MILAN – The world is facing the prospect of an extended period of weak economic growth. But risk is not fate: The best way to avoid such an outcome is to figure out how to channel large pools of savings into productivity-enhancing public-sector investment.
Productivity gains are vital to long-term growth, because they typically translate into higher incomes, in turn boosting demand. That process takes time, of course – especially if, say, the initial recipients of increased income already have a high savings rate. But, with ample investment in the right areas, productivity growth can be sustained.
The danger lies in debt-fueled investment that shifts future demand to the present, without stimulating productivity growth. This approach inevitably leads to a growth slowdown, possibly even triggering a financial crisis like the one that recently shook the United States and Europe.
Such crises cause major negative demand shocks, as excess debt and falling asset prices damage balance sheets, which then require increased savings to heal – a combination that is lethal to growth. If the crisis occurs in a systemically important economy – such as the US or Europe (emerging economies' two largest external markets) – the result is a global shortage of aggregate demand.
And, indeed, severe demand constraints are a key feature of today's global economic environment. Though the US is finally emerging from an extended period in which potential output exceeded demand, high unemployment continues to suppress demand in Europe. One of the main casualties is the tradable sector in China, where domestic demand remains inadequate to cover the shortfall and prevent a slowdown in GDP growth.
Another notable trend is that individual economies are recovering from the recent demand shocks at varying rates, with the more flexible and dynamic economies of the US and China performing better than their counterparts in the advanced and emerging worlds. Excessive regulation of Japan's non-tradable sector has constrained GDP growth for years, while structural rigidities in Europe's economies impede adaptation to technological advances and global market forces.
Reforms aimed at increasing an economy's flexibility are always hard – and even more so at a time of weak growth – because they require eliminating protections for vested interests in the short term for the sake of greater long-term prosperity. Given this, finding ways to boost demand is key to facilitating structural reform in the relevant economies.
That brings us to the third factor behind the global economy's anemic performance: underinvestment, particularly by the public sector. In the US, infrastructure investment remains suboptimal, and investment in the economy's knowledge and technology base is declining, partly because the pressure to remain ahead in these areas has waned since the Cold War ended. Europe, for its part, is constrained by excessive public debt and weak fiscal positions.
In the emerging world, India and Brazil are just two examples of economies where inadequate investment has kept growth below potential (though that may be changing in India). The notable exception is China, which has maintained high (and occasionally perhaps excessive) levels of public investment throughout the post-crisis period.
Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns. Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.
The problem is that unconventional monetary policies in some major economies have created a low-yield environment, leaving investors somewhat desperate for high-yield options. Many pension funds are underwater, because the returns required to meet their longer-term liabilities seem unattainable. Meanwhile, capital is accumulating on high-net-worth balance sheets and in sovereign-wealth funds.
Though monetary stimulus is important to facilitate deleveraging, prevent financial-system dysfunction, and bolster investor confidence, it cannot place an economy on a sustainable growth path alone – a point that central bankers themselves have repeatedly emphasized. Structural reforms, together with increased investment, are also needed.
Given the extent to which insufficient demand is constraining growth, investment should come first. Faced with tight fiscal (and political) constraints, policymakers should abandon the flawed notion that investments with broad – and, to some extent, non-appropriable – public benefits must be financed entirely with public funds. Instead, they should establish intermediation channels for long-term financing.
At the same time, this approach means that policymakers must find ways to ensure that public investments provide returns for private investors. Fortunately, there are existing models, such as those applied to ports, roads, and rail systems, as well as the royalties system for intellectual property.
Such efforts should not be constrained by national borders. Given that roughly one-third of output in advanced economies is tradable – a share that will only increase, as technological advances enable more services to be traded – the benefits of a program to channel savings into public investment would spill over to other economies.
That is why the G-20 should work to encourage public investment within member countries, while international financial institutions, development banks, and national governments should seek to channel private capital toward public investment, with appropriate returns. With such an approach, the global economy's “new normal" could shift from its current mediocre trajectory to one of strong and sustainable growth.
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CommentedBen Leet
The U.S. growth history was strongest during the late 1930s and early 1940s when government had high taxes on the wealthiest and also engaged in high borrowing. Demand was restricted by the WWII war effort, savings broadly established as the workforce increased by a phenomenal 40% between 1940 and 1946 and GDP increased by 75%, a 10% growth rate compounded over 6 years. Demand was realized by increased growth because of wide-spread prosperity, not because of private investment. The horse goes before the carriage. Marriner Eccles, the chair of the Fed for 12 years, said as much, with far superior results. Read more
Commentedroberto martorana
i had write about this on "rio-dialogues" as consequence of reserch to overcome current monetarism , so : because first we need to find as financing sosteinible development ,so,because is difficoult from fiscal policy or keynesian or older idea whitout depress economy or corrupt government ,so I suppose a new mechanism through a new rule of central bank: when one of the central bank have a new emission of money whith each rate the same bank print corrispective quantity of money of the rate ,out of his bookkeeping ,and gives this quantity to compense the monetary mass at a "pubblic commission" that use for pubblic necessity,equality and sustanible development etc etc...in this way we resolve three problem :pubblic necessity,pubblic budget bat also market crisis,(this another consideration about compensation of monetary mass) ,we have heard of "quantitative easing" as an intervention to revive growth, but this is still a post-crisis intervention, and that does not solve the problem that I assume that is the algebraic inconsistency to lend x and ask in return x + y, y without any being placed on the market, which instead was resolved naturally with the release of gold from the mines ...... So I was thinking of a systemic intervention prevenient the crisis that could be defined "quantitative free", corresponding to y to the extent as described here ;for example : the B.C. have a emission of hundred billion "unit" and fix a rate of 3% , gives this money to commercial bank,or other but, and ,at the same moment print 3 new billion and gives ,for free, to pubblic commission that spend for pubblic problem ....i hope to be clear bat if not you can read more here https://www.facebook.com/pages/Teoria-della-compensazione-della-massa-monetaria/137335536277534 Read more
CommentedPaul Daley
Capital markets are supposed to channel savings towards investments. What's gone wrong there that special programs are needed to move funds to "productivity-enhancing" investments? What use do capital markets now make of that large pool of savings? And why? Spence is offering an answer to a problem before he identifies the cause. Read more
CommentedTom Shillock
Lawrence Summers identifies a, or perhaps the central, cause: rentiers: corporate and upper 1%
The Future of Work in the Age of the Machine
http://www.hamiltonproject.org/events/the_future_of_work_in_the_age_of_the_machine/ Read more
CommentedKC LOH
Why public investment? Indeed, why not! In productivity-enhancing infrastructures, that is: Infrastructures that generate economic returns even when the private sector does not see a commercial return. But this begs the question: how does one go about measuring economic return? Using growth accounting.
Two years ago, when debate in UK about HS2 was intense, I suggested in the FT Alphaville using growth accounting to frame the debate. I used economic data from 2010. You might do this exercise using more current data, but I expect the results will not differ too much. Here is a shortened version (alas, it is still quite lengthy!).
I love high-speed trains, and I do hope that Britain will have its HS2. But I also firmly believe that infrastructure projects should be embarked upon only if there is evidence that it will provide adequate economic returns.
Could HS1 perhaps give us a sneak peek at what the economic returns of HS2 might be? If HS1 has proven to be a good investment for the UK economy then perhaps I have good reasons to look forward to HS2.
So, was HS1 good value for money? To keep this post brief, I will describe only the general approach.
Total economic benefits, presented as the present values measured over 60 years, at 3% discount rate for the first 30 years and at 3.5% thereafter, were estimated to be £877million.
And the project cost of HS1 was £5,700 million
To carry out the growth accounting calculations, I had to make a few assumptions about how much of the project cost was spent on infrastructural assets such as land, buildings and rail tracks, how much on medium life assets such as rolling stocks and how much on miscellaneous shorter life assets such as computer and signaling systems, but the overall project costs of HS1 was £5,700 million.
And the additional number of persons employed as a result of HS1, but not counting jobs engaged in the construction, was 98,400,
Next, I represented the UK economy by the growth accounting function,
log V = log A + a log K + b log L
I first learnt about growth accounting from a post written by Paul Krugman. He didn’t invent growth accounting although he is so smart he could have done that if it wasn’t already invented.
If A increased, it means that the growth in the economy was greater than the sum of the growths in inputs and I count that as positive, i.e. the economic benefits of HS1 exceeded its costs.
So, did HS1 deliver?
The growth in A worked out to be –0.004%! Given that measuring economic benefits has a notoriously wide margin of error, and that it is so easy to miss counting the myriad of small economic spillovers, I would say that HS1 delivered. Well, just. At least HS1 wasn’t an abject economic failure, the way that opponents to high-speed rail try to make it out to be.
Perhaps I might yet get to ride the HS2 between London and Manchester. Read more
CommentedM A J Jeyaseelan
Productivity gains are, without any doubt, the only guarantees for long term progress. Investments in infrastructure including knowledge and technology provide the foundations required for sustained surge in productivity. Public investments however, become crucial in these areas since private investments are invariably driven by quicker and higher returns than what most infrastructure projects offer.
There is every reason to keep increasing public investments in infrastructure, knowledge and technology. But, these IKT investments must take place autonomously for helping growth in productivity and not for raising the level of aggregate demand and much less for creating higher rates of return for private investors - as these involve serious moral and economic implications.
Public investments do bail out economies more effectively than the massive bail outs doled out to businesses in the name of saving jobs and securing the economy. Why should it always be the poor taxpayer who is compelled to shell out money to save the economy and make it fit for the private investors to skim it all over again and siphon off all the cream? This process only aggravates the inequalities further.
Surely, IKT investments will save the economy. But the returns on such investments must flow back to the taxpayers and not to the investors. What Michael Spence is advocating will only perpetuate the very same processes, which impoverish the taxpayer and serve the greed of the rich. We cannot keep repeating the very same devious economic processes, which have been the major causes behind growing inequalities over the past several decades.
We need fresh thinking and approaches, which would pull the economy out of its current problems without aggravating inequality. Because, so long as the inequalities persist, there is no way to stop the recurrence of economic turmoil, which the world experienced since 2008.
https://www.linkedin.com/pulse/root-causes-inequality-jeyaseelan-m-a-j? Read more
CommentedKC LOH
Why public investment? Indeed, why not! In productivity-enhancing infrastructures, that is: Infrastructures that generate economic returns even when the private sector does not see a commercial return. But this begs the question: how does one go about measuring economic return? Using growth accounting.
Two years ago, when debate in UK about HS2 was intense, I suggested in the FT Alphaville using growth accounting to frame the debate. Here is a shortened version (alas, it is still quite lengthy!). I used economic data from 2010. You might do this exercise using more current data, but I expect the results will not differ too much.
I love high-speed trains, and I do hope that Britain will have its HS2. But I also firmly believe that infrastructure projects should be embarked upon only if there is evidence that it will provide adequate economic returns.
Could HS1 perhaps give us a sneak peek at what the economic returns of HS2 might be? If HS1 has proven to be a good investment for the UK economy then perhaps I have good reasons to look forward to HS2.
So, was HS1 good value for money?
To keep this post brief, I will describe only the general approach. Here is a summary of the reported economic benefits, presented as the present values measured over 60 years, at 3% discount rate for the first 30 years, and at 3.5% thereafter. Values are in £millions
Description PV Annual value added
HS1 revenue 3,400 52
Commuters’ time savings 3,800 145
Wider economic benefits 7,836 299
Regeneration benefits 10,000 381
Total economic benefits 877
And the project cost of HS1, according to the final report, was, in £millions:
Description £ millions
Project cost 5,700
I have to make a few assumptions about how much of the £5.7 billion was spent on infrastructural assets such as land, buildings and rail tracks, how much on medium life assets such as rolling stocks and how much on miscellaneous shorter life assets such as computer and signaling systems:
Description % £million Useful life years
Infrastructural 85 4,845 60
Rolling stocks 10 570 25
Systems 5 285 7
And the additional number of persons employed as a result of HS1:
Description Number employed
Regenerated regions 87,300
Additional central London jobs 11,100
Total additional employment 98,400
Next, I represent the UK economy by the growth accounting function,
log V = log A + a log K + b log L
I first learnt about growth accounting from a post written by Paul Krugman. He didn’t invent growth accounting although he is so smart he could have done that if it wasn’t already invented.
If A increased, it means that the growth in the economy was greater than the sum of the growths in inputs and I count that as positive, i.e. the economic benefits of HS1 exceeded its costs.
So, did HS1 deliver?
The growth in A worked out to be –0.004%! Given that measuring economic benefits has a notoriously wide margin of error, and that it is so easy to miss counting the myriad of small economic spillovers, I would say that HS1 delivered. Well, just. At least HS1 wasn’t an abject economic failure, the way that opponents to high-speed rail try to make it out to be.
Perhaps I might yet get to ride the HS2 between London and Manchester. Read more
CommentedJerry Nutter
Michael Spence would do well to lift his writing from the obfuscation of economist jargon to include some real world identifiable examples. His analysis reminds me or the clever solutions to a Rubics Cube, producing nothing tangible, certainly not insight. I would recommend Paul Krugman for clear thinking and telling. Read more
CommentedPingfan Hong
Well argued. Public investment in many countries is indeed in shortage. One institutional constraint on public investment is perhaps the lack of far-sighted decision-makers in public sector, as most public projects, such as infrastructure, require long-term investment, with a horizon much longer than the election cycle for public leaders. Read more
CommentedEd Rector
And this man won a Nobel Prize for thinking like this?? Read more
CommentedJohn Brian Shannon
Hi Michael,
Sound reasoning.
"Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns."
By properly targeting public investment in conjunction with re-targeting existing public spending for best effect (which simply means more jobs per billion dollars) will allow economies to get the most bang for the buck.
Jobs are drivers of growth. Working people buy more, make larger purchases, and purchase more often, compared to their unemployed peers.
Not only that, significant costs are incurred when paying millions of people unemployment insurance or those on social welfare schemes.
Want to end a recession? Don't just dump billions of dollars into the economy in a nebulous, unguided attempt to stimulate the economy. Instead, check the government stats to see which industries provide the largest number of jobs per billion dollars. That's where to direct the stimulus.
I've not much against the gas power generation industry and not much against the nuclear power industry, but they only provide 1.3 person-years of employment per MegaWatt -- vs. renewable energy power plants which provide *up to* 24 person-years of employment per MegaWatt.
Pls. see the chart at: http://jbsnews.com/2015/02/08/creating-jobs-via-renewable-energy-adoption/
Always -- but especially at the beginning of, and during economic downturns -- governments should re-prioritize stimulus to those parts of the economy that provide the largest number of jobs per billion dollars.
"Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns."
Whether we are in the austerity camp or the stimulus camp, re-targeting existing spending for the best employment increase is logical.
Austerity + re-targeted spending = good result.
Stimulus + re-targeted spending = excellent result.
I always enjoy reading your fine posts, Michael.
Best regards, JBS
Read more
CommentedMichael Heng
Very well argued. To make up for the weak demands, the driver for growth must come from more investment, especially productive investments. History suggests that productive investments are likely to be investments in scientific research and discovery, technological inventions and innovations, and infrastructure. Given the enormous waste in mega-cities, this is another area of productive investment by restructuring mega-cities to reduce waste. Besides IT, promising areas of technological innovation are in new materials, 3-D printing, healthcare, and green technologies. Read more
Commenteddan baur
"Excessive regulation of Japan...
rigidities in Europe...
[China] perhaps excessive levels of public investment...
Structural reforms, ... are also needed"
Where is the argument for Public "Investment"? What's wrong with Private Investments?
"US, infrastructure investment remains suboptimal" - where are the examples? Is this just the construction lobby talk?
Read more
Commenteddan baur
The comment below was for jagjeet sinha. Read more
Commenteddan baur
The Private Sector does not take up those challenges because the Public Bureaucracy does not allow it.
As an Indian, you go to London not for the nasty weather and food but because that society is much less corrupt and bureaucratic than back home.
"Public Investment" is a misnomer as bureaucrats are not qualified to invest. Besides, spending someone else's money is definitely not Investing. Read more
Commenteddan baur
Walter Gingery, do you even understand the difference between willing and forced participation?
If no one is forcing you to lend or own company X, then you agree to their investments. No the same with the state. Read more
CommentedWalter Gingery
"spending someone else's money is not investing"
You should stop and think a moment: what is a corporate bond or a share of stock but a way for you to spend someone else's money?
Read more
Commentedjagjeet sinha
Thanks.
Indeed, The Anglosphere has a Mecca - called London, and India has its greatest believers. Perplexed by the outflow from The Eurozone, that soon threatens to overtake the outflow of European migration to The Anglosphere after Waterloo and WWI and WWII. Now that they have their own currency Euro and their own Capital Brussels and their Central Bank ECB, where is its Private Sector to build the New Londons (or better called New Brussels) to absorb its migratory millions. The Infrastructure for many similar needs seems to be predicated on Public Investment - that The Nobel Laureate focusses on in this article. Especially if these needs are considered global challenges that mankind faces - e.g. EBOLA, Climate Control, Alternative Energy, et al. Read more
CommentedTomas Kurian
....they typically translate into higher incomes
Well, definitely not Always. That depends if the productivity gains are passed onto the people ( which increases demand) or are only accumulated in the hands of capital owners, as is the situation of last 15-20 years.
Profit and productivity
http://www.genomofcapitalism.com/index.php/5-profit-and-productivity-2
What we need is directly stimulating the demand, which will channel the resources where they are really needed
Need for new institutions and macroeconomic tools
http://www.genomofcapitalism.com/index.php/18-1-need-for-new-institutions-and-macroeconomic-tools Read more
Commentedjagjeet sinha
The Nobel Laureate hits the nail on the head. Credit markets in The West gravitate towards the Treasuries, leaving the apparently more efficient Private Sector gasping for credit supply. Numerous challenges faced by The West and by Mankind require The Public Sector - because the Private Sector does not take up those challenges. With Governments in a vantage position in the Credit Markets, Professor Spence is more than spot on in recommending the emphasis shift towards Public Investment. Public Investment perhaps also the greatest value creator. With 5 million Eurozone migrants now in Britain, perhaps 5 London's needed - the Cross Rail Project has already enhanced Real Estate values along its entire route. Indeed, G20 ought to be triggering a worldwide wave into creation of 100 MegaCities in Emerging Europe, Emerging America, Emerging Asia and Africa - perhaps led by funding from the Global financial institutions as the Anchor Investors. The Nobel Laureate has brilliantly argued the case for Public Investment - such brilliance perhaps the reason why God blesses the Nobel Laureates with minds that enlighten the world. Wish Godspeed. Read more
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