Stagnation by Design
Joseph E. Stiglitz
FEB 6, 2014
NEW YORK – Soon after the global financial crisis erupted in 2008, I warned that unless the right policies were adopted, Japanese-style malaise – slow growth and near-stagnant incomes for years to come – could set in. While leaders on both sides of the Atlantic claimed that they had learned the lessons of Japan, they promptly proceeded to repeat some of the same mistakes. Now, even a key former United States official, the economist Larry Summers, is warning of secular stagnation.
The basic point that I raised a half-decade ago was that, in a fundamental sense, the US economy was sick even before the crisis: it was only an asset-price bubble, created through lax regulation and low interest rates, that had made the economy seem robust. Beneath the surface, numerous problems were festering: growing inequality; an unmet need for structural reform (moving from a manufacturing-based economy to services and adapting to changing global comparative advantages); persistent global imbalances; and a financial system more attuned to speculating than to making investments that would create jobs, increase productivity, and redeploy surpluses to maximize social returns.
Policymakers’ response to the crisis failed to address these issues; worse, it exacerbated some of them and created new ones – and not just in the US. The result has been increased indebtedness in many countries, as the collapse of GDP undermined government revenues. Moreover, underinvestment in both the public and private sector has created a generation of young people who have spent years idle and increasingly alienated at a point in their lives when they should have been honing their skills and increasing their productivity.
On both sides of the Atlantic, GDP is likely to grow considerably faster this year than in 2013. But, before leaders who embraced austerity policies open the champagne and toast themselves, they should examine where we are and consider the near-irreparable damage that these policies have caused.
Every downturn eventually comes to an end. The mark of a good policy is that it succeeds in making the downturn shallower and shorter than it otherwise would have been. The mark of the austerity policies that many governments embraced is that they made the downturn far deeper and longer than was necessary, with long-lasting consequences.
Real (inflation-adjusted) GDP per capita is lower in most of the North Atlantic than it was in 2007; in Greece, the economy has shrunk by an estimated 23%. Germany, the top-performing European country, has recorded miserly 0.7% average annual growth over the last six years. The US economy is still roughly 15% smaller than it would have been had growth continued even on the moderate pre-crisis trajectory.
But even these numbers do not tell the full story of how bad things are, because GDP is not a good measure of success. Far more relevant is what is happening to household incomes. Median real income in the US is below its level in 1989, a quarter-century ago; median income for full-time male workers is lower now than it was more than 40 years ago.
Some, like the economist Robert Gordon, have suggested that we should adjust to a new reality in which long-term productivity growth will be significantly below what it has been over the past century. Given economists’ miserable record – reflected in the run-up to the crisis – for even three-year predictions, no one should have much confidence in a crystal ball that forecasts decades into the future. But this much seems clear: unless government policies change, we are in for a long period of disappointment.
Markets are not self-correcting. The underlying fundamental problems that I outlined earlier could get worse – and many are. Inequality leads to weak demand; widening inequality weakens demand even more; and, in most countries, including the US, the crisis has only worsened inequality.
The trade surpluses of northern Europe have increased, even as China’s have moderated. Most important, markets have never been very good at achieving structural transformations quickly on their own; the transition from agriculture to manufacturing, for example, was anything but smooth; on the contrary, it was accompanied by significant social dislocation and the Great Depression.
This time is no different, but in some ways it could be worse: the sectors that should be growing, reflecting the needs and desires of citizens, are services like education and health, which traditionally have been publicly financed, and for good reason. But, rather than government facilitating the transition, austerity is inhibiting it.
Malaise is better than a recession, and a recession is better than a depression. But the difficulties that we are facing now are not the result of the inexorable laws of economics, to which we simply must adjust, as we would to a natural disaster, like an earthquake or tsunami. They are not even a kind of penance that we have to pay for past sins – though, to be sure, the neoliberal policies that have prevailed for the past three decades have much to do with our current predicament.
Instead, our current difficulties are the result of flawed policies. There are alternatives. But we will not find them in the self-satisfied complacency of the elites, whose incomes and stock portfolios are once again soaring. Only some people, it seems, must adjust to a permanently lower standard of living. Unfortunately, those people happen to be most people.
Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future.
As a service to Financial Times readers, here is a brief guide to market thinking as to why things went awry but the end of the world is not necessarily nigh.
During the crisis years, quantitative easing deliberately drove investors into riskier assets or sectors, such as equities and emerging markets. Logically, the Fed’s decision to gradually taper its asset purchases, announced in December, would send that process into reverse.
That appears to have happened. As investors searched for safer havens, yields, which move inversely with prices, fell on US Treasuries and German Bunds. The story became one of a generalised “risk-off” market, of the sort that characterised the down phases of the global financial crisis.
But if “reverse portfolio rebalancing” or “risk off” were the story, how come there was no significant sell-off in the bond markets of crisis-hit countries on the eurozone’s periphery? Spanish and Italian bonds were among the biggest beneficiaries of investors’ “hunt for yield”. So far this year the rally has continued largely uninterrupted.
Too much consensus
One explanation is that eurozone prospects had improved such that even its periphery economies’ debt markets were relative havens. An alternative is that after last year’s powerful rallies, US and European equity markets were anyway vulnerable to a long overdue correction.
Market strategists I have spoken to this week rue their failure, with hindsight, to spot the dangerous degree of consensus at the start of the year about how 2014 would unfold. When investors are acting as a herd, the smartest investors take profits; the rest scramble to follow.
How Fragile are Emerging Markets?
FEB 6, 2014
CAMBRIDGE – Emerging-market equities and exchange rates are again under severe downward pressure, but are the underlying economies really as fragile as global traders seem to fear? The short answer, for a few, is probably “yes,” but for most, “not just yet.”
For most countries, what we are seeing is a recalibration as investors incorporate the risk that China’s GDP might rise more slowly, the US Federal Reserve might start tightening monetary conditions more quickly, and policy backsliding in many countries might undermine potential growth. At the same time, Europe’s massive shift to a trade surplus (a key factor underpinning the region’s new-found stability) and the Japanese yen’s sharp depreciation are among myriad factors squeezing countries seeking to rein in current-account deficits.
It seems like only yesterday that Goldman Sachs analysts were celebrating the growth miracle of the “BRICS” (Brazil, Russia, India, China, and South Africa) and the International Monetary Fund, in its April 2013 World Economic Outlook, was forecasting a three-speed global recovery led by emerging markets.
What happened? The most popular culprit is the Fed, which has begun to taper its highly experimental policy of “quantitative easing,” or purchases of long-term assets aimed at supporting growth beyond what could be achieved with zero nominal interest rates.
But the Fed’s role is almost certainly overblown. For one thing, the Fed’s retreat partly reflects growing confidence in the US economy, which should mean a stronger export market for most emerging economies. Moreover, the Fed’s modest tightening is being matched by a trend toward looser monetary policy in the eurozone and Japan; so, overall, advanced-country monetary policy remains highly accommodative.
Uncertainty over China’s growth path is more fundamental. For more than a decade, China’s stunning growth has fueled a remarkable price boom that has flattered policymakers in commodity-exporting emerging markets from Russia to Argentina. Remember how the Argentines were able to thumb their noses at the pro-market “Washington Consensus” in favor of an interventionist “Buenos Aires consensus”?
Now, not so much. China’s near-term growth is an open question, as its new leadership attempts to curb the unsustainable credit-fueled boom. Until recently, global markets had not seemed to recognize that a growth recession was even a possibility. Certainly, if there ever is a pause in China’s heady growth, today’s emerging-market turmoil will seem like a mere hiccup compared to the earthquake that will ensue.
There are other notable, if less consequential, fundamentals in the mix. The shale-gas revolution in the US is changing the global energy equation. Energy exporters such as Russia are feeling the downward pressure on export prices. At the same time, hyper-low-cost energy in the US is affecting Asian manufacturers’ competitiveness, at least for some products. And, as Mexico reforms its energy sector, the range of pressures on Asian manufacturing will expand; Mexico is already benefitting from cost pressures in China.
Japan’s Abenomics is also important for some countries, as the sharp depreciation in the value of the yen puts pressure on Korea in particular and on Japan’s Asian competitors in general. In the long run, a Japanese resurgence would, of course, be beneficial to the region’s economies.
Stability in the eurozone has been perhaps the single most important positive factor underpinning market confidence in the last year. But, as periphery countries move into current-account balance and northern countries such as Germany run massive surpluses, the flip side has been deterioration in emerging-market surpluses, heightening their vulnerabilities.
At the core of emerging-market problems, however, is policy and political backsliding. Here, there are significant differences among countries. In Brazil, the government’s efforts to weaken the central bank’s independence and meddle in energy and lending markets have harmed growth.
Turkey is suffering acute challenges to its democratic institutions, as well as government pressure on the central bank. Russia’s failure to develop strong independent institutions has made it difficult for an entrepreneurial class to emerge and help diversify the economy.
In India, central-bank independence remains reasonably strong, with the Reserve Bank of India now mulling a move to an inflation-targeting regime. But a sustained period of populist policies has weakened trend growth and exacerbated inflation.
Nevertheless, some emerging markets are moving forward and stand to benefit from the turmoil if they are able to stay the course. Aside from Mexico, countries such as Chile, Colombia, and Peru are well positioned to gain from investments in institution-building. But, of course, new institutions can take decades, and sometimes longer, to consolidate.
So, overall, how fragile are emerging markets? Unlike in the 1990’s, when fixed exchange rates were widespread, most countries now have shock-absorbing flexible rates. Indeed, today’s drama can be interpreted, in part, as a reflection of these shock absorbers at work.
Emerging-market equities may have plummeted, but this, too, is a shock absorber. The real question is what will happen when the turmoil moves to debt markets.
Many countries have built up substantial reserves, and are now issuing far more debt in domestic currency. Of course, the option of inflating away debt is hardly a panacea. Unfortunately, there is surely more drama to come over the next few years.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. His most recent book, co-authored with Carmen M. Reinhart, is This Time is Different: Eight Centuries of Financial Folly.
Heard on the Street
ECB Looks in No Rush on Rates
By Richard Barley
Feb. 6, 2014 12:54 p.m. ET
Mario Draghi doesn't sound like a man hurrying to cut rates. The European Central Bank on Thursday kept its key rate at 0.25%, disappointing those who had expected that January's estimated inflation of 0.7% would spur fresh monetary stimulus.
Judging by the ECB president's comments, they may be disappointed for some time to come.
True, the ECB didn't rule out further action. Mr. Draghi reiterated that rates would "remain at present or lower levels" for an extended period.
And he stressed the importance of gathering fresh information on the outlook for inflation. The new ECB staff forecasts in March will include figures for 2016. If inflation is still expected to be significantly undershooting the target of "below, but close to 2%" by then, the pressure to act may be significant. Mr. Draghi noted that inflation at its current low levels could make economic adjustment within the euro zone more difficult if it persisted. The ECB is also keeping a watchful eye on the turmoil in emerging markets.
But many of Mr. Draghi's other comments provided reason to doubt that urgent action is in the cards. In particular, hope about the recovery in the euro-zone economy seems to be trumping the fear of low inflation. Mr. Draghi said that domestic demand was getting stronger, and low inflation was being driven by food and energy prices. Meanwhile, extremely low inflation or falling prices in Spain, Portugal, Ireland and Greece were a "relative price adjustment" rather than evidence of deflation.
Meanwhile, the ECB seems to be hoping that burgeoning activity in the corporate bond market may be making up for lackluster bank lending. Mr. Draghi also suggested the regulatory review being undertaken of banks' balance sheets may be masking underlying improvement in credit trends.
All that poses challenges for the euro and for bond markets. Without ECB action, the euro looks unlikely to fall against the dollar, while German bond prices may be vulnerable. Sure enough, as Mr. Draghi spoke, the euro shot more than a cent higher to just above $1.36, while five-year German yields leapt to 0.62% from 0.55%.
The ECB may yet have its hand forced by a deepening crisis in emerging markets, a sharp downgrade in inflation forecasts, or if the recovery shows signs of faltering. But investors might consider dialing back trades that rely on a rapid ECB reaction.
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