Friday, November 21, 2014

Tradable Prosperity

MILAN – The global economy is experiencing a major growth challenge. Many advanced countries are attempting to revive sustainable growth in the face of a decelerating global economy. But the challenges across countries are not the same. In particular, the tradable and non-tradable parts of a range of economies differ in important ways.

In the non-tradable sector (60-70% of the economy in advanced countries), the main growth inhibitors are weak demand, as in the United States following the financial crisis, and structural and competitive impediments to productivity, as in Japan. In the tradable sector, growth depends on a country’s productivity relative to incomes and competitiveness. At the global level, there can also be a shortage of aggregate demand on the tradable side.

The Nobel laureate economist Robert Solow has shown that growth comes from three sources: the working population, capital investment, and technological progress. A growing young population helps to maintain fiscal balance and ensure intergenerational equity, but it does not by itself increase incomes. On the other hand, economic growth below the sum of growth in the working population and the labor-saving part of technological change fuels unemployment.

Developing countries, once they enter rapid-growth mode, generate growth from capital deepening via investment, in a sense making up for past underinvestment. And it is possible for advanced countries to fall behind by under-investing, particularly in the public sector, relying instead on less sustainable debt-fueled means of generating demand. So a legitimate part of a strategy to restore growth is investment.

But, as Solow noted, investment has its limits, owing to diminishing marginal returns. Often, these limits are not binding, but, once capital deepening is exhausted, technological progress, which makes inputs more productive in creating final value, is the long-run driver of growth.

The challenge is to apply these insights in a world characterized by global economic interdependence, major imbalances, and a worsening growth and employment problem. It is a world in which economies are connected directly in the tradable sector of the global economy, and indirectly through the demand and employment linkages between the tradable and non-tradable sectors of individual economies.

In the short run, the non-tradable sector is, by definition, subject to domestic-demand constraints. A shortfall in non-tradable demand inevitably limits growth on that side of the economy.

Government can, of course, bridge the gap via deficit spending (preferably focused on employment-generating investment that enhances future growth). But the advanced countries are, to varying degrees, fiscally constrained by relatively high and rising public debt, largely owing to fiscal imbalances that were hidden from view until defective growth models broke down in the crisis of 2008.

Just how fiscally constrained these countries are remains subject to debate. Italy and Spain are clearly constrained by the absence of private capital in their respective sovereign-debt markets, with rising yields threatening their fiscal stability and reform programs. They need the eurozone core and the International Monetary Fund as temporary lenders of last resort until they restore policy credibility and regain investors’ confidence.

The US sovereign-debt market shows no similar evidence of having reached a limit yet. But bond markets do not issue many early warning signals: witness the sudden run-up of yields in Italy and Spain a year ago.

The more complex growth issues have to do with the tradable part of the global economy, where global aggregate demand – and the derived demand that lands in various places in global supply or value-added chains – is the target of competition. Total demand and its growth do matter, but so does market share. Given the growth patterns across advanced and developing countries prior to the crisis, and then the large negative shock, it is likely that there is a shortfall of tradable global aggregate demand, impeding an important component of global growth.

But, for individual economies, relative productivity versus income levels determines the share of global tradable aggregate demand that is accessible. Unlike the non-tradable side of the economy, the domestic component of global tradable demand is not an absolute constraint on growth; nor is the rate of growth of global tradable demand an absolute constraint, given the possibility of increasing share.

Of course, not everyone can gain share at the same time. Fortunately, if countries increase productivity with the aim of boosting relative productivity and growth potential on the tradable side, this will increase incomes and accelerate the growth of global aggregate demand. It may look like a zero-sum game, but it is not.

When incomes get significantly out of line with productivity levels (as they have recently), reviving growth requires resetting the terms of trade, which can be done with exchange rates, whether managed or set by markets. In the eurozone, where countries with competitiveness problems do not have the exchange-rate adjustment mechanism, restrained income growth and productivity-boosting reforms are probably needed, as was the case in Germany between 2000 and 2006, and now in several southern European countries.

What is true for countries on the tradable side is also true for workers, who are differentially affected by the evolution of global supply chains. The efficient integration of global supply chains has created employment opportunities in developing countries and in the higher value-added sectors of advanced countries. But it has also reduced employment options for a subset of middle-income people in the tradable sectors of advanced economies.

Many countries are struggling to adapt their growth patterns to the new challenges they face in a slowing global economy. To be effective and properly targeted, policies need to include an accurate diagnosis of growth potential and impediments in both the tradable and non-tradable parts of the economy. Focusing on one (say, the competitiveness problem in the tradable sector) to the exclusion of the other (perhaps a serious non-tradable demand shortfall or stagnant absolute productivity) will not be enough.

Read more from our "Michael Spence on Reinventing Growth" Focal Point.

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    1. CommentedGary Marshall

      Hello Mr. Spence,

      The problem in most European countries is too much big and wasteful government. This will not be the source of all those needed productivity increases. Yet this is all Europe seems to know.

      In an expanding economy, increase generally wasteful public expenditures. Increase taxes and borrow when Taxation fails to supply enough. In a crunch, increase wasteful public expenditures. When Taxation fails to supply enough, borrow. With government finances aggravated, raise taxes.

      The answer is to just lower taxes. Then the private corporations and individuals will get busy.


    2. CommentedTim Chambers

      I would agree with author that investment has its limits, due to diminishing marginal returns, but I believe there are better options, in such cases, than just sloughing those industries off to lower wage countries so the products can be exported back for sale at a profit. But today, even in those industries where good returns can still be had, even with well-payed workers, such as aerospace, we are teaching emerging market countries how to put us out of business on Tuesday for a better ROE today.

      Surely, worker-owned cooperatives that preserve jobs, or work-sharing arrangements that reduce hours, subsidized by partial relief, are a better solution to diminishing returns than simply closing plants and throwing people out of work. Granted, such solutions don't give the vulture capitalists a chance to make a killing, but such people should be the last consideration of the policy makers.

      In Japan, many companies view a cyclical slowdown as an opportunity to catch up on deferred maintenance, improve products and employee skills, and even develop new products. They take a much longer view, and are shocked at the stupidity of American companies that have such a short term perspective as to focus solely on hitting the quarterly numbers.

      Certainly, the Japanese don't live as high as they did in the bubble years, and the evidence of decline is everywhere visible in the countryside, but there is also very little of the misery that is found in our old manufacturing towns.

      I would agree with Mr. Herman, that over-production and over-consumption is an unsustainable economic model. I have always tried to live my life on the basis of necessity, not luxury. It is a far less stressful way to live.

    3. CommentedZsolt Hermann

      If we read this article carefully looking at all the details, we have all the facts and reasons why our present socio-economic system, solely built on excessive, way above natural production and consumption is unsustainable and destructive.
      We have all the proof but we still do not want to accept it, instead we keep stubbornly searching, perhaps we find a magic loophole, some escape rout through which we can simply go back to the lifestyle we are used to without changing ourselves.
      We have been living an illusion like Hollywood movies, where at the end some hero or a miracle saves the day, and everybody sails happily into the sunset.
      But in real life it does not happen.
      We live in a vast natural system with strict, unbreakable laws. Either we get to know these laws and adapt ourselves to them, or we continue to slide into deeper crisis until it becomes intolerable and then we are forced to change through suffering.
      We cannot continue with a totally unnatural human structure built on fulfilling artificially generated desires and pleasures with things that are excessive and harmful.
      The only way out of the crisis is a return to necessity and resource based consumption and a conscious, active return to the natural laws governing our global, integral and interdependent system.

        CommentedEdward Ponderer

        I read the article from a somewhat different perspective than Mr. Hermann, but yet come very much to the same conclusion.

        With all due respect to the author, while the laws of mathematics do not change, those that most realistically model the world do. And even when the basic math is still representative, on broadest scales it tends to be a differential equation, and past a critical change in boundary conditions, the solution to the equation not only changes in terms of magnitudes and frequencies, but can change altogether in form.

        In particular, this can place upon a nominally steady or reasonably fluctuating sinusoidal cycling, an exponential envelope. In turn, this can mean divergence into deterministic chaos, decay to a standstill, or pieces or both. But whether "by fire or by ice," or the hailstones of fire like, as it were, the 7th plague of the Biblical Egypt, this is neither "business as usual," nor good news.

        So what are these changes? For one thing, the closed system introduced by our global world, and the ever-tightening of the coupling constants of national economies across the globe. Further, there is a cross-coupling with the socio-political realities of universal instantaneous communication (read Internet + wireless), climate, energy resources, fresh water limits, and the environmental catastrophes underway because of all those earlier technological breakthroughs (unemployment is far from the only cost).

        The sorry fact, too, is that our real limits in space, resources, and waste management, are reaching limits that can only be breached by overcoming basic issues of thermodynamics, and the laws of physics are not something that technological genius can help with. Short of that, we are facing a limit on "growth" that technology can only make worse.

        The only way out is to not live to excess and stop waste through needless duplication, artificial obsolescence, and outright artificially created "needs." Unemployment doesn't have to be a curse, but it could turn to a blessing of free time if the remaining work (and profits) were probably shared over time. The movement towards "crowd-sourcing" (for research & development ideation and fact finding, as well as failure analysis, etc.), might be a very positive development in just such a direction.

        The key will be developing -- in education and social values, a true sense -- voluntary accept in terms of social pressure -- a deep connection with the idea of mutual responsibility.

        It will be all-for-one, and one-for-all, or in the end, it will be nothing for nobody.