Larry Summers (Washington Post, 10/9/2016) recently summarized the state of global macroeconomic policymaking: “As the world’s finance ministers and central-bank governors came together in Washington last week for their annual global financial convocation, the mood was somber. The specter of secular stagnation and inadequate economic growth on the one hand, and ascendant populism and global disintegration on the other, has caused widespread apprehension. Unlike in 2008 (when the post-Lehman Brothers crisis was a preoccupation) or 2011 and 2012 (when the possibility of the collapse of the euro system concentrated minds), there was no imminent crisis. Instead, the pervasive concern was that traditional ideas and leaders are losing their grip and the global economy is entering unexplored and dangerous territory.” This post looks at economic stagnation, Summers’ first problem which is one of the most important causes of today’s widespread political discontent.
Explaining stagnation. To begin, we need a definition. The simplest one is sufficient for my purposes. Stagnation describes an economy experiencing a jobless rate (U) persistently greater than its natural rate (UN). Next, we need to identify the process that generates stagnation. The GEM Project usefully models the phenomenon. The Project’s most compact analysis, outlined here, is constructed on two empirical characteristics of modern, highly specialized economies. First, chronically slow growth is closely associated with depressed business investment. Second, profit expectations are the most important determinant of business investment.
At this point, non-economists should fasten your seatbelts. Some mathematic notation is about to intrude. Given that the math is followed by words that convey the same message, you can skip the next sentence. Dynamic conditions derived from compact generalized-exchange modeling relevant to stagnation are:
where ΠJ denotes nonstationary nominal profit, DJ is nonstationary demand net of capital-stock rental costs, G is rational nonstationary wage rent, W is the nonstationary market-clearing wage, and H is nonstationary labor hours worked. (Chapter 5) Here are the words: Profits are increasing in total demand. In circumstances of U(t)>UN(t), robust profit growth, expected to persist, supports robust investment in plant, equipment, software, and R&D as well as the sufficient creation of new jobs to push down unemployment. By contrast, weak profit expectations make investors less willing to expand the level of productive capacity, hindering employment growth and (after multi-year delay) inducing large-establishment job downsizing and wage givebacks. (Chapters 3 and 6)
The macro literature features two end-point approaches in macro theorists’ spectrum of policymaking in the circumstances of stagnation. The first is activist demand management, targeting medium-term alignment of U(t) and UN(t), that attempts to stimulate total spending sufficiently to boost profit expectations, investment, and employment. In this Keynesian response, increased nominal spending helps reconcile downward wage rigidity and full employment. The second is the passive classical solution, in which the monetary authority eschews overt action, relying instead on spontaneous market adjustments to inadequate profits that correct stagnation by reducing wage rents sufficiently to reconcile total demand and U(t)=UN(t).
In the real world, neither the passive policymaker nor active approach to dealing with persistently high joblessness associated with stagnation is without challenge. Classical thinking is most burdened, given that its relevance is restricted by ubiquitous rational wage rigidity. Its elimination of stagnation requires many years and the huge cost of widespread downsizing and business failure. (Chapter 3) While the Keynesian policy response is superior, it cannot by itself lower the natural rate of unemployment and may suppress labor-price adjustments that are necessary for overall economic efficiency and competitiveness, especially internationally. Moreover, stabilization authorities’ capacity to induce sufficiently higher aggregate-demand growth may be limited by powerful structural problems, including high debt burdens, sharp deteriorations in labor’s terms of trade, nonmarket forces that hinder adjustment in global currency markets, other nations’ free-riding on stimulation efforts, and political paralysis.
Proper policy. The question: How can we best generate more satisfactory economic growth, breaking out of global stagnation? The answer: Figure out how to increase global demand. That is the message of the GEM Project as well as the evidence. Rothstein (2012) analyzed the persistently high unemployment in the aftermath of the 2007-09 recession and concluded that the poor performance resulted primarily from inadequate aggregate demand, not structural factors.
How to increase global demand? In his Washington Post essay, Summers provides a good short list of policies that reject “austerity economics in favor of investment economics. At a time when markets are saying that inadequate rather than excessive inflation will be the problem over the next generation, central bankers need to embrace spurring demand as a primary objective and to cooperate with governments. Enhancing infrastructure investment in the public and private sector should be an immediate priority for fiscal policy. Domestically, this means recognizing that such a course has budget benefits, as the economy expands and deferred maintenance liabilities are reduced, as well as budget costs. Globally, it means recognizing that enhanced tools for infrastructure finance offer the prospect of more investment demand and better returns to middle-class savers. And the focus of international economic cooperation more generally needs to shift from opportunities for capital to better outcomes for labor. The achievement of this objective will require substantially enhanced cooperation to address what might be thought of as the dark side of capital mobility — money laundering, regulatory arbitrage and tax avoidance and evasion.”
Summers’ list is, of course, incomplete. I would especially add one more policy goal, which concerns a dark side of the global economic malaise, that the more politic Summers sidesteps. Effective policy to combat chronic stagnation should force the transition of nations like Germany, Japan, and China, global abusers that run persistent, huge trade surpluses, from export-driven to consumption-driven economic growth. In a chronically demand-deficient world, the abusers must not be ignored.
Blog Type: Policy/Topical Saint Joseph, Michigan