent in describing the challenges but all the efficiency in that sector will be of little importance if we do not implement an educational environment where students can be flexible, innovate and be able to respond to continuous changes--rather than preparing for a set career that may collapse from under them.

    7. CommentedJohn A Werneken

      Why is a recession better than a depression, or malaise better than recession? Human nature, not lax regulation, causes asset bubbles. Recession and depression, not public investment, cures excesses and restores growth. A stable currency and market-set interest rates create investment and jobs, not "stimulus".

      “Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people” – Advice from Andrew W. Mellon which had it been followed bt President Hoover would have prevented the stock market corrections of 1929 from becoming the Great Depression in the first place.

      Mr. Mellon was far from heartless:

      Andrew Mellon's plan had four main points:
      1. Cut the top income tax rate from 77 to 24 percent – predicting that large fortunes would be put back into the economy.
      2. Cut taxes on low incomes from 4 to 1/2 percent – tax policy "must lessen, so far as possible, the burden of taxation on those least able to bear it."
      3. Reduce the Federal Estate tax – large income taxes tempted the wealthy to shift their fortunes into tax-exempt shelters.
      4. Efficiency in government – lower tax rates meant few tax returns to process by few government workers; cutting the actual size of paper bills to fit into wallets saved expenses in paper and ink.

      Mellon believed that the income tax should remain progressive, but with lower rates than those enacted during World War I. He thought that the top income earners would only willingly pay their taxes if rates were 25% or lower. Mellon proposed tax rate cuts, which Congress enacted in the Revenue Acts of 1921, 1924, and 1926. The top marginal tax rate was cut from 73% to 58% in 1922, 50% in 1923, 46% in 1924, 25% in 1925, and 24% in 1929. Rates in lower brackets were also cut substantially, relieving burdens on the middle-class, working-class, and poor households.
      By 1926 65% of the income tax revenue came from incomes $300,000 and higher, when five years prior, less than 20% did. During this same period, the overall tax burden on those that earned less than $10,000 dropped from $155 million to $32.5 million.[7]

      Mellon also championed preferential treatment for "earned" income relative to "unearned" income. As he argued in his 1924 book, Taxation: The People's Business[8]
      The fairness of taxing more lightly incomes from wages, salaries and professional services than the incomes from business or from investments is beyond question. In the first case, the income is uncertain and limited in duration; sickness or death destroys it and old age diminishes it. In the other, the source of the income continues; the income may be disposed of during a man's life and it descends to his heirs.
      Surely we can afford to make a distinction between the people whose only capital is their mental and physical energy, and the people whose income is derived from investments. Such a distinction would mean much to millions of American workers and would be an added inspiration to the man who must provide a competence during his few productive years to care for himself and his family when his earning capacity is at an end.[9]

      Mellon's policies helped reduce the overall public debt (the national debt skyrocketed from $1.5 billion in 1916 to $24 billion in 1919 because of World War I obligations) from $33 billion in 1919 to about $16 billion in 1929,[10] but then the Depression caused it to rise again because of reduced revenue and increasing spending. The top tax rate went to 80% by 1935 and the federal government increased excise taxes in an attempt to make up for the lost revenue.[7]
      (From Wikipedia)

    8. CommentedRocio L. Barrientos

      Very well thought article; it would have been nice if Dr. Stliglitz would had elaborated a bit more about how bad things are by quoting some education and health related indicators.

    9. Commenteddavid ursiny

      Your crises of asset bubbles in sectors, is the result of to much money in the rich class, they just buy paper securities, inflating false value on the assets by a false demand by pumping more money into paper value then its real value, the whole investment market system is designed in this manner ,raise the taxes real high on the wealthy and that will slow down this investment bubble system by restricting inflow of cash to inflated value paper

    10. Portrait of Michael Heller

      CommentedMichael Heller

      Peter Gosnell, this must be true in part, 'the people' (that great receptacle of common sense) are 'freely' imposing austerity by deleveraging, and we live in free societies only because they have proved the most adaptable kind. If so the evolutionary process admired by some commenters on this site will produce a fitter economic system better tuned for survival. A consequence is that firms and governments become leaner / smarter to survive lower demand / lower revenue (IF they are not on 'cheap money' life support). Logically Schumpeter's 3 'r's rationalisation, retrenchment, restructuring most rapidly restore capitalism's wave (hello America). But, by definition there is a down side during the trough. Insolvency professionals get hit !

        CommentedStamatis Kavvadias

        "Schumpeter's 3 'r's rationalisation, retrenchment, restructuring"

        Ouaou! How familiar you are with throwing economic sugar over issues you cannot address with economic thinking!

        "the evolutionary process [..] will produce a fitter economic system better tuned for survival. A consequence is that firms and governments become leaner / smarter to survive lower demand / lower revenue [...]"

        Is that a representative example of economic science thinking? Because this is an exemplary logical jump. "Fitter" is not always better tuned for survival --unless survival in your case always refers to the richest people!

    11. CommentedPeter Gosnell

      Not one "flawed policy" specifically identified and convincingly dismantled. Not one "alternative" presented. I understand why this is free content. For what it's worth, my view is that demand is weak largely because income is being deployed to deleverage. The people are imposing their own austerity. I know progressives don't trust the people enough to leave them alone but if their choice is to discharge debt then if you want to avoid being branded a Fascist then let them get on with it.

        CommentedJames Goodman

        Austerity and financial deregulation.

        On the matter of austerity, analysis by Moritz Schularick shows the co-evolution of public and private debt in 17 advanced economies over the last 140 years, where “the government’s capacity to alleviate a downturn is limited by the prevailing level of public debt.” Holding fiscal space constant, austerity during private-sector deleveraging will most certainly compound and prolong the effects of deleveraging.

        On the matter of financial deregulation…

        Jacob Assa: Financialization has had a strong, adverse impact on 1/inequality, 2/economic growth, and 3/unemployment in OECD countries since 1970.

        Lin & Tomaskovic-Devey: In US corporations between 1970 and 2008, financialization accounts for more than half of the decline in labor’s share of income, 10% of the increase in executive pay, and 15% of the growth in earnings dispersion among workers at the industry level.

        William Lazonick: The Explosion of Executive Pay and the Erosion of American Prosperity

        Richard B. Freeman on financialization: Reform finance or the real economy will suffer the consequences. “Reforming finance will be an uphill battle requiring the countervailing power of groups outside the sector in order to succeed.”

        Lin & Tomaskovic-Devey: Income Dynamics, Economic Rents and the Financialization of the US Economy

    12. Portrait of Michael Heller

      CommentedMichael Heller

      Joseph, where *have* you been? Don’t you know that because most politicians had the good sense not to heed the king-Keynes hysteria whipped up by you and a certain other highly-decorated 4th international economist the world survived the crisis? You must find life tedious now that recovery is evidently underway. I don’t sympathise. Were it not for a couple of limelight-hogging veteran ideologues with nobels pinned to their lapels and a coterie of huff ‘n puff media lapdogs at FT and NYT we might be riding the crest of the next Schumpeterian wave by now. History won’t look gently on you for sowing seeds of doubt and weighing down the entrepreneurial bandwagon with all your moaning and groaning.

      Hi James Goodman, my gosh I’m glad I didn’t stick around at UTS. Are ALL of you still spouting class warfare 10 years on, or was it just you who got left behind ?!

        CommentedStamatis Kavvadias

        "Were it not for a couple of limelight-hogging veteran ideologues with nobels pinned to their lapels and a coterie of huff ‘n puff media lapdogs at FT and NYT we might be riding the crest of the next Schumpeterian wave by now."

        So, you suggest the media should host only the opinions you would appreciate?

        And, really, is all that vulgar comment your "expert" opinion?
        And all these things you know about the future!

    13. CommentedProcyon Mukherjee

      This is one of the best commentaries on the current stagnation, a rather strong message for those who seem to be celebrating a mild recovery in absence of nothing else to frame. Stiglitz is so right to point out the biggest remiss that a sector which gained so much before the crisis, gained even more after, from the relentless back-stops and printing, which never reached goods and services it was meant to reach out to; the reversal of wage growth, instead of being the center of discussion has been relegated to the smaller academics, while the focus has always been on capital formation in whatever way. Such divergence in the history of the world can only come from a design, rather bizarre that a recovery that is anodyne on prices and wage could have such an impactful poise on the stocks, transitory as it can only be, otherwise.

    14. CommentedJames Goodman

      Joe Stigltitz cuts to the core of the issue – flawed policy. Deregulation of financial and labour markets is most certainly behind the snowballing inequality that is underlying secular stagnation in the US. Yet, there seems to be no political impetus to make bold policy changes. The neoliberal ideological focus on deregulation has enabled growing financialization, like an economic cancer of welfare income that feeds the financial elite and a growing financial sector by eating away at the real sector. The real sector is where prosperity evolves (nod to Matt Ridley), and as Joe Stiglitz says, the financial sector is there to allocate investment capital in profitable activity – not speculation. The rising share of US national income that is being expropriated by the financial sector and stock-based CEO compensation is essentially welfare income for the rich (Lazonick, link 1; Mishel & Sabadish, link 2; Palley, link 3). Long story short, the problem will not magically solve itself, unless there is enough testicular fortitude and civic virtue in US politicians to focus on increased regulation of financial markets and labour markets. So, will the US lead by example for other OECD countries, or serve as an example of what not to do? Hopefully, common sense and independent judgement will prevail over political ideology.

    15. CommentedEpicurean Analyst

      Prof. Stiglitz, I love you, but you have to stop layering your analysis with "I" statements. You're brilliant, we know it, your reputation is definitely at stake, but it simply doesn't matter that you've been right all along. It's a problem in economics today, and it's one of the reasons that people discount good opinions. Smart social science is only rarely presented as "this is what "*I* said, *I* was right." Please, for your own sake and for the sake of the discourse, try to write pieces that leave out "I warned" "I raised" etc. Your reputiation is secure, and you can easily do without.

    16. CommentedTim Nevins

      The inability of policy makers to predict or deal with the consequences of the global financial crisis raises the question whether greater oversight of policy is needed. Politicians ceded control of monetary policy to independent economists at the central bank so maybe a similar body responsible for regulating fiscal spending and pushing for reforms should be given greater consideration. For more, see