Thursday, November 27, 2014

The Real Challenges to Growth

MILAN – Advanced economies’ experience since the 2008 financial crisis has spurred a rapidly evolving discussion of growth, employment, and income inequality. That should come as no surprise: For those who expected a relatively rapid post-crisis recovery, the more things stay the same, the more they change.

Soon after the near-collapse of the financial system, the consensus view in favor of a reasonably normal cyclical recovery faded as the extent of balance-sheet damage – and the effect of deleveraging on domestic demand – became evident. But, even with deleveraging now well under way, the positive effect on growth and employment has been disappointing. In the United States, GDP growth remains well below what, until recently, had been viewed as its potential rate, and growth in Europe is negligible.

Employment remains low and is lagging GDP growth, a pattern that began at least three recessions ago and that has become more pronounced with each recovery. In most advanced economies, the tradable sector has generated very limited job growth – a problem that, until 2008, domestic demand “solved” by employing lots of people in the non-tradable sector (government, health care, construction, and retail).

Meanwhile, the adverse trends in income distribution both preceded the crisis and have survived it. In the US, the gap between the mean (per capita) income and the median income has grown to more than $20,000. The income gains from GDP growth have been mostly concentrated in the upper quartile of the distribution. Prior to the crisis, the wealth effect produced by high asset prices mitigated downward pressure on consumption, just as low interest rates and quantitative easing since 2008 have produced substantial gains in asset prices that, given weak economic performance, probably will not last.

[To view a high-resolution version of this graph, click here.]

The growing concentration of wealth, together with highly uneven educational quality, is contributing to declines in intergenerational economic mobility, in turn threatening social and political cohesion. Though causality is elusive, there has historically been a high correlation between inequality and political polarization, which is one reason why successful developing-country growth strategies have relied heavily on inclusiveness.

Labor-saving technology and shifting employment patterns in the global economy’s tradable sector are important drivers of inequality. Routine white- and blue-collar jobs are disappearing, while lower-value-added employment in the tradable sector is moving to a growing set of developing economies. These powerful twin forces have upset the long-run equilibrium in advanced economies’ labor markets, with too much education and too many skills invested in an outmoded growth pattern.

All of this is causing distress, consternation, and confusion. But stagnation in the advanced countries is not inevitable – though avoiding it does require overcoming a daunting set of challenges.

First, expectations are or have been out of line with reality. It takes time for the full impact of deleveraging, structural rebalancing, and restoring shortfalls in tangible and intangible assets via investment to manifest itself. In the meantime, those who are bearing the brunt of the transition costs – the unemployed and the young – need support, and those of us who are more fortunate should bear the costs. Otherwise, the stated intention of restoring inclusive growth patterns will lack credibility, undercutting the ability to make difficult but important choices.

Second, achieving full potential growth requires that the widespread pattern of public-sector underinvestment be reversed. A shift from consumption-led to investment-led growth is crucial, and it has to start with the public sector.

The best way to use the advanced countries’ remaining fiscal capacity is to restore public investment in the context of a credible multi-year stabilization plan. This is a much better path than one that relies on leverage, low interest rates, and elevated asset prices to stimulate domestic demand beyond its natural recovery level. Not all demand is created equal. We need to get the level up and the composition right.

Third, in flexible economies like that of the US, an important structural shift toward external demand is already underway. Exports are growing rapidly (outpacing import growth), owing to lower energy costs, new technologies that favor re-localization, and a declining real effective exchange rate (nominal dollar deprecation combined with muted domestic wage and income growth and higher inflation in major developing-country trading partners). Eventually, these structural shifts will offset a lower (and more sustainable) level of consumption relative to income, unless inappropriate increases in domestic demand short-circuit the process.

Fourth, economies with structural rigidities need to take steps to remove them. All economies must be adaptable to structural change in order to support growth, and flexibility becomes more important in altering defective growth patterns, because it affects the speed of recovery.

Finally, leadership is required to build a consensus around a new growth model and the burden-sharing needed to implement it successfully. Many developing countries spend a lot of time in a stable, no-growth equilibrium, and then shift to a more positive one. There is nothing automatic about that. In all of the cases with which I am familiar, effective leadership was the catalyst.

So, while we can expect a multi-year process of rebalancing and closing the gap between actual and potential growth, exactly how long it will take depends on policy choices and the speed of structural adjustment. In southern Europe, for example, the process will take longer, because there are more missing components of recovery in these countries. But the lag in identifying the challenges, much less in responding to them, seems fairly long almost everywhere.

Of course, the technological and demographic factors that underpin potential growth ebb and flow over longer (multi-decade) timeframes; and, regardless of whether the US and other advanced countries have entered a long-run period of secular decline, there really is no way to influence these forces.

But the immediate issue confronting many economies is different: restoring a resilient and inclusive growth pattern that achieves whatever the trend in potential growth permits.

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    1. CommentedStamatis Kavvadias

      Good points but, except for the 1st ("those of us who are more fortunate should bear the costs"), they are in the direction of kicking the can down the road. The author is among the few that state so clearly the issue, when identifying diminishing returns from growth based on the tradable sector, in the 3rd paragraph. Then he goes on to propose *nothing* about it, except ...flexibility in the ability to adapt to structural change (which rightfully meats comments below about meaning everything and nothing)!

      The extend to which the handling of employment and of "technological and demographic factors" the author mentions, cannot be dealt with by utilizing privately created credit, needs to become part of the fundamental structure of the economy. Economists must realize this and deliver to sovereign governments their rightful means to manage such problems. Social capacity for progress and innovation is, to some extend, independent of financing (depends on social, scientific and complexity factors) and, thus, it is an "externality" to the global economy. The structure of the international monetary system and the global economy will have to adhere to their needs, because the list of reasons we can no longer match growth with growing social needs grows longer every day (environmental degradation and resource depletion are waiting down the line)!

      Economists must propose how to manage the extend to which sovereign governments are allowed to print *and spend* money to manage such externalities. It should be obvious that if this is done at some kind of federal, collective, or global level it will be more manageable, equitable and less intrusive to markets.

    2. CommentedPaul Mathew Mathew

      Open your eyes - the reason there is no growth is because we have plucked the low hanging fruit (resources) - particularly oil.

      What is left is EXPENSIVE. Expensive resources = less money in the pocket of the consumer = less stuff sold = layoffs = less stuff sold = more layoffs = death spiral.

      QE, ZIRP, and other stimulus policies are trying to fight against this - and losing.

      Don't ask an economist about this -- they believe growth can go on forever --- ask a mining engineer --- they are realists:

    3. CommentedWilliam Holland

      Well written (as usual), for this to be effective our author needs to drop the pretense of sophisticated neutrality and pull off the gloves. How about a synoptic view embodied by Von Mises or Hayek regarding the social impact of confiscatory taxation, depreciation, inflation and numerous other fiscal/political realities intrinsic to getting "lift-off".

        CommentedRalph Musgrave

        Austrians have been around for a long time. They’re a sort of constant background noise. Mainstream economics has never taken them very seriously, and hopefully it will remain that way.

    4. CommentedRobert Snashall

      Emphatically agree with the increase in public sector investment.
      However, that is politically impossible. Fall in tariffs and capital flow restrictions has permanently lowered the tax rate that can possibly be achieved by the political system, discounting the effect of racial fractionalisation that is. I don't see anyway in which the political system would raise taxes to support such investment, and thus think we are stuck in the current system until the next blow up, probably 10ish years from now.

        CommentedRalph Musgrave

        Neither you nor Robert Spence cite any actual evidence that there is a large amount of public sector investment that will be worthwhile. In the twenty first century (unlike the thirteenth century), it is normal in any subject that claims to be a science, to cite evidence to back claims.

        Second, whence the idea that taxes are needed to fund additional public spending (whether that takes the form of public investment or current spending)? Assuming there is spare capacity, and Robert Spence quite rightly in my view suggests there is, then a country can simply print money to fund extra spending (as pointed out by Keynes).

    5. CommentedZsolt Hermann

      The real challenge of constant quantitative growth is that it is impossible.
      Constant quantitative growth is only possible in an infinite space, but not in a closed and finite natural system.
      Real quantitative growth, driven by necessity, the thrive for a better, healthier, more comfortable human life has long been surpassed. Even today each and every human being, and much more could enjoy all the benefits of innovations, breakthroughs if we distributed wealth equally and fairly.
      For dozens of years now our growth has been inside an ever inflated balloon, best expressed by the expression "aggregate demand", or in simple word inserting artificial, unnecessary desires, lacks into people in order to drive them towards over producing and over consuming goods they never really wanted or they never needed, which we throw away and don't even use most of the time.
      In the process we started to work more and more, have to take debt increasingly, thus despite the worries that we run out of natural resources in the process first we have run out of human resources.
      And now the other paradox appears, that through technological progress most of the workforce has become obsolete, so unemployment is increasing and while this gives people a "break" they cannot consume as they used to, cannot maintain their previous lifestyle, so the whole machinery is breaking down on multiple front, as if the candle is burnt from both ends without any solution.
      And this is still only the surface in explaining why this constant quantitative growth, ruthless, exploitative competition has turned self-destructive as we haven't even mentioned natural resources, the destruction of our natural environment, increasing social tensions breaking out in riots, revolutions all over the world already, increasing international tensions threatening with full scale wars...
      We cannot chase this dream any longer as we will miss the last chances to turn the train heading towards the broken bridge backwards, or at least to stop it while we figure out how to build a new, sustainable human system.

    6. CommentedMarcos Alejandro Aldana Dávila

      The emergence of other countries (Brazil, China, India, etc), necessarily affects the process of recovery of the economies of Europe and the United States. Participation in international markets causes prices of raw materials and commodities have not dropped, as in other international crises, favoring lower cost recovery process.

      Also the process of globalization and the low cost of labor, make countries with high income levels are no longer competitive in the global economy, which raises two possibilities: i) greater specialization, prinicipal technology, or ii ) a decrease in income of workers.

    7. CommentedJose araujo

      Structural adjustments is such a broad concept that it doesn’t mean anything. It would be nice to read someone like Professor Spence tell us what are these Structural Adjustments that we need, that all people agree and that are so obvious that nobody talks about them.

      Is it labor flexibility and lower wages… Is it market efficiency and deregulation? We have enough evidence to see that first, it wasn’t labor rigidity that caused the crisis, and that it was financial deregulation that triggered this crisis.

      Is it less social state, welfare and government spending? And how does disinvestment on the structure of an economy qualify has a structural adjustment? How moving into a private production of social goods paradigm makes us more efficient when the empirical evidence points to the opposite way?

      Is it free trade and lowering barriers of international trade, and how does this improve the structure of an economy when you are forced to develop your competitive advantages on inferior value skills?

      In conclusion are the structural adjustments less regulation and government or better regulation and better government? Is it higher taxes and lower public spending to balance the deficits, or lower consumption taxes and higher public investments to fuel growth?

        CommentedAbhimanyu Arora

        I see what you mean, Jose, thanks for your clear explanation. I had in mind initially was US in general and the minimum wage debate in particular. The evidence there indicates that it is the middle class teenagers who lose relatively less than others upon it's increase. Given the your interesting point regarding skill outflow in the long run, yes, these is a parallel need to increase the skill-set and make the work-force more competitive. But I am not sure in the short-term especially considering Prof. Spence's cautions against growing inequality.
        In addition, I think what you seem to have omitted in your initial comment was efficient tax policies especially corporate taxes.

        CommentedJose araujo


        I'm not the one linking the causes of the crisis to labor. I'm just puzzled that market flexibility and lowere wages are on the recipe to cure the present crisis, and it's presented like the cure to the less competitive countries when the empirical evidence is that when you lower the wages the capacity to retain skill workers go away and your economy becomes less competitive.

        Also that when we look at empirical evidence we see the opposite of what is claimed. The more competitive a country is, the higher the wages are and the less flexible the markets are.

        CommentedAbhimanyu Arora

        Good questions raised by Jose Arauju. With regard to your point on linking the *cause* of the crisis to labor market structure, it is more important to focus on how to restructure it to address slow (sustainable) recovery irrespective of whether it is related to the cause or not.