Crazy things are happening in the world economy. In Europe and Japan, interest rates have turned negative, something long thought impossible. In the U.S., workers’ productivity is improving at the feeblest five-year rate since 1982. China is a confusing welter of slumping growth and asset bubbles.
Larry Summers (Harvard Prof and almost Fed chair) says world economy is in much worse shape than central bankers understand. Focusing on monetary policy alone, he says, they’re doomed to fall short of reviving growth. They need to reach out to the governments they work for, he argues, and insist on strong fiscal stimulus in the form of infrastructure spending and the like.
For economic policymakers, the most disturbing question is why global growth remains paltry and uneven. The annual growth rate of gross domestic product in the U.S. in the January-March quarter was just 0.5 percent. The euro zone was stronger than the U.S., at 2.2 percent; Japan, which has been flipping in and out of recessions for a quarter century, shrank 1.1 percent. Deflation once seemed to be a strictly Japanese problem—now it’s a worldwide threat. Pessimism about growth prospects is reflected in low forecasts for long-term interest rates. The annual yield on German 10-year notes is only 0.13 percent.
Other explanations for what is happening have been proposed, notably Kenneth Rogoff’s theory of a debt overhang, Robert Gordon’s theory of supply-side headwinds, Ben Bernanke’s theory of a savings glut, and Paul Krugman’s theory of a liquidity trap. All of these have some validity, but the secular stagnation theory offers the most comprehensive account of the situation and the best basis for policy prescriptions.
Northwestern economics professor Robert J. Gordon, place less emphasis on lack of investment and more on Hansen’s other idea: that technological innovation has faltered—for real this time. Gordon agrees with many of Summers’ concerns, but blames much of the slowdown over the last fifty years on a lack of important new inventions. “We had a complete transformation of human life in the special century between 1870 and 1970,” Gordon says. “Since then we’ve had plenty of innovation, but in a narrower sphere; in entertainment, communication, and information technology.” Gordon argues those recent innovations have failed to increase productivity in the same way running water, the combustion engine, and indoor plumbing did for the previous generation. As a result, economic growth has been comparatively sluggish—especially now that the gains from the internet boom have largely been absorbed.
Harvard Professor Kenneth Rogoff agrees with some of the stagnation theory, such as lower population growth hurting output, but attributes most of the slowdown to a passing “debt supercycle” where post-recession economies are dragged down by high levels of debt that hold back growth until deleveraging is complete. Former Federal Reserve Chair Ben Bernanke chalks up slow post-recession growth to a global savings glut where investment is held back by various trade and economic policies, such as the decision by some countries to build large hoards of foreign currency reserves. If Bernanke is right, there is nothing fundamentally wrong with the economy and those bad policies must simply be reversed.
In November 2013, Summers went to the International Monetary Fund in Washington and raised the specter of “secular stagnation,” a term coined in the Great Depression by Harvard economist Alvin Hansen, who lamented “sick recoveries which die in their infancy, and depressions which feed on themselves and leave a hard and seemingly immovable form of unemployment.” “Secular” is econospeak for long-lasting, as opposed to cyclical. Hansen’s warnings about secular stagnation seemed to be disproved when U.S. growth accelerated in World War II and then remained strong after the war stimulus ended.
Summers claimed world economies could be so imbalanced that even zero interest rates would be too high—and for many years, not just briefly as economists had believed.
Summers’s deeper argument is that world growth is stuck in a rut because there’s a chronic shortage of demand for goods and services and a concomitant excess of desired savings. The U.S. and other industrialized nations tend to save more as their populations age, he says. Meanwhile, growing inequality puts a bigger share of the world’s income in the pockets of rich people; they can’t spend everything they make, so they save it. The investment that would ordinarily soak up those savings is falling short. That’s partly because the new economy is asset-lite: Companies such as Uber and Airbnb prosper by exploiting assets (cars and houses) that already exist. Software, which is pure information and doesn’t require the construction of factories, accounts for a bigger share of the economy. Slow growth in output and productivity reduces investment as executives lose faith in the payoff from capital spending.
Exhibit No. 1 in Summers’s case: Interest rates have been trending down for 30 years, even after taking into account the decline in inflation. The interest rate, like any price, reflects supply and demand. It’s fallen because the demand for loans is weak and the supply of loans from savers, who have extra cash to deploy, is strong. It used to be thought that interest rates couldn’t go below zero, but the Bank of Japan and the European Central Bank, among others, are so desperate to kindle growth that they’ve pushed some rates below what used to be called the “zero lower bound” into negative territory.
Despite opposing the Fed’s December hike, Summers continues to worry that an extended period of ultralow and even negative rates will cause bubbles in assets like stocks and housing, as desperate investors chase after higher returns.
He says fiscal policy needs to play a much bigger role than it has. How? On the investment side, he favors government spending to fix America’s dilapidated roads and bridges, combat global warming, and improve education—big, expensive projects that would provide value while soaking up excess savings.
DeLong calls the debate on long term stagnation one of the most important. However, using economic theory has problems because of large problems developing proper measurement of the economy and explaining what is happening.
Gaps in Economics understanding energy and innovation
In The Attention Economy: Measuring the Value of Free Digital Services on the Internet, a draft paper written by Brynjolfsson and MIT postdoctoral fellow JooHee Oh, they introduce a framework for quantifying the value of users’ attention to online applications with very low cash prices. After doing the math and plugging in numbers, the annual welfare gain from all these free digital goods over the Internet averaged over the past ten 10 years is roughly $300 billion or $1,400 per person.
GDP measurements, while helping us better manage the 20th century industrial economy, do not adequately reflect some of the most critical areas we need to better understand and manage in our 21st century economy, including services and quality-of-life, digital goods over the Internet, or value creation and value capture. If our metrics of economic performance are flawed, our policies and decisions will be distorted. We need a revolution in measurements to go along with our digital technology and digital economy revolutions.
These examples on energy and innovation show that economics has not been able to properly measure events until decades after they happen. This is a big problem if we are trying to avoid economic and financial disasters.
SOURCES – Bloomberg, Wikipedia, Larry Summers