Secular Stagnation Heads South

Andrés Velasco

JAN 21, 2014



SANTIAGO – As commodity prices come back to earth and the Federal Reserve’s gradual exit from quantitative easing leads to higher interest rates in the United States, Latin America’s economies face the challenge of sustaining growth. The region’s main economies recorded slower GDP growth in 2013, and much the same is being forecast for 2014.

It is pretty clear by now that an extraordinarily benevolent external environment, not a revolutionary policy shift, underpinned Latin America’s rapid growth in the years following the 2008-2009 global economic crisis. As long as the price of soy, wheat, copper, oil, and other raw materials remained stratospheric, commodity-rich countries like Brazil, Chile, and Peru got a tremendous boost; even Argentina grew rapidly, despite terrible economic policies.

But now “secular stagnation” – the concept du jour in US policy debates since former Treasury Secretary Larry Summers argued last November that the US (and perhaps other advanced economies) has entered a long period of anemic GDP growth – may also be coming to Latin America.

The argument goes like this: high consumer debt, slowing population growth, and rising income inequality have weakened consumer demand and stimulated savings, while slowing growth in productivity and output itself has discouraged investment. So the “natural” rate of interest – the rate at which the demand for investment equals the supply of savings – has fallen, and arguably has become negative. But, because real interest rates cannot be strongly negative unless inflation is high (which it is not), there is a savings glut. With consumption and investment lagging, the US economy is bound to stagnate.

But how could such a situation apply to Latin America, where GDP growth is faster, interest rates are higher, and domestic demand is stronger than in the US?

Consider the region’s history. Until the recent commodity-driven boomlet, growth in Latin America was mediocre. The 1980’s are known as the “lost decade,” owing to a debt crisis and massive recessions, while the market-based reforms of the 1990’s did little to reignite short-run growth. From 1960 to 2007, only four countries in Latin America and the Caribbean – Brazil, Chile, the Dominican Republic, and Panama – grew faster than the US. So meager growth in the coming years would be a return to Latin America’s historical pattern, not a deviation from it.

That brings us back to secular stagnation. Yes, Latin American countries’ average per capita GDP is only one-quarter that of the US, so they should be growing faster than their rich northern neighbor. The question is how much faster. Stagnation in this context means a growth rate that is too low to ensure convergence toward US living standards within a reasonable period of time.

Unlike the US, Latin American economies’ actual output is at or near potential, so growing more means investing more. Yet investment has been disappointing. 

And the region’s problem is not too much domestic savings, but too little. Latin American countries save 18% of GDP, on average, compared to 30% in fast-growing East Asia.

As a result, every time investment picks up in Latin America, it has to be financed with loans from abroad. Foreign investors are willing to live with the resulting current-account deficits, but only up to a point.

It took only a few words from Fed Chairman Ben Bernanke last May – announcing the eventual end of quantitative easing – for markets to lose confidence in emerging economies with current-account deficits near or above 4% of GDP. Brazil was the most prominent among the Latin American economies under attack, but analysts worried about similar vulnerabilities elsewhere in the region. As a result, now, as in the recent past, whenever foreigners get jittery, financing and investment in Latin America are curtailed, and growth suffers.

The scarcity of savings in the region reflects the weak incentives embedded in poorly designed tax and pension systems. But savings performance is also related to long-standing fiscal problems. To be sure, the fiscal stance improved in many Latin American economies in the years leading up to 2007, so countries like Chile were able to mount a strong anti-crisis fiscal response. But, as a 2013 Inter-American Development Bank (IADB) report makes clear, the fiscal stimulus was not always withdrawn in time when the crisis abated, so the fiscal position across the region today is weaker than it was in 2007.

The composition of government spending is also a problem. According to the same IADB report, investment accounts for only 16% of fiscal outlays, less than half the share in emerging Asia. So Latin America suffers from a longstanding infrastructure deficit, which acts as a drag on growth.

Even abundant domestic savings in the future would not guarantee higher investment. Firms’ eagerness to invest depends on how much additional output they can get out of that investment, and recent productivity growth in Latin America – as in the US – has been disappointing.

Lagging productivity has many causes, but one is the failure to diversify local economic structures. Economies become more productive either by doing what they do more efficiently, or by shifting resources into new sectors in which productivity is higher – a process that can be observed (or not) by looking at export diversification. And the sad fact is that today most Latin American countries – Mexico being a notable exception – export pretty much the same goods that they exported a generation ago. That is yet another big difference between the region and East Asia.

So, can Latin American economies keep growing once commodity prices and world interest rates edge back toward normality? We in the region hope they can. But a return to stagnation is also a possibility – one that can be minimized only if policymakers acknowledge it and begin taking preventive action right away.


Andrés Velasco, a former presidential candidate and finance minister of Chile, is Professor of Professional Practice in International Development at Columbia University's School of International and Public Affairs. He has taught at Harvard University and New York University, and is the author of numerous studies on international economics and development.

January 21, 2014 3:50 pm

Ben Bernanke, outgoing chairman, deserves credit for the Fed’s handling of the crisis

In their patter song in The Pirates of Penzance, Gilbert and Sullivan satirised the notion of an educated “modern major-general”. Today they might satirise academic central bankers, of which Ben Bernanke – soon to be ex-chairman of the Federal Reserve – is the very model. As a distinguished scholar, he brought to the Fed a brilliant and well-informed mind. His knowledge of economic history helped him halt a terrifying panic. But he also made mistakes. History will probably judge him kindly. But there is much to be learnt from his time at the Fed.

Mr Bernanke was hugely influential even before he became chairman, in 2006. As governor from 2002, he made notable contributions, including his 2002 “Making Sure ‘It’ [Japanese-style deflation] Doesn’t Happen Here”, and his 2004 celebration of the “Great Moderation”. Before this, not least in a 1999 paper co-authored with Mark Gertler of New York University, he had argued that “the best policy framework for attaining [price and financial stability] is a regime of flexible inflation targeting”. This is the core dogma of modern central banking.

In a valedictory this month, Mr Bernanke started with “transparency and accountability”, pointing to the fact that, in January 2012, the Federal Open Market Committee “established, for the first time, an explicit longer-run goal for inflation of 2 per cent”. He added that the Fed’s transparency and accountability proved “critical in a quite different sphere – namely, in supporting the institution’s democratic legitimacy”. He was surely right. Central banks wield great power. Transparency and accountability are vital if its exercise is to be both effective and legitimate.

Another area on which Mr Bernanke focused was financial stability. Here, in the run-up to the crisis, he made two mistakes.

First, in his 2004 praise for the great moderation, the vainglorious label given to the performance of the US economy before the largest financial and economic crisis for 80 years, Mr Bernanke claimed that “better monetary policy may have been a major contributor to increased economic stability”. In this, he displayed the blinkers of his profession. As the disregarded economist Hyman Minsky tried to tell us, stability destabilises. 
An active and enterprising financial system creates risk, often by raising leverage dramatically in good times.

Second, he missed the implications of subprime mortgages. Thus, in May 2007, he remarked that “we believe the effect of the troubles in the subprime sector on the broader housing market will probably be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”.

Fortunately, when it became evident that this judgment was in gross error, the Bernanke Fed acted decisively and effectively, slashing interest rates and sustaining credit. As panic-fighter Mr Bernanke followed the guidance of the great Victorian economic journalist Walter Bagehot, who urged unrestricted lending by central banks to solvent institutions in times of crisis. This is a world of manias and panics. Happily, Mr Bernanke knew this.

Having prevented the seizure of financial markets, the Fed focused on the moribund economy. As Mr Bernanke explains, “to provide additional monetary policy accommodation despite the constraint imposed by the effective lower bound on interest rates, the Federal Reserve turned to two alternative tools: enhanced forward guidance regarding the likely path of the federal funds rate and large-scale purchases of longer-term securities for the Federal Reserve’s portfolio”.

Such actions were widely condemned for risking hyperinflation or thwarting a desirable liquidation of pre-crisis excesses. These criticisms were nonsense. Fear of hyperinflation was based on a mechanistic model of the links between central bank reserves and bank lending, which is irrelevant to contemporary banking.

Banks are constrained not by reserves but by their perception of the risks and rewards of additional lending. The former had soared and the latter collapsed in the crisis, which is why the central bank had to intervene. The calls for liquidation failed to understand that an unchecked panic could cause mass bankruptcy and another Great Depression.

Many have also expressed concern over the exit from these exceptional policies. Again, this concern is misplaced. Tools exist for managing or eliminating excess reserves. Many complain, too, about over-reliance on monetary policy. But the determination of Congress to impose a grotesquely ill-timed fiscal squeeze left the Fed the only actor.

In all, the Fed managed to deal with the crisis and its aftermath in fraught circumstances. For this, Mr Bernanke deserves great credit.

Where, however, does Mr Bernanke leave finance and monetary policy? The answer is: in great uncertainty. There are two huge challenges, both related to pre-crisis errors.

The first is how far it will be possible to combine inflation-targeting monetary policy with financial stability. Pulling this off depends on making a new idea – macroprudential policy – effective. Nobody really knows whether this can be made to work.

The second is whether enough has been done to make the financial system less fragile. I remain concerned. Yes, regulation and oversight have improved. But, in essence, today’s financial system is the same as before. 

Worse, it is yet more dominated by a small number of thinly capitalised, complex, global behemoths. The notion that such institutions could be “resolved” in a panic without triggering panic remains untested and, partly for this reason, government promises not to bail them out are not credible. This is a highly troubling legacy.

Mr Bernanke will surely be regarded as one of the Fed’s most significant chairmen. Yet the fact that such hyperactivity was needed to save the world from economic ruin tells us how fragile was the bright new global financial system and how ill-judged the confidence in its stability. Mr Bernanke saved the day. But he also leaves behind unresolved questions about the future of central banking, money and finance. We should not forget them. They matter.

Copyright The Financial Times Limited 2014.

The Circular Revolution

Frans van Houten

JAN 21, 2014



DAVOS – In the sixteenth century, the astronomer Nicolaus Copernicus made a profound discovery: the sun, not the earth, was at the center of the known universe. At the time, many denounced Copernicus’s insight as heresy against established Christian doctrine; eventually, of course, the Copernican Revolution paved the way toward a new, scientific worldview and enhanced human prosperity.

Today, the world needs a similar paradigm shift. But this time it is the prevailing economic model that must be transformed.

By 2030, the global middle class will total nearly five billion people, all of whom will expect the same kinds of opportunities and comforts that wealthy populations have long enjoyed. This will put increasing strain on the environment and deplete the world’s stock of resources.

The problem is that the world has long maintained a myopic focus on producing and consuming goods as cheaply as possible. The result is a linear economy based on the rapid use, disposal, and replacement of goods.

Sustaining the current model would require unlimited, easily accessible resources and infinite space for waste – something that clearly is not possible. Indeed, the consequences of our disposable economy – skyrocketing CO2 emissions, unmanageable waste streams, and the increasing difficulty of extracting resources, to name a few – are already apparent.

To find a sustainable alternative, one need only look to nature, where nothing is wasted. Forests, for example, are completely efficient systems, with species’ lifecycles occurring in perfect harmony with the seasons. This underpins levels of resilience and longevity that economic systems should strive to emulate.

Just as ecosystems reuse everything in an efficient and purposeful cycle, a “circular” economic system would ensure that products were designed to be part of a value network, within which the reuse and refurbishment of products, components, and materials would ensure the continual re-exploitation of resources.

Of course, building a circular economy would require a fundamental restructuring of global value chains. Instead of selling products, businesses would retain ownership, selling the use of the goods they make as a service. Selling a product’s benefits instead of the product itself would create a powerful incentive for producers to design for longevity, repeated reuse, and eventual recycling, which would enable them to optimize their use of resources.

This requires a new generation of materials, as well as innovative development and production processes. It also demands new business models, a redefined concept of legal ownership and use, new public-tendering rules, and novel financing strategies. Finally, a circular economy calls for adaptive logistics and a leadership culture that embraces the new system and rewards progress toward establishing it.

Beyond the moral imperative, there is a strong financial argument in favor of the transition to a circular economy – namely, the promise of over $1 trillion in business opportunities. This includes material savings, increased productivity, new jobs, and possibly new product and business categories.

But businesses cannot transform the economy alone. In order to shift firms’ emphasis from minimizing initial costs to maximizing total value, while ensuring the protection of people’s health and well-being, governments should change their tendering processes by implementing requirements for circularity, thereby helping to drive demand for new solutions.

At the same time, consumers must be open to using products that they do not own. Because the circular economy is inherently systemic, it can succeed only if all stakeholders co-design, co-create, and co-own products and services.

With this in mind, my company is redesigning its products and considering how to capture their residual value. At the same time, it is shifting from a transaction- to a relationship-based business model – one that entails closer cooperation with customers and suppliers. And it is changing its corporate culture to emphasize long-term solutions. None of these changes is easy to implement, but all of them are necessary.

Like all major transitions in human history, the shift from a linear to a circular economy will be a tumultuous one. It will feature pioneers and naysayers, victories and setbacks. But, if businesses, governments, and consumers each do their part, the Circular Revolution will put the global economy on a path of sustainable long-term growth – and, 500 years from now, people will look back at it as a revolution of Copernican proportions.


Frans van Houten is Chief Executive Officer of Royal Philips.