Current Issues in Economics Secular Stagnation or Growth Explosion? 1.

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Current Issues in Economics

Secular Stagnationor

Growth Explosion?

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Secular Stagnation or Growth Explosion

Growth – historical perspective• The pace of growth since 1750 till 1970 is the sequence of two

industrial revolutions. • First 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 been implemented by then.

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Secular Stagnation or Growth Explosion?

Great Moderation • From the early 1980s on, most advanced economies

experienced what has been dubbed the “Great Moderation,” a steady decrease in the variability of output and its major components— such as consumption and investment.

• There were, and are still, disagreements about what caused this moderation. – Central banks would like to take the credit for it, and it is indeed

likely that some of the decline was due to better monetary policy, which resulted in lower and less variable inflation.

– Others have argued that luck, unusually small shocks hitting the economy, explained much of the decrease.

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Before storm• The mid-2000s was a period of strong economic performance

throughout the world. Economic growth was strong; inflation low; international trade and financial flows expanded; and the emerging and developing world experienced widespread progress and a notable absence of crises.

• This favorable trends was underpinned, however, by three trends that appeared increasingly unsustainable as time went by: – real estate values were rising at a high rate – a number of countries were simultaneously running high and rising

current account deficits – leverage had built up to extraordinary levels in many sectors across

the globe among consumers and financial institutions

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History moves again: global economic shift• Advanced economies accounted for two-thirds

of world GDP (in purchasing-power-parity terms) in 1992 but their contribution fell to less than half of global GDP by 2012 (IMF)

• Cities emerging as power centers—about 60 percent of global GDP today is generated by 600 urban centers (McKinsey, 2011).

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Vicious circle of pre ‘08 global economic system:• China trade surplus invested in US debt led to low

interest rates (low cost of financing)• US low cost public debt financing and low cost

private credit real estate financing and false wealth effect

• European demand for US structured debt financial products financed by export of investment goods to China and peripheral Euro countries

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Demographic pressures• The world population is projected to increase to more

than 8 billion by 2030 and to age at an unprecedented rate.

• For the first time in history, by 2020 children younger than 5 will be outnumbered by people 65 and older.

• In all regions except sub-Saharan Africa the elderly population will increase more than the working-age population, driving up age-related costs.

• Some emerging markets, including China, may get old before they get rich owing to a declining population.

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EU- the labor market perspectives:• the unemployment rate would be reduced slightly from 7.2% in

2007 to 5.7% in 2020• the employment participation rate would increase the

employment rate (of people aged 15 to 64) in the EU would increase from 65.5% in 2007 to almost 70% in 2060. the employment rate of women is assumed to rise from 58.4% in 2007 to 65.1% in 2060, and for older workers (55-64), from 44.9% in 2007 to 59.8% in 2060.

• the labor input, measured by total hours of work, would increase by 5.4% until 2020; a reversal would start in 2020 and hours worked are expected to fall by 12.9% between 2020 and 2060.

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EU – labor shortage• Increasing labor force participation rates in most countries and

rising net immigration levels in some can only moderate the fall in employment caused by the ageing of the population and the negative population growth of the period 2020 to 2060.

• A reduction in labor input in 18 Member States over the period 2007 and 2060, with drops of 20% and more in Bulgaria, the Czech Republic, Germany, Estonia, Latvia, Lithuania, Hungary, Poland, Romania, Slovenia and Slovakia.

• A few Member States would see an increase in hours worked (Belgium, Ireland, Spain, France, Cyprus, Luxemburg, Sweden and the UK).

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Labor shortage vs unemployment dilemma• Youth unemployment is one of Europe’s most

glaring problems. Opponents of austerity point to the swelling ranks of unemployed young (15-25 years of age) people in Europe’s periphery as proof that fiscal tightening can no longer be tolerated.

• Youth unemployment rates have reached 51% in Greece and Spain, 36% in Italy and Portugal, and 30% in Ireland

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• Youth unemployment in the Eurozone crisis countries has been exacerbated by the crisis, but it is not a by-product of the crisis.

• The problem has deep roots in a policy that attempted to overcome rigidities in the labor market and the production structure by creating a deeply divided labor market, with ‘ins’ and ‘outs’. The ‘outs’, mostly young people, provided the necessary flexibility to adjust in the years before the crisis, where domestic expansion coexisted with increasing competition from the Asian and Central European producers.

• Today’s unemployment creates expectations of low prospective employment, which in turn causes an endogenous drop in demand, reducing activity and raising unemployment even further.

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Demography turning into political problem Reduction and delay of pensions while resulting in budgetary savings, the inadequate pension levels may lead to: • increase in inequality: young vs old• future demands for ad-hoc government interventions to

address declines in public pensions relative to wage developments and the risk of poverty of pensioners,

• democratic destabilization – elderly vote

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Demographic pressure - the positive side:• increased life expectancy means people can work longer. • serving older people - new areas of demand• elderly better in building social capital:

– Less crime– More free time for volunteer activities

Mixed blessing: many developing economies, especially in sub-Saharan Africa and south Asia, will have to generate job opportunities for new labor market entrants amid rapidly increasing populations.

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Changing demographic patterns can affect individual countries’ saving and investment and alter future global financial and labor flows.• Older societies more savings less demand

particularly for high-tech products• Migration from poorer countries to fill the

labor gap

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Problem of growth not of distribution• Given the extent of labor-saving technological

progress, there is increasingly weaker "natural" reason for relationship between the overall productivity of the economy and the size of the labor force.

• Societies raising retirement ages meant to reduce the cost of social security outlays.

• However, it risks aggravating the generational issue. The older generation stays in their positions for longer, blocking the ascendancy of the next generation.

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EU – a sharp decline in potential growth rate?• The annual average potential GDP growth rate in

the EU is projected to fall from 2.4% in the period 2007-2020, to 1.7% in the period 2021-2040 and to a meagre 1.3% in the period 2041-2060.

• While all EU Member States would experience a future slowdown in their potential growth rates, owing to the adverse impact of demographic trends, growth rates would differ substantially from country to country.

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Impact of growing complexity • Institutions: Banks are only part of a complex network of

financial institutions and markets, and risks are far from gone.

• Financial products: When the U.S. housing boom turned to bust, a complex and opaque structure of financial products led to confusion which institution was holding which claims and which institutions were solvent.

• This in turn led to major liquidity runs, not so much on banks, but on many nonbank financial institutions, such as investment banks—many of which over the years operated like banks but without the regulation and protections banks received.

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Impact of regulatory system• Markets, having been progressively deregulated since the

1970s, were confronted by a particularly fragmented and ineffective system of government prudential oversight.

• The reality of financial regulation is that new rules open new avenues for regulatory arbitrage, as institutions find loopholes in regulations. That in turn forces authorities to institute new regulations in an ongoing cat-and-mouse game (between a very smart mouse and a less nimble cat).

• Global regulatory arbitrage. Hoping to reduce their required regulatory capital under the Basel II framework, European banks eagerly acquired AAA-rated (but systemically risky and opaque) structured products.

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Impact of globalization:• By 2014, the world had 96 mobile phone subscriptions and 40

Internet users for every hundred inhabitants from zero 20 yeas earlier

• Flows of goods, services, and finance rose from 24 percent of global output in 1980 to a peak of 52 percent in 2007

• In 1990, 60 percent of trade in goods was among the high income economies, another 34 percent was between high income and emerging market economies, and just 6 percent was among emerging market economies. By 2012, these ratios were 31 percent, 45 percent, and 24 percent, respectively.

• In 1980, FDI was negligible. Today, it is a large flow averaging 3.2 percent of global output between 2005 and 2012

• Total cross-border financial flows peaked at 21 percent of global output in 2007, before collapsing to 4 percent in 2008 and 3 percent in 2009.

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Impact of energy revolution• Not long ago, the prevailing concern was that there wasn’t enough

energy to power the world. Now, among players from oil producers to electric utilities to multinational manufacturers, there’s a new worry: that a proliferation of new energy technologies and supplies is starting to undermine world powers.

• From a boom in fossil-fuel production to a flowering of renewable energy to the rollout of an array of contraptions and business models to cut energy waste, the new energy riches of the 21st century are destabilizing the old economic order.

• The energy revolution is starting to remake the global energy landscape: – They’re shifting the center of gravity of global oil production westward, to

North America from the Middle East. – They’re reorienting the adolescent renewable-energy industry eastward, to

China from the United States and Europe.

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Impact of policy worldview: Washington consensus

• Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP;• Redirection of public spending from subsidies toward pro-growth, pro-poor

services like education, health care and infrastructure investment;• Tax reform, broadening the tax base and adopting moderate marginal tax rates;• Interest rates that are market determined and positive in real terms;• Competitive exchange rates;• Trade liberalization: liberalization of imports, with elimination of quantitative

restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;

• Liberalization of inward foreign direct investment;• Privatization of state enterprises;• Deregulation: abolition of regulations that impede market entry or restrict

competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions;

• Legal security for property rights.

In practice: "Stabilize, privatize, and liberalize"

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Forces behind secular stagnation• There was virtually no growth before 1750, and thus there is no

guarantee that growth will continue indefinitely. • U.S. economy faces six headwinds that will limit future potential

growth and hold it below the pace which innovation would otherwise make possible: – The “demographic dividend” of more hours worked per capita is now

in reverse motion. – The plateau in educational attainment – Holding down the growth is raising inequality.– Outsourcing of all types, from call centers to radiologist jobs.– Energy and the environment represent the fifth headwind. – The twin household and government deficits.

Robert J. Gordon

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Ongoing 3rd industrial revolution• The computer and Internet revolution began around

1960. • Many of the inventions that replaced tedious and

repetitive clerical labor by computers happened in the 1970s and 1980s.

• 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.

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Two narratives:• Macroeconomic– Central actors: policy makers– Question: how to use production factors and

distribute outcomes• Schumpeterian– Central actors: entrepreneurs– Question: creating conditions to innovate

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Current Issues in EconomicsHomework

Powerpoint of 5 slides up to 3 people teams.Your takeout from the lectures, based on the following:

• “I must say I find television very educational. The minute somebody turns it on, I go to the library and read a good book”. Groucho Marx

• “I think there is a world market for maybe five computers.” T. Watson, president of IBM, 1943

• “640 kilobytes floppy disc ought to be enough for anyone.” Bill Gates, 1981• “Who would like to pay for a message sent to no one in particular?” Advise to D.

Sarnoff not to invest in radio• “The Americans need phones but we do not, we have plenty of messenger boys”

Chief, British Post, 1878• “It’ll be gone by June” Variety Magazine on Rock n’Roll, 1955

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Current Issues in Economics Secular Stagnation or Growth Explosion? 1.

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