Recent evidence on long term growth
dynamics and drivers decomposition across the advanced economies presents a
striking paradox relating to the post-recessionary experience around the world.
In a traditional business cycle, recovery period growth exhibits certain
historical regularities, that are no longer present in the current cycle. These
regularities involve the following stylised facts:
1) Following a recessionary contraction in
aggregate output, advanced economies enter a stage of recovery associated with
strong growth in investment and domestic demand;
2) Gains in factors' productivity,
especially in labour productivity, are amplified in the early stages of
post-recessionary recovery compared to their pre-crisis trend levels; and
3) Rates of growth in the recovery cycle
are in excess of pre-recessionary growth.
These facts are patently absent from the
data for the major advanced economies today, some four to five years into the
recovery. This realization has prompted some economic and financial analysts to
speculate about the potential structural decline in long term growth rates, the
thesis commonly termed "secular stagnation".
Currently, there are two prevailing theses
of secular stagnation, linked to two long-term cycles gaining prominence in the
global economy: the demand side and the supply side theses.
Investment-Savings
Mismatch
The first theory suggests that secular
stagnation is linked to a structural decline in aggregate demand, manifesting
itself though a decades-long mismatch between aggregate savings and investment
and more broadly related to the demographic effects of ageing.
This theory traces back to the 1930s
suggestion by Alvin Hansen that the U.S. Great Depression aftermath was coinciding
with decreasing birth rates, resulting in oversupply of savings and a fall off
in demand for investment. The thesis was salient throughout the 1930s and the
first half of the 1940s, but was overrun by the war and subsequently forgotten
in the years of the post-WW2 baby boom and investment uplift. Large scale
increase in public investment, linked to rebuilding destroyed (in Europe and
Japan) or neglected (in the war years in the U.S.) public infrastructure, helped
to push Hansen's forecasts of a structural growth slowdown aside.
The thesis of demand-driven secular
stagnation made its first return to the forefront of macroeconomic thinking
back in the 1990s, in the context of Japan. As in Hansen's 1930s U.S., by the
early 1990s, Japan was suffering from a demographics-linked glut of savings, and
a structural drop off in investment. Suppressed domestic demand has led to a
massive contraction in labour productivity. During the 1980-1989 period,
Japan's real GDP per worker averaged 3.2 percent per annum. In the following
decade, the rate of growth was just over 0.82 percent and over the period of
2000-2009 it fell below 0.81 percent. Meanwhile, Japan's investment as a
percentage of GDP fell from approximately 29-30 percent in the 1980s and the
1990s to under 23 percent in the 2000s and to just over 20 percent in
2010-2015.
Following Japan's experience and the shock
of the Great Recession, the theory that the entire developed world is set for a
structural growth slowdown has gained traction. Between 1980 and 2014, the gap
between savings and investment as percentage of GDP has widened in Canada,
Japan, and the Euro area. Controlling for debt accumulation in the real
economy, the widening of savings surplus over investment over each decade since
the 1980s is now present in all major advanced economies, including the U.S.
In line with this, labour productivity also
fell precipitously across all major advanced economies. As shown in the chart
below, even a period of unprecedented rise in unemployment in the U.S. and the
euro area over the recent Great Recession did not shift the trend for declining
labour productivity growth.
CHART:
Five-year Cumulated Growth in Real GDP per Employee
Percentage
Points
Source: Author own calculations based on
data from the IMF
Worse, current zero rates monetary policy environment
is reinforcing the savings-investment mismatch, rendering the monetary policy
impotent, if not damaging, in stimulating the return to higher long term
growth.
Traditionally, low interest rates create
incentives for investment and reduced saving by lowering the cost of the former
and increasing the opportunity cost of the latter.
However, today's ageing demographics and
rising dependency ratios offset these 'normal' effects. This means that for the
older generations, retirement pressures work through both insufficient reserves
built in pensions portfolios, and also through lower yields on retirement
portfolios, incentivising more aggressive savings.
For the working age population, the
pressures are more complex. On the one hand, middle age workers today face
severe pressures to deleverage their balance sheets, aggressively reducing
liabilities accumulated before the crisis. On the other hand, growing
proportions of middle-age adults are facing twin financial pressures from the
rising demand for support for ageing parents and, simultaneously, for
increasing number of satay-at-home younger adults who continue to rely on
family networks for financial and housing subsidies. A recent Pew Research
study found that 64 percent of Italian middle-aged generations find themselves
sandwiched between ageing parents and children. In the U.S. this proportion is
47 percent and in Germany 41 percent. All along, the same households are under
pressure to build up their pensions, as retirement security and social provision
of pensions are now highly uncertain.
1) Existent legacy of the private debt
overhang;
2) Demographics of ageing;
3) Rising income inequality that induces
greater financial insecurity today and into the future, thus creating
incentives for increased ordinary and precautionary savings;
4) Access to low cost capital;
5) Positive real interest rates that
continue to prevail despite historically low policy rates; and
6) Large scale holdings of banks' reserves
on central banks balance sheets.
All of these factors are currently at play
in the U.S., UK and the euro area, as well as Japan. With a lag of about 3-5
years, they are also starting to manifest themselves in other advanced
economies.
Tech
Investment: Value-Added Miss
The supply side of secular stagnation thesis
is a relatively new idea coming from the cyclical view of historical
development of physical and ICT-linked technologies. First formulated by Robert
Gordon some years ago it is summarised in his August 2012 NBER paper, titled
"Is the US Economic Growth Over? Faltering Innovation Confronts the Six
Headwinds" (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2133145).
Gordon looks at long-term - very long-term
- trends in growth from the point of challenging the traditional view of
macroeconomists that perpetual economic progress is subject to no time
constraints. In Gordon's view, U.S. economy over the period through the 2050s
is likely to face an uphill battle. Per Gordon, "The frontier established
by the U.S. for output per capita, and the U. K. before it, gradually began to
grow more rapidly after 1750, reached its fastest growth rate in the middle of
the 20th century, and has slowed down since.
It is in the process of slowing down further."
The reason for this, according to the
author, is the exhaustion of economic returns to the most recent technological
/ industrial 'revolution'. "A
useful organizing principle to understand the pace of growth since 1750 is the
sequence of three industrial revolutions. The first with its main inventions
between 1750 and 1830 created steam engines, cotton spinning, and railroads.
The second was the most important, with its three central inventions of
electricity, the internal combustion engine, and running water with indoor
plumbing, in the relatively short interval of 1870 to 1900. Both the first two revolutions required about
100 years for their full effects to percolate through the economy. …After 1970
productivity growth slowed markedly, most plausibly because the main ideas of
[the second revolution] had by and large been implemented by then. The computer
and Internet revolution began around 1960 and reached its climax in the dot.com
era of the late 1990s, but its main impact on productivity has withered away in
the past eight years. …Invention since 2000 has centered on entertainment and
communication devices that are smaller, smarter, and more capable, but do not
fundamentally change labor productivity or the standard of living in the way
that electric light, motor cars, or indoor plumbing changed it."
Gordon’s argument is not about the levels
of activity generated by the new technologies, but about the rate of growth in
value added arising form them. In basic terms, ongoing slowdown in the U.S.
(and global) economy is a function of six headwinds, including the end of the
baby boom generation-linked demographic dividend; rising income and wealth
inequality; factor price equalisation; lower net of cost returns to higher
education; the impact of environmental regulations and taxes; and real economic
debt overhangs across public and non-financial private sectors.
Gordon estimates that future growth in
consumption per capita for the bottom 99 percent of the income distribution is
likely to fall below 0.5 percent per annum over the period of some five decades.
A recent study from IBM, titled
"Insatiable Innovation: From sporadic to systemic", attempted to
debate the thesis, but ended up confirming Gordon’s assertion that incremental
and atomistic innovation is the driver for today's technological progress. In
other words, the third technological revolution is delivering marginal returns
on investment: significant and non-negligible from the point of individual
enterprises, but hardly capable of sustaining rapid rates of growth in economic
value added over time.
Disruptive
Change Required
The problem is that both theses of secular
stagnation are finding support not only in the past historical data, but also in
the more recent trends. Even the most recent World Economic Outlook update by
the IMF (April 2015) shows that the ongoing economic slowdown is structural in
nature and traces back to the period prior to the onset of the Great Recession.
As both, the demand and supply side theses
of secular stagnation allege, the core drivers identified by the IMF as the
force behind this trend are adverse demographics, decline in investment, a
pronounced fall off in total factor productivity growth (the tech factor), as
well as the associated decline in labour and human capital contributions to
productivity. IMF evidence strongly suggests that during the pre-crisis spike
in global growth, much of new economic activity was driven not by expansion on
intensive margin (technological progress and labour productivity expansion),
but by extensive margin (increased supply of physical capital and emergence of
asset bubbles).
Like it or not, to deliver the growth
momentum necessary for sustaining the quality of life and improvements in
social and economic environment expected by the ageing and currently productive
generations will require some serious and radical solutions. The thrust of
these changes will need to focus on attempting to reverse the decline in
returns to human capital investment and on generating radically higher economic
value added growth from technological innovation. The former implies dramatic
restructuring of modern systems of taxation and public services provision to
increase incentives for human capital investments. The latter implies an
equally disruptive reform of the traditional institutions of entrepreneurship
and enterprise formation and development.
Absent these highly disruptive policy reforms, we will
find ourselves at the tail end of technological growth frontier, with low rates
of return to technology and innovation and, as the result, permanently lower
growth in the advanced economies.
