Tuesday, September 20, 2016

Learning to Live With Stagnation

The term “stagnation” often arises in discussions of current economic issues.  The “experts” expected the sharp decline in economic activity caused by the Great Recession to be followed by a rapid recovery in economic growth as indicated by the Gross Domestic Product (GDP).  Instead, we have been faced with nearly a decade of slower than expected growth—at least within the club of developed nations.  This development has generated a large number of articles trying to explain why slow growth—stagnation—is occurring.  The actual measurement of growth (GDP) has been called into question, stagnation has been explained as a fundamental evolution of our capitalist system, and a lack of innovation are examples of what has been discussed.  Thomas Picketty, in his book Capital in the Twenty-First Century, provides another perspective.
The historical data on economic growth suggests that much that has occurred was driven by population growth, and once that is factored out to obtain economic growth per individual (per capita GDP), low growth rates have been the norm not the exception.  He provided this chart.

From the dawn of the industrial age to the start of World War I, growth (per capita GDP) in the developed countries of North America and Western Europe never exceeded 2% over extended periods.  The unique circumstance of two world wars and the Great Depression caused sufficient disruption and destruction that the postwar years from roughly 1945 to 1970 had to be a period of enormous economic activity.  Note, however, that during this period in the North American countries, often referred to as the “golden era,” growth averaged below 2.5%.  Note also that since 1970, Western Europe, thought to be shackled by an economically inefficient social welfare system, and North America, dominated by the presumed ideal free-market system, have been falling in economic growth rate in lockstep.  One way or another, the developed economies are returning to the historical mean of low per capita growth.

From this perspective, low growth can be expected for the foreseeable future.  If that is the case, is it a disaster requiring ambitious countermeasures, or is it less of a problem than thought?

Zachary Karabell considers the latter point of view in an article that appeared in Foreign Affairs: Learning to Love Stagnation.

Since GDP is an attempt to measure income, the growth rate is taken to indicate the rate of growth of income; one then assumes that also indicates a growth in prosperity for the population.  But if the population grows by 2% and GDP grows by 2% the economy is just keeping its head above water and, on average, there is no gain in prosperity.  The most quoted figure for GDP is one that includes population growth, and, as indicated by Piketty, it can be very misleading. 

Karabell argues that simple GDP tallies can be misleading in other ways.  He claims that the economics professionals focus strongly on income and measures of inflation, but only loosely on costs and their consequences.  It is the interplay between wages and costs that is the more appropriate measure of prosperity.

“Because GDP measures simply the value of all the goods and services produced by a country, lower costs can reduce it; economies that depend on high prices will contract as prices fall. That is true both for real GDP, which adjusts for price changes and inflation, and for nominal GDP, which does not. And this contraction alarms not only economists….but also most government officials, whose legitimacy has become tethered to their ability to increase GDP growth.”

There are numerous ways in which the standard GDP tally leads to incorrect conclusions with respect to prosperity and well-being.

“But GDP growth is no longer an especially useful way of measuring the health of modern economies. Many of the most important developments in the modern economy contribute little to official GDP figures. Browsing on Wikipedia, watching videos on YouTube, and searching for information on Google add value to people’s lives, but because these are digital goods that have zero price, official GDP figures will consistently downplay their impact. Improvements in efficiency, which reduce costs, have a negative impact on GDP. Consider solar panels: their installation boosts GDP initially, but thereafter the savings in oil or gas will reduce GDP.”

“The combination of lower costs and less growth can lead to the same endpoint as higher costs and higher growth.”

Since GDP fails to measure prosperity or well-being in any useful manner, the dependence on growth in GDP can therefore lead to decision making that is not in the public interest.

“This is more than just a problem of perspective. The view that growth is stagnating leads to a crisis mentality that makes policymakers adopt measures designed to boost growth: stimulus spending, tax cuts, investments in higher education. Some of these may be beneficial, but they can also crowd out other actions that may be more beneficial: investing in greater efficiency, developing a leaner bureaucracy, and, above all, establishing and securing a baseline minimum standard of living. A society that followed these steps would be better off in the long run.”

One of the reasons for focusing on maintaining strong growth is the fear of deflation and the feeling that there must follow a deflationary death spiral.

“But most economists and central bankers fear deflation even more than they fear inflation. They worry about a deflationary trap: if prices fall, people have less incentive to spend today, as they can simply wait for cheaper prices tomorrow. If consumers keep their wallets shut, the economy will grind to a halt, resulting in falling prices, and the cycle continues. To make matters worse, deflation increases the cost of debt, which can further depress spending. And deflation is often taken as a sign that demand is weak, which in turn is interpreted as a sign that consumers lack spending power.”

“But some of these fears are ungrounded. Although it is true that deflation offers little relief to those in debt, it, like income, matters only to the extent that it affects people’s affluence and quality of life. Deflation and lower demand may hobble growth, but they do not necessarily jeopardize prosperity. One country knows this better than most: Japan.”

Japan is the country that Karabell turns to in order to make his case.  Most economists turn to Japan to indicate an economy where everything has gone wrong.

“For almost three decades, since Japan’s immense property and asset bubbles burst in 1991 and growth suddenly decelerated, pundits from across the political spectrum have used the country as a cautionary example of what can befall economies that become ensnared in the trap of large amounts of government debt, zero inflation, and little to no growth. Search the Internet for “Japan syndrome” or “lost decade,” and you’ll find scores of articles and papers addressing the country’s purported malaise and the lessons it offers to other societies hoping to avoid its fate.”

Karabell thinks these concerns are misplaced.

“But the reality is that there is nothing really wrong with Japan. It may have negative real interest rates, an undervalued currency, a debt-to-GDP ratio approaching 250 percent, and an average annual GDP growth rate over the last decade of less than one percent. Yet it is also one of the richest and most stable countries in the world.”

“On almost every major metric that societies use to measure individual and collective well-being, Japan ranks near the top. Life expectancy is among the highest in the world; crime rates are among the lowest. The Japanese people enjoy excellent health care and education. The UN Human Development Index, the Legatum Institute’s Prosperity Index, and the Better Life Index of the Organization for Economic Cooperation and Development all regularly give Japan high marks. Income inequality in Japan has increased in the past decade, as it has in much of the world, but that shift has not meaningfully eroded living standards for the bulk of the population. What’s more, Japan’s very high level of public debt hasn’t led to financial collapse.”

“Economic stagnation, in short, has had little impact on the Japanese public’s high quality of life.”

Karabell provides some words of advice for policy makers who insist on focusing on growth as the primary driver.

“Rather than start with the assumption that growth is the only viable path to collective economic security, policymakers must first consider what ultimate goal they are trying to reach. Presumably, it is at least to provide all people with adequate calories, shelter, health care, education, clothing, appliances, and some basic opportunities to improve their station. This is hardly a new idea.”

“A world where growth is lower but where more people than ever before have access to life’s essentials is hardly a dire scenario. In fact, it is just the opposite. The world may be reaching the limits of growth, but it has not begun to reach the limits of prosperity.”

Karabell’s perspective deserves serious discussion.  Japan now has a falling population.  This is not a bad thing; it is a good thing.  A falling population, by conventional economic thinking is a disastrous situation leading to all sorts of difficulties, including slow or negative growth.  The message to economists should be: “Make yourselves useful and figure out a way for populations to decrease gracefully with minimal economic disruption.”

Japan made a conscious decision to limit its population growth and succeeded.  China made the same decision and is succeeding.  Both will soon have to live with falling populations.  For the inhabitants of developed countries across the globe, low fertility rates indicate that falling populations will soon become the norm.  Hopefully, somewhere out there are a few clever economists trying to figure out how to help make this work.

The interested reader might find these articles informative:

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