For most governments, the rate of economic growth that can reasonably be expected in the coming years is a key question. And, at least for the advanced economies, it has become a particularly puzzling one.
If the past is a good predictor of the future, the outlook is bleak. Since 2008, economic growth has consistently disappointed expectations. Of the countries most affected by the financial crisis, only a few – the United States, Germany, and Sweden – have rediscovered the path to sustained growth. Yet, even for them, GDP in 2013 was far below the level projected prior to the crisis.
The consensus view among economists and policymakers is that the financial crisis and the euro crisis have damaged both demand and supply, but that a gradual healing process has begun.
On the demand side, according to this view, the hangover from pre-crisis private indebtedness and crisis-generated public indebtedness still weighs on domestic demand. This is likely to persist for several more years, though the burden will diminish steadily. Gradually, consumers will start spending and investing again (as is becoming the case in the US), and fiscal policy will become neutral again (as is already the case in Germany).
On the supply side, the crisis has lowered potential output growth, because, in Europe at least, firms have invested less, impeding the adoption of new technologies. Moreover, in some cases – for example, the United Kingdom – wage decreases and flexible layoff rules have encouraged firms to substitute labor for capital, reducing output per employee. Clogged capital markets and resistance to social hardship have also delayed the replacement of incumbent firms by more efficient new entrants. The aggregate result has been lower-than-anticipated productivity: in the UK, more person-hours were needed to produce a unit of output in 2013 than in 2007. Here, too, the supply-side effect of the crisis is likely to persist until firms invest in new equipment, innovation accelerates, and the churning process in labor markets resumes.
But the view that advanced economies are gradually healing is challenged from both sides. Starting with demand, Larry Summers, the Harvard economist and senior US official under Presidents Bill Clinton and Barack Obama, recently proposed that advanced economies have found themselves in the grip of secular stagnation.
Summers’s view is that pre-crisis indebtedness was not an exogenous anomaly; it was the consequence of insufficient global demand. The global distribution of income had shifted away from the advanced countries’ middle class toward the rich and the emerging economies, resulting in excess worldwide savings. The only way to avoid stagnation was to push the middle class deeper into debt, helped by low interest rates and lenient lending rules.
In other words, the savings glut (as former US Federal Reserve Chairman Ben Bernanke called it) predated the crisis and could continue to affect global demand, unless the emerging countries’ middle class provides the global economy with a new consumer of last resort. This is likely to happen eventually; but, despite efforts by the US and the International Monetary Fund in the context of the G-20, this rebalancing process has not yet been completed.
The challenge on the supply side stems from a new dispute among economists and technology experts about the pace of technological progress. For Robert Gordon of Northwestern University, information and communication technologies have already delivered most of the productivity boost that can be expected from them; there is no major innovation wave in sight that could offset the slowdown in potential growth. Laggards can look forward to reaping catch-up dividends; but countries at the technology frontier should accept that very slow annual per capita growth – little more than 1% – is the new normal.
By contrast, the MIT scholars Erik Brynjolfsson and Andrew McAfee argue that the Second Machine Age is yet to come. They claim that ever-increasing computing power, worldwide connectivity, and the almost unlimited potential for generating new innovations through recombining existing processes will trigger major transformations in both production and consumption, in the same way that the steam engine transformed the world in the nineteenth century. Growth should accelerate as a consequence, at least if properly measured.
Combining the challenges cited by Gordon and Summers to the view that advanced economies are gradually healing leads to some depressing conclusions. If Gordon is right about slow productivity growth, the debt overhang inherited from the crisis and public-finance woes will persist for much longer than anticipated. If, in addition, Summers is right that demand is bound to remain deficient, the combination of financial troubles and persistent mass unemployment is likely to push governments toward radical solutions – debt default, inflation, or financial protectionism.
If, on the contrary, Brynjolfsson and McAfee are right, growth will be much more robust, and debt issues will be forgotten sooner than expected. The challenge, instead, will be to cope with the labor-reducing and income-inequality effects of emerging technologies.
That will be especially true if these transformations take place against the background drawn by Summers of persistent mass unemployment. The risk is that social problems become intractable, as technological advances come to be regarded as benefiting the rich while creating additional hardship for the masses. In such a scenario, governments will have to look for innovative responses.
Scenarios like these may seem far-fetched. But, while certainly discomfiting, they are hardly irrelevant.
Jean Pisani-Ferry teaches at the Hertie School of Governance in Berlin, and currently serves as Commissioner-General for Policy Planning in Paris.