Predictions of continued slow economic growth are mounting across the globe. The implications are significant – from reduced capital investment to political instability.
When influential American economist Larry Summers brought the concept of secular stagnation out of mothballs during an address to the International Monetary Fund in 2013, he inadvertently put pressure on his peers to make a call.
Were they true believers, agnostics or sceptics on the notion that the US and other advanced nations are facing a sustained slowdown in economic growth that could last for decades, rather than problems merely to do with business cycles?
Four years on, with working-age populations shrinking and inflation and interest rates stuck at low levels in many nations, more economists are joining the secular stagnation camp.
Economist Alvin Hansen coined the phrase secular stagnation in 1938 to explain his theory that a long-term slowing of economic growth – due to lower population growth and modest technological advances – could stifle investment and prolong the recovery from the Great Depression.
The outbreak of World War II meant his theory was never tested, as the war sparked massive government spending and innovation in areas such as communications and medicine, and the post-war baby boom led to a population explosion in the US and elsewhere.
Summers, a Harvard University professor who served as US treasury secretary in Bill Clinton’s administration, issued a call to world leaders to address the secular stagnation issue in a 2016 Foreign Affairs article: “Secular stagnation and the slow growth and financial instability associated with it have political as well as economic consequences.
“Slow economic growth will reduce the need for new capital investment, which will work in turn to make growth even slower.” Robert J. Gordon, Northwestern University
If middle-class living standards were increasing at traditional rates, politics across the developed world would likely be far less surly and dysfunctional. So mitigating secular stagnation is of profound importance.”
US Federal Reserve chair Janet Yellen has commented: “we cannot rule out the possibility expressed by some prominent economists that slow productivity growth seen in recent years will continue into the future.”
What the numbers say
Even in the wake of the global financial crisis (GFC), few thought that long-term economic stagnation would occur around the world. Yet late last year, the OECD’s Global Economic Outlook warned that a “low-growth trap has taken root”, tipping that developed nations’ gross domestic product (GDP) growth will rise from 1.7 per cent per annum to a still unimpressive 2 per cent in 2017 – a far cry from levels of around 4 per cent in the years before the GFC. China, too, has seen real GDP growth more than halved from 14 per cent in 2007 to below 7 per cent in 2015.
Cause and effect
Robert J. Gordon, an economics professor at Chicago’s Northwestern University, says the US and other advanced economies will struggle to hit past highs.
He blames four key factors: a reduced fertility rate in many countries, leading to lower population growth; the retirement of the baby boomer generation; a decline in the labour force participation rate of adult workers; and a fall in the rate of productivity growth.
“All of these make a significant contribution to slower growth in output,” Gordon says.
He also puts a modern twist on one of Hansen’s other theories – that technological innovation had faltered and put the brakes on growth. Yes, there has been innovation in the form of the internet, smartphones, artificial intelligence and machine learning, but it has failed to drive jobs growth and productivity in the way breakthroughs such as power stations and the combustion engine did in the past.
“So far, the main use of machine learning with big data has been in marketing, helping companies to steal market share from each other rather than raising economic growth for society as a whole,” he explains.
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Demography is another element. Australian economic commentator Saul Eslake notes that a sharp slowdown in the growth rate of working-age populations (people aged 15-64) in OECD countries started in 2010-11, when the first of the baby boomers began turning 65 and retired.
This could contribute to lower rates of economic growth in major advanced economies and some emerging economies during the next two decades, compared with the period between the recessions of the early 1990s and the GFC in 2007.
“That obviously has further to run, as a rising proportion of those born in the years after World War II move past the statutory retirement age,” he says.
A contributor to lower productivity growth, Eslake argues, is that the war on terror has seen deployment of enormous resources – managing security at airports, for example – for questionable returns.
“So, in my view, the slow growth Larry Summers identified as the hallmark of secular stagnation is more likely to be the corollary of slower population growth and weaker productivity growth.”
If this slow growth lingers, the implications are significant. Some analysts fear continued political instability – highlighted by the Brexit vote in the UK and Donald Trump’s accession to the White House – as voters react to low growth by demanding change.
On the economic front, companies’ prospects for expansion may be undermined. Tax revenues, too, are being hit at the same time as governments are trying to support an ageing population. The warning from Gordon is stark.
“Slow economic growth will reduce the need for new capital investment, which will work in turn to make growth even slower,” he says.
“Governments everywhere will find that their projections for old-age pensions and medical care are too optimistic, and to fund those obligations to senior citizens will require higher tax rates or force a reduction in benefits paid per person.”
For investors and the public, the prospect of interest rates remaining low means bank deposits are likely to remain an unattractive option, except for those who cannot bear any capital losses.
“To the extent that Trump’s proposed fiscal stimulus does boost demand, it will stimulate higher inflation.” Saul Eslake, economist
Disposable income and consumer spending is also likely to suffer, in turn hurting business growth and the capacity for enterprises to employ more people or lift wages. A growing cohort of poor part-time and contract workers struggling on meagre salaries, mirroring the example of Japan, is also on the cards.
The IMF, in its World Economic Outlook April 2016 report, called Too Slow for Too Long, points out that persistent slow growth has “scarring effects” that limit output and, consequently, consumption and investment.
“Consecutive downgrades of future economic prospects carry the risk of a world economy that reaches stalling speed and falls into widespread secular stagnation,” it states.
The implications for jobs are significant, the IMF says, with overall weak demand leading to “higher unemployment that results in a reduced labour supply as (1) skill depreciation generates a higher natural rate of unemployment and (2) discouraged workers withdraw from the labour force”.
Shane Oliver, AMP Capital’s chief economist, does not think global economies are heading for the “bleakest interpretation of secular stagnation”. All the same, the actions of international policymakers will be crucial. He points out that Japan’s debilitating period of low growth since the Nikkei Index peaked in 1989 was exacerbated by delays in implementing interest rate cuts and stimulus packages.
Oliver believes Europe is most at risk now because its political framework is not fully integrated, so there’s a lack of decisive policymaking. Despite Europe having a common currency, “as it stands it takes a long time to get agreement on monetary policy,” he says.
Qian Wang, senior economist at investment manager Vanguard in Hong Kong, is more upbeat than some about the future. Wang’s argument is that pre-GFC growth had been artificially boosted by aggressive credit expansion during the 1990s and 2000s. She adds that trend growth of about 2 per cent in an economy such as the US is now perfectly normal.
“We don’t think the global economy is in secular stagnation,” she says, “[but] we do admit there are significant growth headwinds, like demographic or productivity factors, that are keeping the global economy from really having a significant rebound.”
With China, Wang puts recent lower economic growth down to the fading “catch-up effect” as the mainland closes the gap with developed countries. Beijing’s political leaders should maintain stability in the economy and pursue modest structural reforms, she says. “If you push too aggressively you run the risk of a sharper slowdown in economic growth.”
Impact of a spending spree
One possible way to encourage economic growth is for governments to ramp up their own spending. Summers has called for a decade-long infrastructure renewal program in the US to upgrade roads and airports and create new capacity in areas such as green technology and health care. In a speech at Princeton University in 2015, he bemoaned the share of public investment in GDP, saying that “if we have a moral concern about my children’s generation, deferring maintenance is just as surely passing the burden on to them as issuing debt”.
Eslake, however, worries about a combination of looser fiscal policy (such as tax cuts and additional spending on the military and certain types of infrastructure) and protectionist policies (such as tariff barriers). It may well be wishful thinking, he argues, that such an approach will boost US economic growth to something like the 4 per cent achieved during the Reagan years.
His view is the strong growth of the Reagan era owed a lot to US interest rates falling from 17 per cent to 6 per cent, “something that can’t be repeated in current circumstances”. Unemployment was more than 10 per cent at its peak in 1983, compared with less than 5 per cent today, and the working-age population was growing at almost 1 per cent per annum compared with barely more than 0.2 per cent today.
“Secular stagnation and the slow growth and financial instability associated with it have political as well as economic consequences.” Larry Summers, Harvard University
“To the extent that Trump’s proposed fiscal stimulus does boost demand, it will stimulate higher inflation – because Trump’s protectionist trade policies will … instead add directly to inflation by raising the price of imported goods and services, creating room for US producers to raise their prices, too,” Eslake says.
For his part, Gordon endorses government infrastructure investment, but not the Trump scheme that encourages spending by private investors by giving them large tax breaks.
“We must recognise that infrastructure spending is not a panacea and cannot have nearly the effect in boosting productivity as the original interstate highway system investment of the 1960s and 1970s,” he says. “Much of the needed infrastructure investment is to repair deterioration in highways and bridges, and inherently these repairs will not have the same impact as building the roads and bridges in the first place.”
A dissenting view
Not everyone agrees with the global secular stagnation view. Former Federal Reserve chair Ben Bernanke is among those who believe that when problems in the banking sector and restrictive fiscal policies recede, growth rates will strengthen.
Manu Bhaskaran, an economics consultant at Centennial Asia Advisors in Singapore, says in the past decade a perfect storm of economic shocks – the global financial crisis, the eurozone crisis, geopolitical shocks, the collapse of commodities markets and an evolving Chinese economy – has contributed to an inevitable slowing of growth.
“It is unlikely these shocks will continue to keep hitting us,” Bhaskaran says. He believes the ongoing rise of developing economies such as India, Indonesia, Vietnam and the Philippines can drive growth at sustainable but higher levels. Technologies hitting their take-off in areas such as renewable energy, advanced manufacturing through the use of AI and robotics, cloud computing and data analytics will also make a difference.
Japan’s slow burn
When economists discuss slow growth, Japan is the go-to case study. After enjoying annual gross domestic product (GDP) growth of about 4.5 per cent in the 1980s, the wheels fell off the Asian powerhouse. An asset price bubble burst in 1992 and in the past two decades Japan’s GDP has grown at an average rate of less than 1 per cent. Interest rates are effectively locked at about zero per cent.
While many Japanese continue to live well, and Japan is still one of the world’s largest economies, the downturn has had significant psychological, social and financial impacts, says the IMF. These impacts include:
- Forcing a shrinking working-age population to support a growing pool of pensioners
- Contributing to the rise of 100-yen shops, Japan’s answer to discount shops
- Fuelling a high suicide rate, which has risen sharply since economic stagnation set in
- Shattering consumer confidence and leading to a drop in consumption and a dip in real household income
- Creating a sharp division between regular workers who have so-called jobs for life, and part-timers with little or no security
- Fostering an environment in which low wages growth has hurt many families