The Unbound Economy
An Age of Diminished Expectations?
Kenneth Rogoff
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CAMBRIDGE – As the United States and European economies continue to struggle, there is rising concern that they face a Japanese-style “lost decade.” Unfortunately, far too much discussion has centered on what governments can do to stimulate demand through budget deficits and monetary policy. These are key issues in the short term, but, as every economist knows, long-run economic growth is determined mainly by improving productivity.
There is no doubt that Japan’s massive 1992 financial crisis was a hammer blow, from which it has yet to recover, and the parallels with the US and Europe today are worrisome. Both seem set for a long period of slow credit growth, owing both to necessary stricter financial regulation and to the fact that their economies remain significantly over-leveraged. There are no simple shortcuts in the healing process.
Yet, in assessing the Japanese experience and its relevance today, it is important to recognize that Japan’s fall to earth was due not only to its financial crisis. Japan also suffered a number of severe productivity shocks, which had much to do with its longer-term problems. Even if Japan had never experienced a real-estate and stock-market bubble, the meteoric rise of its giant neighbor China would have been a huge challenge.
At the dawn of the 1990’s, Japan’s dominance in export markets worldwide had already been dented somewhat by the rise of its smaller Asian neighbors, including Malaysia, Korea, Thailand, and Singapore. But China presents an entirely different challenge, one for which adjustment will take much longer.
Moreover, even if it never had a financial crisis, Japan would have been plagued by adverse demographics, as its population is both aging and shrinking. Last but not least, Japan’s hyper-growth years were built on a phenomenal rate of investment. But, because productivity ultimately must be built on innovation, not just on ever more buildings and equipment, it was inevitable that returns on investment would turn south at some point.
In principle, with a healthier financial system, Japan’s economy would have had more flexibility to meet these challenges to its productivity growth. But, one way or another, Japan’s once sky-high growth rates probably would have fallen sharply. As is usually the case, financial crisis amplified other causes of economic meltdown, rather than igniting it directly.
The US Great Depression of the 1930’s is another case in point. Again, a great deal of attention has been lavished on the ebbs and flow of fiscal and monetary policy. But New Deal economic policies, by expanding the role of the state in an often chaotic and unpredictable fashion, probably also played a role in at least temporarily impeding productivity growth.
The US today seems to be moving towards a gentler and more European-style state, with higher taxes and possibly greater regulation. Supporters of the US administration might fairly argue that it is undertaking long-deferred maintenance on issues such as income inequality. But if the US does experience slow growth over the next decade, can it all be blamed on the financial crisis?
Likewise, Europe’s latest existential identity crisis is again creating a great deal of policy uncertainty and unpredictability. In Europe, too, if there are adverse growth effects over the next decade, they cannot all be blamed on the financial crisis.
In the short term, it is important that monetary policy in the US and Europe vigilantly fight Japanese-style deflation, which would only exacerbate debt problems by lowering incomes relative to debts. In fact, as I argued at the outset of the crisis, it would be far better to have two or three years of mildly elevated inflation, deflating debts across the board, especially if the political, legal, and regulatory systems remain somewhat paralyzed in achieving the necessary write-downs.
With credit markets impaired, further quantitative easing may still be needed. As for fiscal policy, it is already in high gear and needs gradual tightening over several years, lest already troubling government-debt levels deteriorate even faster. Those who believe – often with quasi-religious conviction – that we need even more Keynesian fiscal stimulus, and should ignore government debt, seem to me to be panicking.
Last but not least, however, it is important to try to preserve dynamism in the US and European economies through productivity-enhancing measures – for example, by being vigilant about anti-trust policy, and by streamlining and simplifying tax systems.
For better or for worse, productivity trends are very difficult to extrapolate, depending as they do on hugely complex interactions of social, economic, and political forces. Nobel Prize winners Robert Solow and Paul Krugman famously once questioned whether the proliferation of computers and technology would lead to bottom-line growth. (This theme underlies the title of Krugman’s classic 1990 book “The Age of Diminished Expectations.”)
In the end, policymakers must remember that whether or not the US and Europe avoid a lost decade depends on their ability to retain productive vitality in their economies, not simply on short-term demand-stimulation measures.
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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McDruid 09:41 05 Aug 10
A great deal of hand-waving standing in for argument (e.g. "New Deal... probably...imped(ed) productivity growth"). Rogoff also has a quasi-religious conviction that further stimulus is not necessary and that messing with the tax code will inevitably lead to long term productivity. Apparently messing with the tax code is the solution to all problems.
There are, in reality, some well-justified casuses of long-term productivity growth that are also stimulative. Improving infrastructure and education, for example, would lead to gains in long-term productivity as well as being immediately stimulative.
Ivan 08:18 10 Aug 10
Unfotunately, human primitivism in the form of hunter, gatherer, and hoarder time and again trumps the need to do what is right by those in power with visions of grandeur.
mawsonii 05:33 01 Sep 10
I think we are a long way from transitioning from a growth economy to a sustainability economy, as urgently needed as that transition ma be. It will take a growth economy to replace our current fleet of carbon-belching automobiles with the array of alternative forms of green transportation needed to bend the curve on current carbon emissions. Same goes for coal-burning power plants. The fastest way to get from A to B is high productivity. I believe Dr. Rogoff is correct on emphasizing the need for higher productivity.
I agree with Dr. Rogoff that streamlining tax policy would be a very effective way of encouraging innovation and stimulating productivity. To this end I agree with Simon Johnson and James Kwak that a Financial Activities Tax (FAT) as well as a Value Added Tax are needed to supplant our current morass of tax codes. The FAT tax needs to be targeted to those financial activities that inhibit innovation, for example, mergers and acquisitions, which are notoriously inefficient, tending to serve short-term gains at the expense of long-term, strategic efficiencies.
Considering the enormous amounts of cash in the coffers of large corporations today, their current M&A activity has the appearance of plutocrats playing a grand game of Monopoly. I have yet to see any justification for this M&A activity based on our national need for innovation and productivity.
What we have here is a liquidity problem. Most of the cash in our nation is in the hands of a relatively few corporations. They apparently want to hold onto that cash because they are afraid that the American consumer won't be spending their cash. What these corporations fail to acknowledge extracting any more cash from the middle and lower classes of this nation would spell 'game over' for those classes and ultimately for the marriage between democracy and capitalism.
if the plutocrats want to create more wealth, the primer for that pump is in their hands. They need to invest in innovation in a way that puts the languishing American worker back on the job where his or her efforts can be transformed into measurable productivity. A languishing workforce is a drag of national productivity and the death of innovation, where creative minds sit idle and die for lack of an income.
Here's a rudimentary equation: l + i = p, where l is liquidity, i is innovation, and p is productivity. The FAT tax extracts resources from the application of liquid assets to non-innovative uses of wealth; thereby, creating an incentive for the alternative choice of applying those assets toward innovative job-creating investments. Mergers and acquisitions do not create jobs; they destroy them. This is not the time for job destruction. It's the time for a headlong push toward a green economy that puts everyone to work on the goal of achieving a sustainable economy in a sustainable global environment.
Nico 07:57 04 Aug 10
The hollow god of growth reappears. One has to ask oneself, when reading this piece, what exactly is the alternative now to fixing this so called 'productivity crisis'. It is clear that we are reaching the limits of sustainable growth, if we already haven't already passed them. As per usual with 'vulgar' economists, the wrong questions are being asked. The question should not be, 'more growth', but 'redistribution'. We are living in an era where the riches of society could, in theory, benefit everyone to the point where there is no poverty, yet we believe that only through more growth - a belief that contradicted by reality - we can solve all our problems. The point, as Keynes and J.S. Mill point out is that we will, and we have, reached a point where further growth is counter-productive and unnecessary in the developed world. Japanese people are not exactly starving, nor is Japan exactly a poor country, regardless of its growth prospects. Therefore, whether we like to admit it or not, we are living in a world of finite resources, and finite labour power.
Thus, if being more 'productive' means more unemployment, particularly long-run structural unemployment; if it means ever lower wages and benefits; if it means more and more regressive taxation policies; if it means continuously replacing labour with capital, then I do not see the utility in growth, because IT IS starting to leave tens of millions of people out of the system, and if you care about the system, you really don't want a reinvigorated proletariat.
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