MILAN – A remarkable pattern has emerged since the 2008 global financial crisis: Governments, central banks, and international financial institutions have consistently had to revise their growth forecasts downward. With very few exceptions, this has been true of projections for the global economy and individual countries alike.
It is a pattern that has caused real damage, because overoptimistic forecasts delay measures that are needed to boost growth, and thus impede full economic recovery. Forecasters need to come to terms with what has gone wrong; fortunately, as the post-crisis experience lengthens, some of the missing pieces are coming into clear focus. I have identified five.
First, the capacity for fiscal intervention – at least among developed economies – has been underutilized. As former United States Deputy Secretary of the Treasury Frank Newman argued in a recent book, Freedom from National Debt, a country’s capacity for fiscal intervention is better assessed by examining its aggregate balance sheet than by the traditional method of comparing its debt (a liability) to its GDP (a flow).
Reliance on the traditional method has resulted in missed opportunities, particularly given that productive public-sector investment can more than pay for itself. Investments in infrastructure, education, and technology help drive long-term growth. They increase competitiveness, facilitate innovation, and boost private-sector returns, generating growth and employment. It does not take a lot of growth to offset even substantial investment – especially given current low borrowing costs.
Research by the International Monetary Fund has indicated that these fiscal multipliers – the second factor overlooked by forecasters – vary with underlying economic conditions. In economies with excess capacity (including human capital) and a high degree of structural flexibility, the multipliers are greater than once thought.
In the US, for instance, structural flexibility contributed to economic recovery and helped the country adapt to long-term technological changes and global market forces. In Europe, by contrast, structural change faces resistance. Fiscal stimulus in Europe may still be justified, but structural rigidity will lower its impact on long-term growth. Europe’s fiscal interventions would be easier to justify if they were accompanied by microeconomic reforms targeted at increasing flexibility.
A third piece of the forecast puzzle is the disparity between the behavior of financial markets and that of the real economy. Judged only by asset prices, one would have to conclude that growth is booming. Obviously, it is not.
A major contributor to this divergence has been ultra-loose monetary policy, which, by flooding financial markets with liquidity, was supposed to boost growth. But it remains unclear whether elevated asset prices are supporting aggregate demand or mainly shifting the distribution of wealth. It is equally unclear what will happen to asset prices when monetary assistance is withdrawn.
A fourth factor is the quality of government. In recent years, there has been no shortage of examples of governments abusing their powers to favor the ruling elite, their supporters, and a variety of special interests, with detrimental effects on regulation, public investment, the delivery of services, and growth. It is critically important that public services, public investment, and public policy are well managed. Countries that attract and motivate skilled public managers outperform their peers.
Finally, and most important, the magnitude and duration of the drop in aggregate demand has been greater than expected, partly because employment and median incomes have been lagging behind growth. This phenomenon preceded the crisis, and high levels of household debt have exacerbated its impact in the aftermath. The stagnation of incomes in the bottom 75% of the distribution presents an especially large challenge, because it depresses consumption, undermines social cohesion (and thus political stability and effectiveness), and decreases intergenerational mobility – especially where public education is poor.
Sometimes change occurs at a pace that outstrips the capacity of individuals and systems to respond. This appears to be one of those times. Labor markets have been knocked out of equilibrium as new technology and shifting global supply chains have caused demand in the labor market to change faster than supply can adjust.
This is not a permanent condition, but the transition will be long and complex. The same forces that are dramatically increasing the world economy’s productive potential are largely responsible for the adverse trends in income distribution. Digital technology and capital have eliminated middle-income jobs or moved them offshore, generating an excess supply of labor that has contributed to income stagnation precisely in that range.
A more muscular response will require an awareness of the nature of the challenge and a willingness to meet it by investing heavily in key areas – particularly education, health care, and infrastructure. It must be recognized that this is a difficult moment and countries must mobilize their resources to help their people with the transition.
That will mean redistributing income and ensuring access to essential basic services. If countering inequality and promoting intergenerational opportunity introduces some marginal inefficiencies and blunts some incentives, it is more than worth the price. Public provision of critical basic services like education or health care may never be as efficient as private-sector alternatives; but where efficiency entails exclusion and inequality of opportunity, public provision is not a mistake.
One hopes that a growing awareness of the significance of these and other factors will have a positive effect on policy agendas in the coming year.
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CommentedJose araujo
I confess I’m puzzled by the definition of structural rigidity. IMHO there are no doubts Europe is structurally less flexible then the US, the question is why?
First we should put aside labor rigidity because the increase in unemployment in Europe works against the argument. Also we should expect the increased flexibility to increase the value per unit of output, hence there would be no problems in labor rigidity, since wages would tend to increase not decrease. The question is what rigidities we face in Europe that makes us less competitive, and how do we address them, namely how do we address the rigidities in the northern European countries that prevented the relocation of activities to more cost competitive countries in Europe.
We should also explain better in what sense were some of the rigidities detrimental to the crisis, in the sense that for instance all labor rigidities that are pointed has some of the causes of the troubles in Europe, actually work has a stabilizer and in some way prevented the increased problems in aggregated demand. We should put an end to the myth that debt levels were the root cause of our troubles and start analyzing why Europe continues to specialize on lower value activities and industries. What rigidities are there that prevent innovation in Europe.
Other thing I don’t understand is on why did the ultra-loose monetary policy (which actually I don’t think it is true, we just have to take inconsideration the interest rate hike in the beginning of the crisis) is detrimental. We can argue for monetary neutrality under the current liquidity trap conditions, but to say it was detrimental….I think again that with the labor rigidity argument it translates more the prejudices of some economists then a real problems in Europe.
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Commentedjagjeet sinha
Critical that Public services, Public investment, Public policy must be best managed - countries outperform if their State Capitalism succeeds. For Capitalism to succeed forever, indeed for Democracy to be the success amongst alternative templates, State Capitalism capacity to outperform perhaps is the most critical lesson. There are a few examples where Private Players outperform but most challenges that confront mankind requires State Capitalism. Asset prices bubbles are driven by Private greed. Asset prices can and must be democratized always to remain inclusive. Public policies will follow if the need to retail Asset prices drives the Financial architecture. If Hongkong is great for China, State Capitalism must create 100 Hongkongs. If London is great for The Anglosphere, State Capitalism must create 100 Londons. Financial meltdown happens when the asset price benefits do not percolate to the last retail outlet. Aggregate demand is best driven when it includes the entire target domain - not just 1 %. Read more
Commentedezra abrams
How exactly is education supposed to help, given that Chinese universitys are now almost as good as ours ?
and highly educated chinese work at some very low wage relative to us
Is there some magical property of US education that is not exportable ?
The idea that education is gonna help is nonsense Read more
CommentedStewart Early
We need more public discussion of the fifth contributing factor-- that this is a special time, when change, brought about by new technology and shifting global supply change, exceeds the capacity of individuals and system. We also need more discussion of how, in the world of politics, can we improve the effectiveness of our investments in education, healthcare and infrastructure. Read more
CommentedGary Palmero
We must invest heavily in three key areas, education, health and infrastructure (according to the author).
The US has invested very heavily in education, just not the right kind. It might be helpful if responsible companies were subsidized to train workers for real jobs. This proposal can be seriously abused but if the US is serious about this issue then it must be undertaken and pitfalls dealt with in a logical manner.
The US has overinvested in health care to the detriment of infrastructure. Obamacare was poorly timed, it should have been preceded by a strong program of infrastructure improvement which would have provided jobs and increased social benefits. Helath subsidization most likely would have been more politically palatable in a stronger economy.
At this juncture, there should be a move to increase necessary infrastructure investments. Read more
CommentedDallas Weaver, Ph.D.
Why I don't believe this is the whole story:
With truly complex problem with multiple variables, like the slow growth problem (aka stagnation problem, or "Joe Median getting the shaft problem") we find the same old causes and solutions being proposed based upon economic theories of long dead economists. Experience has shown that Japan didn't solve the problem with massive infrastructure construction and debt. Europe didn't solve it with austerity approaches. The US didn't solve it with the stimulus spending and massive amounts of liquidity from the Feds, enriching wall street and blowing asset bubbles. Greece didn't solve it with riots and Russia hasn't solved it with diversionary wars (which didn't work in the US either).
When we see this type of situation, we need to ask what variable or parameter has changed somewhat uniformly in the developed world to cause this slow growth in all the advanced countries relative to emerging economies around the world with 5% to 10% growth rates. In these fast growing countries, the key step seems to be the freeing up the creativity of private sector. This was done in China by allowing farmers to decide what, when and how to grow, which decreased the power, authority, social status and income of the millions of agricultural "planners" who used to decide for the farmers. Even a "deal" with the farmers that made share cropping in the US look like a good deal for the farmer, was so much better at utilizing the knowledge and creativity of the massive number of farmers. It resulted in farmers going from starvation to eating pork/fish. We know what freeing up some of the industrial sector has done for better jobs for the hundreds of millions of rural poor.
In India, restricting the "License Raj" of bureaucratic delays, fees, bribes, etc. created an economic miracle, but the Raj is fighting back.
In the US we do have the "permissionless" sector of our society dealing with digital technology (apps, software, etc.). This sector of our economy is growing rapidly with few, if any, regulatory considerations. Hiring is focused on creative technical talent, not on legal/regulatory talent. Engineers can be hired with funds other sectors, hampered by regulations, must spend on lawyers.
However, whenever this permissionless sector touches the real world creating large numbers of "Joe Median" type jobs for non-programmers, like UBER, AirBandB or the emerging Drone industry, regulators crawl out of their holes, as their very livelihoods and pensions are threatened by innovation.
All the advanced countries have evolved into societies in which almost anything having to do with the real physical world has multiple layers of regulations, permissions, approvals, etc., essentially giving every existing interest a veto over any innovation that could harm them. The advanced countries have become "Vetocracies". Most of the "existing interests" are among the ruling and economic elite.
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CommentedTom Shillock
The "private sector" at least in the U.S. is not lacking in creativity especially with it comes to effectively lobbying on behalf of their narrow interests. This is, of course, a cause of increasing inequality which, in turn, is retarding growth, as Spence argues. To be sure, organizations and institutions, government or corporate, have become ossified as they focus on pursuing their own narrow interests blocking broader economic and social interest.
As Freeman (Harvard labor economist) pointed out at least a decade ago, the global workforce doubled since 1990. Together with free flows of capital and advancements in communication and computer technology, workers are at a huge disadvantage vis a vis capital. The effectiveness of owners / managers of capital to prevent redistribution restricts growth in largely consumer economies. Inequality seems set to increase, as Piketty argues. Read more
CommentedProcyon Mukherjee
No matter how productive a public investment may be as Mr. Spence says, this would need to fore-go some other private investment and / or consumption; it does not balance otherwise. The best public investment can however make this switch from the worst private investment and / or consumption possible. On the contrary the best private investment would always make any other worst public investment look like useless. But making any change in consumption due to a fiscal stance, is something which isn't that straight forward. Read more
CommentedF. W. Croft
Many of the issues cited are real, but the prescriptions are dubious. Redistributive taxation hasn't reduced inequality. And taxation won't reduce the use of regulation (mostly sponsored by big corporations and special interests) as a weapon to maintain the status quo. This has INCREASED inequality, squelching competition and grind down new c0mpeting businesses for the benefit of the 1%. Middle classes can't be created by tax policy. They need an open field where individuals can profit from their legitimate contributions, either by founding companies or selling their skills and efforts to growing new firms. Additional taxes won't provide that, and they won't reduce inequality. Read more
CommentedVanishing Leprechaun
I agree with many considerations in this article. I'm nevertheless always doubtful when earing about "liquidity floods". Financial systems makes it own liquidity by itself. Central Banck can supply liquidity to replace money flow blocked by credit crunch and corresponding inter-banking loans, and inserting liquidity into the system backing government' fiscal policies. I don't know the figures for USA, the ratio to money creation by FED to the regular endogenous money supply in normal times. I can nevertheless say that in Europe there was no liquidity flow at all. But this isn't the reason of the bad EU performance: it comes from the impossibility to do fiscal policies, due to the institutional framework of EU.
It's not politics, its institutions who are bad. And this is the problem., because institutional changes (treaties) are in practice impossible.
Flexibility of labor market doesn't matter. Read more
CommentedBob Green Innes
overoptimistic forecasts? How about overoptimistic measurements - fake measurements that make everybody look good. GDP, unemployment especially. And can we really expect to grow the impact of 7 billion on one lousy little planet? Read more
CommentedMatthew Kilburn
You forgot demographics. The Developed world is, almost without exception, stagnant or regressing in terms of population. Aging, graying, and dying citizenries are not reliable consumers to encourage growth. Read more
CommentedMichael Public
The problem lies in the 4th factor. Business controls politics in most countries for its own benefit tot the detriment of the voter. Fix the limitation of campaign contributions in the US, for example, and then things will start to fall in line. Read more
Commentedradek tanski
doesn't qe by design inflate asset prices and depress real wages? in which case 3 causes 5? Read more
CommentedPaul Daley
Good article. On the third factor, too much of monetary stimulus has been diverted to existing assets by low capital gains taxes that were never structured to lean against movements in real interest rates. That's easy to correct, and should be one of the first lessons learned from this slow recovery. Read more
CommentedRobert Bostick
Agreed, under utilization of fiscal policy for monetarily sovereign nations is inexcusable. These nations are never, involuntarily, resource constrained and should, therefore, move to creating Job Guarantee Programs to employ all who are willing and able to work. http://goo.gl/O8GI5P The additional contribution of these programs properly structured is price stability. Read more
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