Saturday, November 29, 2014

The World Economy’s Impossible Demand

WARSAW – The global economy’s glory days are surely over. Yet policymakers continue to focus on short-term demand management in the hope of resurrecting the heady growth rates enjoyed before the 2008-09 financial crisis. This is a mistake. When one analyzes the neo-classical growth factors – labor, capital, and total factor productivity – it is doubtful whether stimulating demand can be sustainable over the longer term, or even serve as an effective short-term policy.

Consider each of those growth factors. Over the next 15 years, demographic changes will reverse, or at least slow, labor-supply growth everywhere except Africa, the Middle East, and South Central Asia. Europe, Japan, the United States, and eventually China and East Asia will face labor shortages.

Although large-scale migration from labor-surplus regions to deficit regions would benefit recipient economies, it would almost certainly trigger popular resistance, especially in Europe and East Asia, making it difficult to support. Increasing the labor-force participation rate, especially among women and the elderly, might ease tight labor markets, but this alone would be insufficient to counter the decline in working-age populations.

The world economy cannot count on higher investment levels either. The global investment/GDP ratio, especially in advanced economies, has been gradually declining over the past 30 years, and there is no obvious reason why it would pick up again in the medium to long-term. Until recently, falling investment in the developed world had been offset by rapid increases in investment in emerging markets, mostly in Asia. But high rates of investment there are also unsustainable. As in Japan, China’s investment rate (running at almost 50% of GDP since 2009) will decline as its per capita income rises.

The third engine of growth, total factor productivity, will also be unable to maintain the relentless gains witnessed from the late 1990’s to the mid-2000’s. During this time, the global economy benefited from the confluence of several unique developments: an information and communications revolution; a “peace dividend” resulting from the end of the Cold War; and the implementation of market reforms in many former communist and other developing economies. Moreover, global growth received a further boost from the completion of the Uruguay Round of free-trade negotiations in 1994 and the overall liberalization of capital flows.

It is difficult to point to any growth impetus of similar magnitude – whether innovation or public policy – in today’s economy. No new technological revolution appears to be on the horizon. The World Trade Organization produced only a limited agreement in Bali in December, despite 12 years of negotiations, while numerous bilateral and regional free-trade agreements might even reduce world trade overall.

Worse, in the wake of the 2008 financial crisis, sluggish growth and high unemployment in developed countries have fueled demands for more protectionism. Thus, the financial liberalization of the 1990’s and early 2000’s is also under threat.

The far-reaching macroeconomic and political reforms of the post-Cold War era also seem to have run their course. The easy gains have already been banked; any further structural change will take longer to agree and be tougher to implement.

Thus, with supply-side factors no longer driving global growth, we must reassess our expectations of what monetary and fiscal policies can achieve. If actual growth is already close to potential growth, then continuing the current fiscal and monetary stimulus will only create more bubbles, exacerbate sovereign-debt problems, and, by reducing the pool of global savings available to finance private investment, undercut long-term growth prospects.

Instead, policymakers should focus on removing their economies’ structural and institutional bottlenecks. In advanced markets, these stem largely from a declining and aging population, labor-market rigidities, an unaffordable welfare state, high and distorting taxes, and government indebtedness.

The list of growth obstacles in emerging markets is even longer: corruption and weak rule of law, state capture, organized crime, poor infrastructure, an unskilled workforce, limited access to finance, and too much state ownership. In addition, markets of all sizes and levels of development continue to suffer from protectionism, restrictions on foreign capital flows, rising economic populism, and profligate or poorly targeted welfare programs.

If these problems can be addressed, both globally and at the national level, we can end the dangerous fiscal and monetary expansionism on which the world economy has come to rely and allow growth to be sustained over the long term – though at lower rates than in recent years.

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    1. CommentedEdward Ponderer

      I want to thank Mr. Herman for a very powerful comment and Mr. Mathew for an extremely well-researched video lecture backing it up. [It is very powerful, and I see why Mr. Mathew has repeatedly posted it here. I'm glad that I finally got the message and watched it.]

    2. CommentedFernando Ferreira

      Expanding demand now is "impossible" because "over the next 15 years, demographic changes will reverse, or at least slow, labor-supply growth"????

    3. CommentedVal Samonis

      Marek, the ICT revolution (of Gutenberg's print importance some 500 years ago) and the biotech revolution (of antibiotics importance OR HIGHER!) are just beginning. The key to unleashing these & other scientific revolutions' full TFP impact is education. Admittedly, this is not readily available to middle-income trapped and rapidly aging populations (e.g. CEE, etc) that would not use immigration or other tools (e.g. ICT) to avert catastrophic demographics.

      Val Samonis
      Vilnius U and Royal Roads U

    4. CommentedPaul Mathew Mathew

      You forgot to mention the biggest drag on growth namely the fact that we have picked all the low hanging resources --- oil, copper, fish --- you name it -- the cheap stuff is gone.

      And what is left is very expensive.

      Take oil - $12 in 1998 - over $100 now. That means higher prices and that the average person has less money to spend on 'stuff'.

      That leads to death spiral of layoffs and even lower consumption.

      Of course that is what this financial crisis is all about - the high cost of energy.

      Ignore the economists --- they are morons... listen to a mining engineer explain why the global economy is dying --- and why the industrial revolution is ending

    5. Portrait of Michael Heller

      CommentedMichael Heller

      Mr Stillerman and Mr Hermann sound suspiciously like the same man from cuckoo land. Both miss the perfectly reasonable central argument of the article which is that continuing with stimulus and artificial remedies in place of needed structural and institutional reform will create bubbles, debt crises, and suffocate the natural market vector of sustainable progress. Sometimes it seems only those who lived the socialist catastrophe can grasp the lesson.

        CommentedPaul Mathew Mathew

        Actually it's the high cost of resources that is the problem - see

    6. CommentedMatt Stillerman

      I have to ask: Growth for who? In my opinion there are only two moral justifications for economic growth. These are (1) to adjust to the change in population, and (2) to relieve poverty. If, as this article alleges, population is set to decline, then that is a good reason for the world economy to shrink.
      For wealthy nations, such as the U.S., which only have poverty because of inequality, it is imperative to tackle the real causes of inequality. Further economic growth in such nations only results in conspicuous consumption of (shared) resources). The idea that "a rising tide lifts all boats" has been demonstrated to be false over the last 30 years or so. This falsehood is promoted primarily by those who stand to benefit from growth the most -- those at the top.
      Certainly, the world populations is *not* predicted to shrink any time soon. However, the increases in population will occur mainly in poor areas. By the moral calculus introduced above, these areas are entitled to economic growth to enable their residents to live with dignity. Conversely, wealthy nations should experience recession, particularly if they do not make any effort to reduce economic inequality.

    7. CommentedZsolt Hermann

      Thank you for the excellent and detailed overview.
      More and more people start to realize that we have been living in an unsustainable illusion, in a true Hollywood style American Dream when we believed only the sky is the limit and we can continue growing, expanding, profiting infinitely.
      Today, especially as humanity evolved into a globally interconnected and interdependent system it becomes clear the Dream is only a dream.
      All the seemingly has propelled us towards development before today has suddenly turned self-destructive.
      Although human beings are still very much integral parts of the vast, closed and finite natural system around us, we tried to behave as if were independent, allowed to do whatever we wanted.
      While nature is a finely balanced system, sustained by homeostasis, working on available resources and natural necessities, all our human system is based on excessive, artificial demand, and inflating unnatural bubbles to sustain this human illusion.
      We are behaving like cancer and a very progressed one, the collective, global body is already full of metastasis.
      Superficial adjustments, old schools political and economical tricks have become obsolete, only worsening the condition.
      A full scale, fundamental paradigm shift, lifestyle change is necessary.
      We have to consciously find our way back into the general balance and homeostasis of the natural system.
      And exactly this conscious, self-critical, self-adjusting phase of our evolution will make us truly human, the creature that can, rise above itself, above natural instincts using its head.
      And in our global, integral humanity this mind is a collective, mutual one.

        CommentedPaul Mathew Mathew

        The unsustainable illusion we are living is that infinite growth is possible in a finite world.

        It is absolutely NOT - see