The case against 'secular stagnation'

Larry Summers' gloomy argument that ‘secular stagnation’ is to blame for low growth ignores the real, fixable problems that major economies are facing.

Lowy Interpreter

Economic growth has been so slow in the advanced countries since 2010 that there has been a revival of an old idea: secular stagnation. This hypothesis suggests that profitable investment opportunities have become scarce. Even with low rates of interest, economies want to save more than they invest.

Is this what explains the feeble performance of most advanced economies in the aftermath of the 2008 crisis?

No one would dispute the 'stagnation' part. Of all the major European countries, only Germany has a higher level of GDP than before the crisis. Even the United Kingdom is well short of its 2007 GDP. American GDP is now above the 2007 level, but only just. Its recovery, normally a vigorous 5 per cent or so per year, has barely registered 2 per cent. All these economies (again except Germany) are operating perhaps 10-15 per cent below capacity. In the euro area, unemployment is over 12 per cent.

Former US Treasury Secretary Larry Summers, always ready to stir debate with a controversial argument, has pondered aloud about the old secular stagnation concern. Summers' comments might have made an interesting conference dialogue but, taken seriously, would distract policy from its proper course. Rather than invoking a unified theory of what has gone wrong, the better explanation is that these weak economies have experienced a mix of common and idiosyncratic influences.

The 2008 financial crisis was certainly widespread. But the worst-hit economies had accumulated country-specific problems which explain their slow recovery. Where the financial collapse reflected over-borrowing and asset price bubbles, it takes time to unwind the over-leveraged balance sheets of both households and banks.

Then there were the policy errors.

The 2009 G20-coordinated fiscal stimulus softened the downturn. But in 2010 there was an abrupt policy reassessment, probably triggered by the Greek debt debacle. Some countries (like Greece) had no choice but to repair their budgets, whatever the cost to output. But just about everywhere, sovereign-debt phobia forced fiscal policies to contract sharply. No one should be surprised that this stunted the recovery.

The US has had two debt ceiling crunches, a Tea Party revolt and sequestration. And the budget deficit has been speedily wound back from 10 per cent of GDP to 4 per cent, with the resulting fiscal contraction this year subtracting 2 per cent from growth.

The European peripheral countries should have been given a deep debt rescheduling in 2010, clearing the slate for a restructuring revival. Instead the debt remains a wet blanket suffocating recovery. For the rest of Europe, bank balance sheets are still weighed down with doubtful assets. Macro policy settings appropriate for Germany are foisted on the whole euro area.

All these factors, both widespread and idiosyncratic, are enough to explain the lacklustre recovery. So this is not structural stagnation (for one thing, structural stagnation is inconsistent with the high profit levels now being experienced in the US). Yet the structural stagnation concern has deep roots.

Paul Krugman has joined the debate and Robert Gordon worries that innovation is not progressing fast enough to avoid very low growth. Japan's 'lost decades' set a disquieting precedent. Looking back on the US before 2008, there seems to be a chronic need for the stimulus of low interest rates, expansionary fiscal policy, fast credit expansion and asset price bubbles just to keep the economy operating close to capacity.

But rather than invoke the despair of secular stagnation, there is a swag of structural fixes that would help if politics allowed. The usual suspects range from regulation simplification to competition policies.

There are also historically anomalous structural shifts which have dampened demand. Exhibit one is the shrunken wage share and the related stunning rise in income inequality. Low-paid workers in the US have had no increase in real wages for over three decades. If workers had more income, they might find something to spend it on and the shortage of demand would disappear.

Then there is the curious role of the financial sector. In advanced economies finance has doubled its share of GDP. Yet its performance before and during the 2008 crisis led the head of the UK bank regulator, Lord Turner, to describe some banks as 'socially useless'. Short-term focus has discouraged longer-term investment.

Perhaps if members of the financial sector spent less time trading with each other on borrowed money and more time linking the savers of the advanced world with the many investment opportunities in the emerging economies, the prospect of secular stagnation would recede into the far-distant future.

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

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