A case for economic optimism amid the pundits' gloom

Economic pessimists are agonising over the world's longer-term growth prospects, but repairing balance sheets, policy mistakes and political ineptitude is not an impossible task.

Lowy Interpreter

Economics has long been seen as the dismal science. Current commentary provides evidence. Whether discussing the cyclical conjuncture or the prospects for longer-term sustainable growth, gloom prevails.

Certainly, the mature economies have had a pathetically limp recovery from the 2008 financial crisis. The classic V-shaped recovery would have seen a quick return to full capacity, involving growth rates well above average during the recovery phase. In fact, among the major European countries, Germany is the only one to have regained its 2007 GDP. America, which historically bounces back with annual growth rates of 5 per cent or more, is struggling to maintain 2.5 per cent.

The story can be explained in terms of balance sheet repair, policy mistakes and political ineptitude. All these factors are fixable.

With most advanced economies are running around 15 per cent below normal capacity, there is still room for substantial growth just to get back to normal. Provided they can get their act together before unemployed workers lose skills and spirit, this is a growth opportunity waiting to be reaped. All that is needed to raise living standards by a couple of per cent a year over the next half-decade is competent policy-making.

Meanwhile, the structural growth pessimists are agonising over longer-term prospects.

Their hand-wringing identifies two contrasting types of malaise. First is the fear that, after two centuries of spectacular innovation, technological progress has slackened, reducing the capacity to go on churning out ever more things. The second is that we can’t use all the available productive capacity: there is chronic over-supply.

Robert Gordon is the main proponent of the first theme — that we have already invented and applied all the really useful ideas. Advances in basic health, nutrition and communications brought huge increases in living standards but, having got on top of these issues, comparable advances aren’t available. The dramatic reduction in child mortality and deaths from infectious diseases, having been achieved, cannot be substantially improved. Electric lights and motors can only be invented once. Higher female workforce participation is another ‘once off’ boost to GDP. Passenger airplanes are traveling no faster now than forty years ago.

The second concern is oversupply. We have been too successful at producing things: to keep everyone employed, governments provide easy credit and run budget deficits to boost demand, both of which store up future problems. In the international context, this is presented either as a ‘global savings glut’ or as ‘international imbalances’, with China’s current account surplus often featuring prominently.  

Tyler Cowen melds the two themes. In The Great Stagnation, Cowen worried that the low hanging fruit has already been picked from the tree of technology. Now his additional concern is that technology and the communications/information revolution will hand out bountiful rewards to the exceptional few who manage the pivotal creative ideas, leaving the rest to lead empty lives of menial work and video games. There has been a fair bit of push-back for the Cowen-Gordon thesis that we have run out of good new ideas. The consensus is that, even if the golden age is gone, there is still quite a bit of room to do things better.

As for the 'savings glut', the international manifestations are probably transitional. China has recognised the need for re-balancing. Raising consumption to more normal levels automatically lowers savings. Just be patient.

As for the US manifestations, if American income distribution had not favoured the extremely rich so heavily and left the average worker with no increase in average real income for three decades, demand might be stronger without the artificial stimulus of easy credit and budget deficits. The ‘winner takes all’ society may be an inevitable part of technological progress, but a more egalitarian policy seems quite consistent with adequate rewards for innovation. This is not just about a less regressive tax scale. Intellectual capital should be rewarded so as to maximise innovation, not to entrench incumbents. It also involves ensuring that the education system is a vehicle for social mobility, seeking out the mute inglorious Miltons in the broad population.

Meanwhile, back in the emerging economies, the gloomsters’ debate is about whether fast-growth convergence will run into the ‘middle-income trap’. There are enough examples of full convergence to say confidently that sustained rapid growth is feasible if policies and politics are supportive. In the first decade of this century the exceptional performance of the emerging economies added an extra full percentage point onto annual world growth. Now, with emerging economies having additional heft from larger GDP, even a more modest pace of expansion would maintain their contribution to global growth.

In short, even if underlying growth potential in already-wealthy countries may be a bit slower, the world is on track to solving the economic problem of poverty. We are getting good growth where it is most needed. What’s there to be so gloomy about?

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.

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