Tuesday, November 25, 2014
10

The Fear of “L”

WASHINGTON, DC – For the last few years, economists have been running through the alphabet to describe the shape of the long-awaited recovery – starting with an optimistic V, proceeding to a more downbeat U, and ending up at a despairing W. But now a deeper anxiety is beginning to stalk the profession: the fear of what I call an “L-shaped” recovery.

Viewed in the light of the past five dismal years, 2013 was not bad for the advanced economies. The eurozone technically emerged from recession, the unemployment rate in the United States was lower than in previous years, and Japan began to stir after a long slumber and the negative shock of the earthquake and tsunami in 2011.

But if we look beneath the surface, it becomes evident that we are still hovering on the edge of a precipice. In the third quarter of this year, GDP contracted, on a year-on-year basis, not just in well-known cases like Greece and Portugal, but also in Italy, Spain, the Netherlands, and the Czech Republic. And GDP in some countries, like France and Sweden, grew at rates lower than population growth, implying that per capita income declined.

Moreover, labor-market conditions deteriorated toward the end of the year. The number of unemployed in Germany grew for four consecutive months up to November. Among the industrialized countries, the US is the bright spot. But, even there, while the unemployment rate has dropped during the year, and now stands at 7%, long-term joblessness is at an unusually high 36% of total unemployment, threatening to erode the skills base and make recovery that much more difficult.

Japan’s revival, meanwhile, was caused by a much-needed liquidity injection. But Japan’s upturn will be short-lived unless Prime Minister Shinzo Abe’s government follows through on its promise of deeper structural reforms.

Given these developments, a few commentators have written recently about the possibility of a prolonged slowdown in industrialized countries. This is not a popular view, with others criticizing its advocates for stoking pessimism. But the pessimists cannot be dismissed out of hand.

The fear of an L-shaped recovery is legitimate. Modern technology has enabled workers in emerging economies to join a global labor market; in the absence of major policy innovation, this is likely to cause a prolonged drag on rich countries. And there are few signs of innovation.

There is, instead, a crisis of the economics profession, one that mirrors the crisis of the advanced economies. Thanks to technological change and relentless globalization, the character of entire economies has changed dramatically over the last 50 years. This has not been matched by changes in policymakers’ thinking.

Why this stasis? One possibility is that the same factors that are making entrepreneurs over-cautious about new ventures are making policymakers prone to conservatism. An engaging paper by the World Bank economists Leora Klapper and Inessa Love shows that one major consequence of the financial crisis has been entrepreneurs’ reluctance to start new firms. They show that after a steady increase from 2004 to 2007, firm creation dropped sharply. In the United Kingdom, for example, the number of newly registered limited-liability companies fell from 450,000 in 2007 to 372,000 in 2008 and 330,000 in 2009.

What is interesting is that while this decline is most marked in advanced economies, which are especially dependent on financial markets, it is visible in virtually all of the 95 countries that the authors studied. The reason is not hard to fathom: A recession is a time when we tend to become cautious and stick to familiar territory, steering clear of new projects.

The same mindset has become apparent among economists and policymakers. In times of profound uncertainty, the tendency is to cling to the domain of the familiar and avoid innovative thinking. This is especially unfortunate nowadays, when the structure of the global economy is changing rapidly.

A telltale sign of over-caution among economists and policymakers has been their propensity to convert the need for evidence to an aversion to analytical creativity. We should, of course, use the best available evidence in crafting policy. But there are areas in which there is no evidence. In these uncharted territories, one must rely on a combination of intuition and theory. To resist new policy on the grounds that it is not founded in hard evidence is to trap us in the status quo.

To see the mistake in this criticism, imagine that, on the basis of theory and some assumptions, one recommends new policy X, even though there is no hard evidence regarding whether or not X works. Now use Y to refer to “not doing X.” If there is no evidence regarding whether X works, there clearly is no evidence concerning whether Y works. So, if the lack of evidence is considered a good reason not to do X, it is also a good reason not to do Y. But this is a contradiction, because it is impossible not to do either X or Y.

The propensity to use this inconsistent argument reflects a proclivity for the status quo and a bias against policy innovation. But what we need now is precisely the type of new analytical thinking that spurred the great advances of economics as a discipline over the last two and a half centuries – and that led to major policy breakthroughs during the Great Depression.

It is the absence of such creative thinking that has led the economics profession into an impasse, forcing economists and policymakers to contend with the fear of “L.”

Read more from "2013: Reversing Gears" here, or on Kindle and iBooks.

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    1. Commentedroberto martorana

      Teoria della compensazione della massa monetaria https://www.facebook.com/notes/teoria-della-compensazione-della-massa-monetaria/bozza-espositiva-/228248770537241 this is my page about a new theory macroeconomic conception monetary system ,and any contribute are well accepted :(exposed in the note, i wrote about this on "riodialogues":I suppose a new rule for central bank: a model that integrates the concepts between von Hayek and J.M. Keynes,because it keeps the economic freedom of enterprise and market , creating resources that can be used by the government but to the extent that they are created and without increasing the tax burden... when one of the central bank(respectively of each country or through international agreements) have a new emission of money whith each rate the same bank print corrispective quantity of money of the rate ,off C.B. budget,and give this quantity ( to compense the monetary mass to solve the lack natural compensation previously provided by 'gold mining ..) at a pubblic commission that use for pubblic necessity etc etc...we resolve three problem :pubblic necessity,pubblic balance,and market crisis,;for example : the B.C. have a emission of hundred billion unit and fix a rate of 3% and give this money to commercial bank,at the same moment print 3 billion and give these to pubblic commission that spend for pubblic problem....

    2. CommentedMichael Heng

      Concretely, 4 suggestions:
      1. with much increased productivity, why can't people work 3 or 4 days a week instead of 5 days a week.
      2. there is an oversupply of university graduates across many disciplines. Why can't government agencies and business firms deploy their services to do research and development work.
      3. increase environment tax and use the money to repair the damage done to the environment
      4. re-design institutions to reward value creation rather than to reward rent seeking
      Economics must return to the fundamental of value creation while enhancing social justice and protecting the physical environment.

    3. CommentedJose araujo

      We are now paying the consequences of Reagonomics and supply supply sidders, and for years of silence, media censorship and self-imposed censorship from the economic community.

      Economy hasn’t change so much that we cannot find a coherent explanation from what’s going on, the problem is that we silenced any explanation not in favor of the view of established economics.

      We forgot Keynes and other economists starting with K… we pronounced the death of class struggle even with mounting information and data about the rise of inequality.

      We praised the miracle of economies based on the exploitation of others and the capture of economic resources by some.

      And now we say that there is no hope, that economic science doesn’t have the answers that real life has failed because it forgot to follow this obscure economic models and that there are no alternatives…

      We knew about risk aversion and its consequences. We already knew that supply side economics is a theory falsity. Keynes wrote its General theory, because he knew that full employment was a particular case and the invisible hand is invisible because it doesn’t exist…

    4. CommentedJason Gower

      Perhaps the only "innovation" that we have seen from the economics side is the QE cocktails concocted by our central banks, the long-term impact of which is yet to be determined. However, what QE (or even the threat of QE-like policies in the ECB’s case) did was buy developed world governments the time to formulate forward looking policy to meet the challenges posed by large debt burdens and structurally reshaped labor markets. Predictably, however, European politicians have declared the acute phase of the crisis to be over and Democrats and Republicans in the U.S. remain heavily divided on partisan grounds with no apparent concern for their actual constituents.

      To understand the political problem we must first, as the author highlights, recognize that a large part of the political procrastination is likely due to the fact that politicians actually do realize that these are massive, generational questions that we are dealing with that have no easy answers. With politicians existing to get elected, and re-elected, who is going to step to the front of the line and honestly tell their constituents that debt levels grew out of control over the past 30+ years and that there is going to be some pain in the near term in order to build a long-term, sustainable platform for prosperity? Doing so would in fact be an indictment of their own policy over the past 30+ years that have enabled us to get to this point. What is needed is a correspondingly generational politician that can rise above party politics and the dogma of established thinking to present this honest assessment and an innovative policy vision of the future.

      So there remain more questions than answers but what will always remain constant is the need for education and a culture of entrepreneurship (and associated rewards) to spur innovation and growth. In 1980 who would have imagined the revolution that the internet has brought about? Similarly, as recently as 2009, who would have imagined that fracking technology would so rapidly reshape global energy fundamentals and the geopolitical landscape in the process. The point is that we cannot predict what the next leap in innovation will be, we can only plant the seeds to encourage innovators to innovate. This means education and economic policy that encourages and rewards such thinking because without these incentives rational humans can quickly calculate that the risk far outweighs the reward.

      The fine line lies between these incentives and inclusive growth for all; bringing us back to this visionary politician that can build a culture of inclusive educational opportunity with innovative policy to make this a reality. As the most prosperous nation in the history of the world, perhaps the U.S. can serve as the best example. How many world changing, innovative ideas are being squandered by failing to develop the minds of so many young people in inner city America? By dedicating the resources required to give all students access to a quality education, the pie (output) only grows for all, allowing us to plow more funding back into further development of students/workforce in a vicious cycle of innovation and prosperity.
      Perhaps the only "innovation" that we have seen from the economics side is the QE cocktails concocted by our central banks, the long-term impact of which is yet to be determined. However, what QE (or even the threat of QE-like policies in the ECB’s case) did was buy developed world governments the time to formulate forward looking policy to meet the challenges posed by large debt burdens and structurally reshaped labor markets. Predictably, however, European politicians have declared the acute phase of the crisis to be over and Democrats and Republicans in the U.S. remain heavily divided on partisan grounds with no apparent concern for their actual constituents.
      To understand the political problem we must first, as the author highlights, recognize that a large part of the political procrastination is likely due to the fact that politicians actually do realize that these are massive, generational questions that we are dealing with that have no easy answers. With politicians existing to get elected, and re-elected, who is going to step to the front of the line and honestly tell their constituents that debt levels grew out of control over the past 30+ years and that there is going to be some pain in the near term in order to build a long-term, sustainable platform for prosperity? Doing so would in fact be an indictment of their own policy over the past 30+ years that have enabled us to get to this point. What is needed is a correspondingly generational politician that can rise above party politics and the dogma of established thinking to present this honest assessment and an innovative policy vision of the future.
      So there remain more questions than answers but what will always remain constant is the need for education and a culture of entrepreneurship (and associated rewards) to spur innovation and growth. In 1980 who would have imagined the revolution that the internet has brought about? Similarly, as recently as 2009, who would have imagined that fracking technology would so rapidly reshape global energy fundamentals and the geopolitical landscape in the process. The point is that we cannot predict what the next leap in innovation will be, we can only plant the seeds to encourage innovators to innovate. This means education and economic policy that encourages and rewards such thinking because without these incentives rational humans can quickly calculate that the risk far outweighs the reward.
      The fine line lies between these incentives and inclusive growth for all; bringing us back to this visionary politician that can build a culture of inclusive educational opportunity with innovative policy to make this a reality. As the most prosperous nation in the history of the world, perhaps the U.S. can serve as the best example. How many world changing, innovative ideas are being squandered by failing to develop the minds of so many young people in inner city America? By dedicating the resources required to give all students access to a quality education, the pie (output) only grows for all, allowing us to plow more funding back into further development of students/workforce in a self-perpetuating cycle of innovation and prosperity.

    5. CommentedProcyon Mukherjee

      There are more than one reason to steer clear of projects in this recession; the most potent is the overhang of excess capacity that is looming at large while the flow of monetary supply allows further stock piling of supplies in goods and services as rates remain low. This waste of resources should be accounted for while we sing praises for the success of the monetary release that has taken us out of the deepening crisis, which to some extent could be avoided by a rising rate or even its hint.

    6. Commentedyancey simon

      Interesting reasoning in the paragraph depicting the inconsistency in the reasoning of doing "X" or "Y," given the lack of factual evidence. Basu has essentially paraphrased Godel's proof of incompleteness. Yet, for our present economy it is clear that "Y" or maintaining the status quo clearly has produced the "L" outcome. Realizing that in and of itself should prompt political policy solutions to go hand in hand with central bank lending---which, absent a governmental policy partner, has proven only capable of restoring the financial/banking sector of the economy, while failing to rescue the broader economy beyond the "L's" flat line.

    7. CommentedH.Publius H.Publius

      I agree that the risk of secular stagnation is real. I am not sure that it is driven by the lack of innovation, though. I see two primary forces that continue to depress the economy - deleveraging and high demand for money (money hoarding). In the US, QE by the Fed has supplied the public with sufficient cash balances to satisfy the demand for money. Households and state/fed governments have also delevered. However, it is not at all clear that they will be willing to lever back up, and businesses seem to be more interested in stock buybacks rather than investment (at least in 2013). Furthermore, the Fed has a limited tool set. It can control only the supply of money, but not what people do with that money (a.k.a the demand for money). To that point, here are some ideas that can help the US overcome stagnation ( http://tinyurl.com/ka55jk5), namely shifting control over fiscal deficits and surpluses to the Fed.

      In Europe, there are even more problems. It is not clear that deleveraging is complete, nor has the ECB fully met the demand for euros. In addition to a shortage of money, those economy have had to deal with fiscal austerity...

    8. CommentedGunnar Eriksson

      What we need is a new paradigm establishing that healthy people do things for other reasons than money.
      The money religion has been preached for 30 years with intensity and made people believe it to be rather obscene to do anything for other reason than money. It has eroded the missions of both private and public organizations with resulting gambling and rent seeking pursuit replacing their basic mission.

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