That Absurd Fear of Stagnation
Seven long years have passed since the outbreak of the financial crisis, but the output of advanced countries has only recently inched past its pre-crisis level. So it is not surprising that a debate on "secular stagnation" rages. Yet the evidence that economic growth is in terminal asphyxia is entirely unconvincing. Instead, bad policies, deficient institutional arrangements and the mistakes of the past are still tying some of the world's largest economies down.
The idea of secular stagnation — popularized recently by economists of renown such as former Secretary of the Treasury Larry Summers and Paul Krugman — is not new. In 1938, nine years into the Great Depression, Alvin Hansen dedicated his presidential address to the American Economic Association to an examination of what he saw as the three big culprits in the failed bid to reignite growth and cure mass unemployment: static population, the absence of technological breakthroughs that could compare with electricity and the combustion engine, and the exhausted supply of new land to occupy and exploit.
Hansen could not have foreseen that arms spending would, within four years, spectacularly pull the U.S. economy out of its doldrums. But he also proved far off the mark in his assessment of the fundamental drivers of growth. Far from stagnating indefinitely, the gross domestic product (GDP) per capita of the United States is now six times greater than in 1938. The population of the United States, boosted by immigration and medical advances, is now 2.5 times its size in 1938. In the last 20 years, computers and the Internet have revolutionized production and distribution, and made possible global communication at essentially zero cost. We have not yet colonized Mars or Venus, but, as it turns out, we did not need to. Instead, we found new worlds at our doorstep, as billions of previously marginalized workers and consumers in developing countries have been brought into the global economic mainstream.
This takes me to what is perhaps the greatest anomaly in the secular stagnation hypothesis of today, and that is the presumption that, because some advanced countries have struggled to recover from financial crisis, the no-growth phenomenon is universal and permanent. So we forget that the average growth rate of the world economy over the last 25 years has been in the vicinity of 3.5 percent a year, and it has approached or exceeded 3 percent every year of the last decade, except in 2009, the worst year of the crisis. Strikingly, almost 60 percent of the world population resides in countries such as China, India and Indonesia, where output grew faster than 5 percent in 2014, a year the International Monetary Fund (IMF) has described as "disappointing." Another 23 percent of the world population resides in countries where output grew faster than 2 percent, well above the rate of growth of the population. That group includes advanced countries, such as Singapore and Israel, which have also seen average annual growth rates of 4 percent during the whole post-crisis period. Countries where income per capita has stagnated or declined, and where productivity has been static for a long time, such as France and Italy, are very much the exception. Ironically, the United States — where the secular stagnation hypothesis found its inspiration — created over 2.6 million net new jobs in 2014, shattering records, and appears set to repeat a similar feat in 2015.
Not only is the emphasis of "stagnationists" on the recent experience of advanced countries excessive, but their arguments rest on three questionable premises. The first premise, favored by Summers, is that there is a structural global excess of savings over investment and that, with interest rates already near zero, and government spending hobbled by a mixture of high public debt and conservative ideology, it is demand is bound to fall short of capacity. Summers's thesis overlooks the growing evidence that the private sector deleveraging process — a well-known feature of financial crises — has largely run its course in countries such as the United States, United Kingdom and Germany. Households in those countries have reduced debts and/or rebuilt equity in their homes and are spending again. Meanwhile, banks, having also undergone a drawn-out balance sheet rebuilding process, and supported by expansionary monetary policy, are lending again. Moreover, the notion that there is a shortage of global effective demand is implausible when billions of people in rapidly growing and increasingly credit-worthy developing countries still lack reliable electricity and water supply and cars for their burgeoning middle class.
The second questionable premise underpinning the secular stagnation hypothesis, most closely associated with Robert Gordon of Northwestern University, is that we are running out of big new inventions. Since new inventions have not, by definition, yet been invented, this thesis is impossible to disprove or to prove. What one can say with certainty is that constant innovation has been a feature of the last 250 years; that there has often been a tendency to underestimate the effect of innovation; and also that there are many innovations, ranging from the Internet of things, to 3-D printing, driverless cars and aircraft, artificial intelligence genetic engineering, where commercial application is still clearly at a very early stage. Information technologies are making many services tradable, storable and divisible into component activities. Many experts believe that this unbundling process will eventually dramatically boost productivity in activities such as retailing, banking, accounting, education, healthcare and entertainment, which account for a huge share of economic activity, triggering a revolution as far-reaching as that of automation in manufacturing.
The third premise behind the fear of secular stagnation, slowing population growth, is more firmly grounded than the other two but still requires careful qualification. The remarkable demographic transition of recent years, which has seen fertility rates drop precipitously as well as longer lives, means that in advanced countries the population of working age is flat or declining and old-age dependency ratios are rising rapidly. However, while these trends may account for one-half of a point or so of slower output growth, roughly in line with the slowdown in population growth, they need not slow GDP per capita, which is what matters most for living standards. Moreover, to mitigate the effects on them of aging, advanced countries have many options, such as creating incentives to extend working lives, fighting agism in the workplace and tapping the still fast-growing young populations of developing countries by allowing increased immigration and relying more on imports of labor-intensive goods and services.
The rich countries of Europe, America and Asia are unlikely to return to the rapid growth rates they experienced 60 years ago when they were still rebuilding after the war, their population were still growing rapidly and when their incomes were a fraction of what they are today. But there is no convincing reason why the advanced countries cannot continue to leverage technology and international trade and return to a moderate long-term expansion of 2 percent or even 3 percent a year, which will again lead to rising living standards and greatly improved prospects for their young.
In the final analysis, it is the inadequacy of policies and institutional arrangements — rather than any shortage of demand, or of technological breakthroughs or of workers — which is preventing some countries from overcoming the legacy of the crisis. The structural reforms that are needed have been extensively documented and hardly need repeating. For example, a Japanese economy which encouraged increased participation of women and of immigrants in the labor force would certainly be a faster growing economy. The United States has again to find the political capacity to articulate and execute a coherent economic policy. And the eurozone still has much work to do to establish a workable currency union so that it can overcome its own homegrown brand of structural stagnation.