Thursday, November 27, 2014

Why Do Economies Stop Growing?

MILAN – Over the years, advanced and developing countries have experimented, sometimes deliberately and frequently inadvertently, with a variety of approaches to growth. Unfortunately, many of these strategies have turned out to have built-in limitations or decelerators – what one might call elements of unsustainability. And avoiding serious damage and difficult recoveries requires us to get a lot better at recognizing these self-limiting growth patterns early on.

Here are some of the items in a growing library of decelerating growth models.

In developing countries, import substitution as a way to jump-start economic diversification can work for a while; but, over time, as productivity growth lags and comparative advantage is over-ridden, growth grinds to a halt.

Small, open economies are naturally somewhat specialized, which leaves them vulnerable to shocks and volatility. But, in terms of growth and living standards, the cost of economic diversification, when implemented by protecting domestic industries from foreign competition, eventually outweighs the benefits. It is better to allow specialization, and build effective social safety nets and support systems to protect people and families during economic transitions. Such “structural flexibility” is better adapted to enabling the broad changes that rapidly evolving technological and global economic forces require.

Mismanagement of natural-resource wealth underpins an especially potent self-limiting pattern of growth and development. If invested in infrastructure, education, and external financial assets, natural-resource revenues can accelerate growth. But, too often, such revenues distort economic incentives, which come to favor rent-seeking and interfere with the diversification that is essential for growth.

More recently, many advanced countries have discovered a “new” set of growth models with built-in structural limitations: excessive private or public consumption, or both, usually accompanied and enabled by rising debt and inflated asset prices, and a corresponding decline in investment. This approach appears to work until domestic aggregate demand can no longer sustain growth and employment, at which point it ends in either gradual stagnation or a violent financial and economic crisis. (In fact, many developing countries have learned this the hard way, but the lessons seem not to have crossed over to advanced countries.)

But the opposite of the excessive-consumption model – excessive reliance on investment to generate aggregate demand – is also a self-limiting growth pattern. When the private and social returns of investment diminish too much, growth cannot be sustained indefinitely, even though rising investment rates can sustain aggregate demand for a while. Altering this growth pattern is a significant part of the challenge that China now faces.

Rising inequality in either opportunity or outcomes (and often both) also poses threats to the sustainability of growth patterns. While people in a wide range of countries accept some degree of market-determined income variation, based on differential talents and personal preferences, there are limits. When they are breached, the typical result is a sense of unfairness, followed by resistance and, ultimately, political choices that address the inequality, though sometimes in counter-productive, growth-impeding ways.

Perhaps the largest long-run sustainability issue concerns the adequacy of the global economy’s natural-resource base: output will more than triple over the coming two or three decades, as high-growth developing economies’ four billion people converge toward advanced-country income levels and consumption patterns. Existing economic-development strategies will require significant adaption to accommodate this kind of growth.

Some adaptation will occur naturally, as rising energy and other commodity prices generate incentives to economize or seek alternatives. But the un-priced environmental externalities – global warming and water depletion, for example – will require serious attention, not myopic, reactive mindsets and approaches. 

All of these self-limiting growth patterns tend to have three things in common. First, in one or several dimensions, some part of the economy’s base of tangible, intangible, and natural-resource assets is being run down. I would include social cohesion as part of the asset base: it is the one that is depreciated by excessive inequality.

Measurement issues play an important role here. It is easier to run down something that is partly invisible because it is not regularly or effectively measured. Expanded measurement of the dimensions of economic, social, and environmental performance is necessary to broaden awareness of sustainability issues.  

Second, unidentified self-limiting growth patterns produce very bad results. Expectations come to exceed reality, and resetting the system to a sustainable growth pattern is difficult. After all, past investment shortfalls have to be made up and future-oriented investments undertaken simultaneously – a double burden that must be borne by the current generation. An inability to resolve the distributional and fairness problem can produce gridlock, paralysis, and prolonged stagnation.

Finally, many of these flawed growth patterns involve fiscal distress. Contrary to the prevailing wisdom nowadays, some degree of Keynesian demand management in the transition to a more sustainable growth pattern is not in conflict with restoring fiscal balance over a sensible time period. On the contrary, applied both individually and together, fiscal stimulus and consolidation are necessary parts of the adjustment process.

But they are not sufficient. The crucial missing pieces are a shift in the structure of accessible aggregate demand and restoration of those parts of the economy’s asset base that have been run down, implying the need for structural change and investment.

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

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    1. Commentedraul ramos

      5 march 2014 manila, ph

      economy in an intelligent view,

      “why do economies stop growing?

      this statements is one of the toughest
      and excellent question that needs a
      brilliant, intelligent answer. why?
      with high respect to sir michael spence,
      a nobel laureate in economics, professor
      of economics at nyu. you wrote this 23
      of may 2012, ahead of my letter dated 3
      october that same year on my facebook
      sir michael, history shall going to repeat
      itself. and this is the problem, there is no
      more room for growth, specially and specifically
      in this greatest country which is america.
      to give you an idea, the u.s. government
      tried their luck with the trillion dollars
      they spend assuring their country, their
      ownselve, that with all these massive
      investment they could literally be saved
      and escape the 2008 economic collapse.
      if they did it correctly, a brilliant approach
      in countering, curing this catastrophic
      crisis. i would say maybe the second
      great depression will not come our way.

      my facebook account:

      kindly please take care and God bless . . . . . . . raul

    2. CommentedJohn Champagne

      An enormous advantage of a public property rights paradigm is that it tends to dampen excesses in the natural and inevitable variations in level of economic activity. A public property rights paradigm is one wherein public property rights are claimed and respected along with private property rights and natural wealth is valued and shared equally.

      When everyone (every adult) receives a natural wealth stipend, the pressure to create safety net programs is reduced and perhaps largely eliminated. The ability to meet one's basic needs largely persists even amid economic dislocation caused by social/technological change.

      A public property rights paradigm moderates further growth of an overheated economy through the efficient signal of rising costs of natural resources. If a limited number of permits are sold at auction, according to what the average opinion will allow, the price of those permits will rise as the level of economic activity rises. But with this method of 'buffering' the downside of an economic system and moderating excessive growth, in no case does the economy grow so as to be a size that is larger (in terms of environmental impacts) than what the people want it to be. In fact, we would have an economy that is the size that the human Earthlings think that it should be. We have been laboring under the delusion that it is our task to promote economic growth. We need to promote growth (promote the effectiveness of the economy to meet human needs) within defined limits. Those limits need to be defined in accord with the will of the people.

    3. CommentedJohn Champagne

      A policy of 'import substitution' involves the state preventing free association of buyers and sellers across national boundaries.

      We should recognize a basic freedom to associate as a fundamental human right. Infringement of this right cannot be the foundation of a viable economic policy. Basic human rights are a kind of natural law. Disregard of these rights will bring harmful consequences (such as an inefficient or more stratified economy).

      Natural law requires respect of PUBLIC property rights, too:

    4. CommentedAman Saini

      I found the concluding point of Keynesian way of managing fiscal distress over a period of time self-contradict the whole premise of your article regarding sustainable development .
      The reason is ,that it sabotages the Social Compact between the generations through an explosion in Fiscal Deficit which makes it all the more challenging for the upcoming generation to overcome , how can that approach ever lead to a sustainable path whereas it has never been the case in the past .

      Radical changes in outlook of people come seldom , so when its an exception not rule the chances of it leading to a transformation in Economic system are highly unlikely .

      Only thing which will transform of our systems is our ingenuity and not flawed Keynesian way of tackling fiscal distress in an already Highly leveraged world .

    5. CommentedAndré Rebentisch

      The points raised about the downsides of economical diversification are far too broad to be significant. Trade protectionism is not the only method to achieve diversification. Undiversified economies as any monoculture are more vulnerable to structural change.

        CommentedAman Saini

        The great Irony is the proponent of free markets in the world USA is fast becoming a Protectionist itself .

    6. CommentedWilliam Hampton

      It seem to me that human nature is the root as to why economies stop growing. At the on set of any system, economic or other wise, the first thing that humans will do is to try to beat the system. This results in graft and corruption that eventually brings the system down. Things like promoting equality might help a little, but short of a multiple check and balance system that enforces the rule of law, I see no way to stop this from happening. Our forefather­s seen the need for a check and balance system, but did not go near far enough and I have my doubts that it could even be accomplished to the point of eliminating graft and corruption. As an individual, what can one do? Recognized it an do your best to use it to survive. Make sure that all of your involvement in the graft and corruption is legal, or safe. I would like to think other wise, but see little evidence to make me think other wise. I was taught other wise and can not over come my basic honesty, so will never reach my full abilities to make money. To date I have been smart and lucky enough to survive. Most seem to not realize just how much luck comes into play in our survival. Not so sure that if I was born today in this country that I would be capable of survival. It looks to me like this system is on the verge of being beat to death.

    7. CommentedJohn Gavin

      The author has provided a fine list of the symptoms that complicate the growth of economies.
      The primary etiologic problem of failing economies is the unnecessary use of debt to create their money supplies.
      When money is created as debt, debt never stops growing until the economy crashes.
      Taxes must be raised to pay for debt, much of which is owned by foreign lenders and therefore these taxes are exported and removed from the economy. All taxes must be created from more debt and growth requires more debt, so debt growth is exponential under this corrupt system.
      When politicians use additional debt to hide spending from immediate taxation, then government has lost its integrity and falls under the control of the lenders.
      Programs to please voters utilize even more debt-based spending and as taxpayers are allowed to receive benefits without paying taxes the system falls totally out of control.
      This moral hazard is a constant threat that politicians use for their personal benefit despite the destruction of both the society and the economy.
      Meanwhile, lenders are accumulating the assets of nations and will use them against those nations that oppose the continuation of this corrupt system.
      Money created as debt is the primary problem that must be terminated or nations will only repeat the same scenario over and over despite the chaos to which it leads them.
      Will the next government ignore these repeating lessons? Will it end the practices that promote a demand for more handouts and class warfare and only degrade the society?
      Will governments take back control of their money supplies and punish the corrupt practices used by lenders to accumulate the wealth of nations?
      Our future depends on how we respond to these questions.

    8. CommentedStephane Levasseur

      I propose a different explanation to the sudden halt in economic growth:

      Economies produce services, manufactured goods and natural resources. Science and technology R&D can mostly help improve productivity of the latter two.

      Western economies produces mostly services (70%) which can be improved by investing in human capital. Through research in humanities, not science and technology, will we be able to make the economy grow again.

      Simple and interesting?

    9. CommentedProcyon Mukherjee

      A very stimulating discussion followed the article and many views have emerged, as always there is not one single way but a multiplicity of approaches that would converge and sometimes diverge as well to make a meaningful improvement to the economies in question. Many have raised questions on inequality and poverty and some have pointers on monetarism; there are some usual suspects like lack of diversification and specialization or the more mundane marginal propensity to consume or invest that plagues so many economies.
      The reins that erstwhile systems had on the trajectory of growth of assets or net worth, got eroded in the last two decades; the responsibility shifted to the ‘market’ and the market did a wonderful job to expand opportunities and also stymie when irrationality stepped in. By trying to create new rules and by intervening at the true functions of the market we have allowed disruptions to step in that had marauding influence on the benefits that should have accrued for the greater majority. It leaves a tempting metaphor that the biggest proponents of the free market worked at cross purpose to the true functioning that was so much desired.

      Procyon Mukherjee

    10. CommentedFrank O'Callaghan

      "Rising inequality in either opportunity or outcomes (and often both) also poses threats to the sustainability of growth patterns. While people in a wide range of countries accept some degree of market-determined income variation, based on differential talents and personal preferences, there are limits. When they are breached, the typical result is a sense of unfairness, followed by resistance and, ultimately, political choices that address the inequality, though sometimes in counter-productive, growth-impeding ways."

      THIS IS CRUCIAL. The core question is not just the aggregate of growth but it's distribution. Growth has been one sided in the developed countries for three decades as the income and consumption increase has been for a tiny minority. The greater part of the productivity growth has benefited the few. Widening inequality will certainly generate "political choices that address the inequality". These may not be contained by media and other control of the masses for much longer and radical solutions may be proposed and implemented. History shows us that they sometimes lead to revolution.

      "Perhaps the largest long-run sustainability issue concerns the adequacy of the global economy’s natural-resource base: output will more than triple over the coming two or three decades, as high-growth developing economies’ four billion people converge toward advanced-country income levels and consumption patterns. Existing economic-development strategies will require significant adaption to accommodate this kind of growth."

      This is also a question of distribution. The great majority of the world was living a sustainable life in poverty and with varying degrees of efficiency. The eco-message of 'recycle' etc was an economic necessity for resource poverty where the emphasis was on the poverty. In the rich developed world the emphasis in resource poverty is on the resource. Convergence will still emphasize the inequality not just between developed and other but within.

    11. CommentedLuke Ho-Hyung Lee

      I believe our economic experts have missed something very important in their ruminations about the economy.

      Consider what entomologists discovered recently, called the ant death spiral, an event that takes place in the natural world under normal conditions in one species of ant’s natural habitat.

      The cause of this behavior is the ant’s use of ground navigation. Ants follow pheromone trails on the ground laid down by other ants. The system works well normally. A scout ant goes out and finds something. Other ants go back to get more by following the scent trail, or by following each other. However, if a loop gets created, the ants will march blindly, sometimes circling until they all die. Unfortunately, it seems that human beings sometimes exhibit similar behavior by blindly following the path others have taken.

      I use this analogy to point out a serious mistake made in the market over the last 20 to 30 years. Nobody else has recognized that mistake. Like the aforementioned ant spiral, I believe that mistake has created an economic death spiral in the economy. If we do not break down this cycle and explore a new order for economic survival, I believe that every new effort we make will be just as ineffective as everything else we’ve tried in the last several years. If we don’t find the solution, our economy will atrophy and die.

      For a more in-depth analysis, I would suggest you read this article: "Breaking Down the Economic Death Spiral – and Saving the World Economy"

      If someone insists that he has found a way out of the economic mess we are in – and, especially, could offer a clear solution for the imminent “economic catastrophe” - wouldn’t it be prudent to at least hear that person out?

    12. CommentedBertha Argueta

      I would like to know why protectionist meausres to achieve diversification involve high costs for a small open economy. Wpuld it be possible to achieve diversification in these countries without these measures? Or if we are to allow specialization, how would this safety nets work to protect these economies from shocks and volatility?

        CommentedJonathan Lam

        Gamesmith94134: A global New Deal

        In the nature of development of human spices; we provided livelihood of the people with much of the finite resources that our intelligence put them to sustain values and purposes. As technology advanced, globalization made it plausible to shift its natural resources from one place to another through trades. Then, our political sovereignties adopted monetarism capital resources dominated the trades and its other sources including Human resources and natural resource.

        Our present crisis was the long oblivion that they misused the resources and misled by the successes of the scientific advancement like efficiency and strength. Based on the levels of miscalculation of balance on the outcome of the values including financial; the polity made the obvious attempt to promote monetarism to gain controls of the natural resources that efficiency undercut the human resources and the finite natural resources were manipulated under the few. First, shortage of natural resources made the price surge. Many gained from the surge and continue such practice to sustain a higher pricing; so, under-funded capitals made the sovereignty debts from the trade externally. It is the macro-economic that broke the financial system that the sovereignty debts. Insufficient funding cut employment during the spell of credit crunch, price on goods like real estate fallen to meet the demand of those can afford, sales are down and real estate devalued cause the domino effect on lower revenues for the governments. Through the micro-economic control system, supply and demand lost their rhythm and purpose to sustain value what workers supported. It causes the outflow of business establishments, then, the economy is ruined and un-retractable even under the measures of liquidity or stimulation.

        It was the imbalance of the tripartite comprised of capital resources, human resources and natural resources that make the monetarism or our present economies failed. Since the human resource and natural resource lost their coordination to comply with the demand of value and purposes. It is how the monetarism became unsustainable and collapsible. When government lost its goal in sustenance of value and purpose; its citizens demand more of natural resources to maintain livelihood. Then, it is the breakdown of the political or capitalist system no matter how Quantitative Easing worked to nationalize the markets or for what money can buy. The nature do have it ways to maintain it right to keep all its resource balance and check on its developments through the boundaries or limits of resources especially the human resource that is infinite and the major factor for growth. Finally, human resource is the only factor that is expanding, natural resource is limited on the boundaries; and capital resource is relatively only a standard that we apply to value we can afford and share proportionately. Disaster arrives when either one is off its balance.

        We should understand by now how important is the balance of control in the capital resources, human resource and natural resources which no money can buy at least up to a point. The present finance system may not remand the deficits since capital resource override the human and natural resources that created the micro-economic failure that dragged down the macro-economic. As much of the trade war begins, now many sovereignty nations is struggling to maintain its harmony for its people. Mr. Jomo Kwame Sundaram gave good points on the control of the United Nations system in retribution of wealth through the programs by UN and accepted the initiatives of the International Labor Organization that are relevant to addressing the current stasis. Moreover, it is advisable for the United Nations system to redraw the boundaries of the resources for what the present system failed to maintain or how globalization had undercut the weaker nations for self-protection to maintain its resource from abuse. Nationalize marketing must be prohibited or hegemony should be examine by the boundary of the nations or continents and the weaker nations with lesser resources can be relieved from controls of the newer system. Therefore, reforms on financial and political are needed to bring on the integrity and harmony to the world; so, each capital, human, and natural resources can be identified, distribute and redistributed through the mechanism of UN’s political system with partners to World Bank, global financial reforms using it principle of boundaries or continents and human supervisions like the international Labor Organization and alike. So, tripartite resolution to the three resources must be improvised to meet the infinite rise of the population, sovereignty nation must pay respects to the natures of its resources and it must be integrated through the globalization to sustain its balance and limits to the boundaries.

        Perhaps, I am under the influence of my readings of the present financial crisis and distracted by the nationalize market, zombie bank and fiat money. Knowingly, the resolution initiated by the troika is not sufficient to maintain its claims of sustainability and liquidity, but the breakup of the Euro-dollar regimes would be more than disaster to the perpetuity growth of the population and loss of values in trade to sovereignties. By illustrating the concept of balance I hope some are convinced that balance of nature should be respected including its resources and boundaries. The last chance is the integration of nations and banks through the reforms or adopted the United Nations resolution to initiate the urgency of need to improvise its reforms; so, once the absolutism by the Euro-dollar regimes yield to the rights of others faithfully. Three for three must apply, and no more tea time on nationalize market, zombie bank and fiat money.

        May the Buddha bless you?

        CommentedKevin Lim


        "Would it be possible to achieve diversification in these countries without these measures"

        I'm no expert, but off the top of my head incentives (e.g. tax breaks for developing industries) would promote diversification.

        Of course, the problem is that whether its a protectionist measure is a grey area. Take ethanol production as a biofuel. If I were to offer farmers in China big subsidies adn cheap loans to promote the growing of a new crop like sugarcane for ethanol production, I would be promoting a nascent industry. On the other hand, its generally accepted that subsidies given to farmers in Iowa to keep planting corn for ethanol production is a thinly disguised protectionist agricultural subsidy to please Iowa voters to the detriment of Third World farmers.

    13. CommentedZsolt Hermann

      This is a very useful article identifying that at the moment we have no pattern for sustainable constant quantitative growth, which is already a huge step ahead of what we still see in the political and financial arena where people still repeat the "religious" mantra of "returning to growth".
      But we are still searching for the causes in the details instead of looking at the root cause.
      Everything starts and ends with basic human nature.
      We are all inherently selfish, subjective, we all feel ourselves unique, independent. At the moment we only care about our own fulfillment many times to the expense of others.
      This human thinking based on our ego reached its peak in the American society which developed this idea of personal freedom, uniqueness, maximum pleasure for ourselves, "unlimited American Dream for all" to its maximum.
      There is only one problem. We never took into consideration the system we exist in, we thought we were above the system and we can do whatever we want like children bursting into a toy store.
      It is only today that we start to understand the system we live in, we evolved into, we saturated into.
      We live in a global, integral, interdependent network with each other, like any other element in nature's living systems.
      We are like cogwheels but before for multiple reasons the cogwheels were not fully connected, we were still in a loose system, as if the clutch pedal was still pushed down allowing the cogwheels turning independently.
      But by the end of the 20th century the teeth of the cogwheels connected together through multiple factors, and thus now we are totally interconnected and interdependent not just among ourselves in human society but human society with the rest of Nature.
      In this integral system our inherent excessively self fulfilling, constant quantitative growth mentality has become like cancer, and we have started self destructing the whole system, we could say the tipping point happened in 2008, or it has become obvious at that point.
      We cannot ignore these facts any longer and we have to start building a totally new system with several important points, challenges:
      1. Obviously each and every human being has the right to maintain his/her integrity, uniqueness, personal freedom.
      2. Any future human system has to be built on free choice, and the willingness to join without any coercion.
      3. But at the same time the new system has to be built on mutual responsibility in a way that each and every person could express his/her 100% ability for the sake of the whole first of all, and after securing the well being of the whole "organism" cater for his/her own needs. Every action, plan has to start with taking the whole system into consideration and only positive input is inserted into the system.
      4. The new system has to be based on true, modern, comfortable necessities without the excessive luxuries making us slaves to the over consumption society today, with the full consideration and appreciation of the available resources.
      5. Each and every person has to receive his/her reward according to his/her contribution to the general, global system.
      So how can we motivate people to change in such a fundamental way that they "buy into" this new attitude, human structure? Only by a global, integral education program helping people understand with clear, objective, scientific data how our global, integral system works, what our role is in it, and how it is our own even selfish interest to help maintaining, sustaining the global human society as any individual can only prosper, remain healthy if the whole system functions optimally.

    14. CommentedMatthew Cowan

      Economists have been preaching the stimulate now, pay back later gospel for nearly 4 years now. This is always a very comforting and soothing message, but when does it end? At what point will we cross the threshold of pay it back now, stimulate later??

      I contend that we never smoothly cross that threshold. The political cost of crossing that threshold in a democracy is often too steep, so leaders typically put off the tough choices until the situation is so dire that someone or something else makes the decision for them. But by the time they get to that point, the needed austerity is too hard to impose on an already weak economy, causing social unrest that contributes to a downward debt/austerity spiral to hell.

      The best option is to freeze spending at current levels and, where needed, adjust social safety nets and entitlements to match the fiscal and demographic realities faced by a country. By holding spending constant and reforming safety nets/entitlements, spending will drop slowly and the difficult adjustments will be made at a measured pace.

      Germany did it in 2005 with excellent results, the rest of the world should follow suit instead of helping themselves to serving after serving of additional stimulus.

    15. CommentedDaniel Rosenthal

      "...some degree of Keynesian demand management in the transition to a more sustainable growth pattern is not in conflict with restoring fiscal balance over a sensible time period."

      Might this be re-stated, in part, to read something like this: "The time period over which the restoration of fiscal balance may take place should be determined by the degree of Keynesian management required for the transition to a more sustainable pattern of growth."

    16. CommentedDaniel Rosenthal

      Does this model of social cohesion and equality scale up to the state level? Does state and regional inequality within the Eurozone explain its current decoherence? What changes do you notice in your model when the effects are scaled from the individual to the state or regional level?

    17. CommentedGordan Zelnicki

      Inflated asset prices is the main culprit (housing, education, health etc...) Progress should be build upon new services, products, innovations...