MILAN – The world is facing the prospect of an extended period of weak economic growth. But risk is not fate: The best way to avoid such an outcome is to figure out how to channel large pools of savings into productivity-enhancing public-sector investment.
Productivity gains are vital to long-term growth, because they typically translate into higher incomes, in turn boosting demand. That process takes time, of course – especially if, say, the initial recipients of increased income already have a high savings rate. But, with ample investment in the right areas, productivity growth can be sustained.
The danger lies in debt-fueled investment that shifts future demand to the present, without stimulating productivity growth. This approach inevitably leads to a growth slowdown, possibly even triggering a financial crisis like the one that recently shook the United States and Europe.
Such crises cause major negative demand shocks, as excess debt and falling asset prices damage balance sheets, which then require increased savings to heal – a combination that is lethal to growth. If the crisis occurs in a systemically important economy – such as the US or Europe (emerging economies' two largest external markets) – the result is a global shortage of aggregate demand.