Over the past few centuries, the natural sciences, - e.g. physics, chemistry, biology, - have developed a variety of principles and models. These have enabled them to analyze and predict the behavior of our highly complex physical systems under widely different conditions. But the situation is quite different in the social sciences, - e.g., economics, sociology, political science. It’s much more difficult to make accurate predictions in social systems, - whose key components are people, organizations and their intricate interactions, - because of their highly fluctuating behaviors.
I was reminded of this major distinction between physical and social systems by a recent issue of Foreign Affairs, which focused on How to Survive Slow Growth. “[G]rowth has ground to a halt almost everywhere, and economists, investors, and ordinary citizens are starting to confront a grim new reality: the world is stuck in the slow lane and nobody seems to know what to do about it,” notes its introductory article. Several prominent authors wrote about various aspects of the economic slowdown. But in the end, they didn’t arrive at consensus reasons for the slow growth or how long it will likely last, - years or decades.
In the lead article, - The Age of Secular Stagnation: What It Is and What to Do About It, - Harvard economics professor Larry Summers wrote: “As surprising as the recent financial crisis and recession were, the behavior of the world’s industrialized economies and financial markets during the recovery has been even more so.” Back in 2009, almost no one would have predicted that we would still be in a period of slow economic growth, that inflation would be around one percent and interest rates would hover around zero. But, “nearly seven years into the U.S. recovery, markets are not expecting normal conditions to return anytime soon.”
The term secular stagnation was first coined by economist Alvin Hansen in 1938 who “thought a slowing of both population growth and technological progress would reduce opportunities for investment. Savings would then pile up unused, he reasoned, and growth would slump unless governments borrowed and spent to prop up demand.” Hansen’s forebodings were proved wrong by the post-war economic boom.
Is Summers right this time around, or will he be proved equally wrong? “Not all economists are sold on the secular stagnation hypothesis,” he noted in the Foreign Affairs article before presenting some of the alternative explanations.
Harvard economists Carmen Reinhart and Kenneth Rogoff argued that our prolonged slow recovery is due to the excessive debt incurred in the build-up to the 2007-2008 financial crisis. The subsequent deleveraging, as the debts were paid off led to low levels of consumer spending and business investments. A related view comes from Nobel Prize economist and NY Times op-ed columnist Paul Krugman, who believes that we’re stuck in a liquidity trap caused by individuals and companies hoarding cash because they expect deflation and/or insufficient demand to justify investment. Given such weak private sector demand, even zero short-term interest rates have failed to stimulate the economy.
Demographic change is another potential cause for the slow economic growth, the subject of of a separate article in the Foreign Affairs issue, - The Demographics of Stagnation: Why People Matter for Economic Growth, - by investor and author Ruchir Sharma. “[E]xperts have largely overlooked what may be the most important factor: the global slowdown in the growth of the labor force,” he wrote.
“Between 1960 and 2005, the global labor force grew at an average of 1.8 percent per year, but since 2005, the rate has downshifted to just 1.1 percent, and it will likely slip further in the coming decades as fertility rates continue to decline in most parts of the world. The labor force is still growing rapidly in Nigeria, the Philippines, and a few other countries. But it is growing very slowly in the United States - at 0.5 percent per year over the past decade, compared with 1.7 percent from 1960 to 2005 - and is already shrinking in some countries, such as China and Germany. The implications for the world economy are clear: a one-percentage-point decline in the population growth rate will eventually reduce the economic growth rate by roughly a percentage point… Ultimately, then, the world should brace itself for slower growth and fewer economic standouts.”
Others, - most prominently Northwestern University economist Robert Gordon, - have argued that slow growth is the result of a fundamental decline in innovation and productivity. According to Gordon, the rapid growth and rising-per-capita incomes we experienced from 1870 to 1970 was a unique episode in human history. Innovation is now stalled and there may well be little growth for the rest of this century.
Earlier this year Gordon published The Rise of Fall of American Growth, - which was reviewed in the Foreign Affairs issue by George Mason University economist Tyler Cowen. In Is Innovation Over? The Case Against Pessimism, Cowen writes that “predicting future productivity rates is always difficult; at any moment, new technologies could transform the U.S. economy, upending old forecasts. Even scholars as accomplished as Gordon have limited foresight… Ultimately, Gordon’s argument for why productivity won’t grow quickly in the future is simply that he can’t think of what might create those gains. Yet it seems obvious that no single individual, not even the most talented entrepreneur, can predict much of the future in this way.”
We’re in a Low Growth World. How Did We Get Here?, a NY Times article by journalist and author Neil Irwin offers a more succinct, easier-to-read take on the slow growth problem, but no overriding conclusions on why it’s happening or what to do about it. “Economic growth in advanced nations has been weaker for longer than it has been in the lifetime of most people on earth…” said Irwin. “It increasingly looks as if something fundamental is broken in the global growth machine - and that the usual menu of policies, like interest rate cuts and modest fiscal stimulus, aren’t up to the task of fixing it…”
“Weak productivity and fewer workers are hits to the supply side of the economy. But there is evidence that a shortage of demand is a major part of the problem, too… The distinction is important if there is to be any hope of solving the low-growth problem. If the issue is a shortage of demand, then some more stimulus should help. If it is entirely on the supply side, then government stimulus is not much use, and policy makers should focus on trying to make companies more innovative and coax people back into the work force. But what if it’s both?…”
“Economic history is full of unpredictable fits and starts. When Bill Clinton was elected in 1992, the internet, a defining feature of his presidency, was rarely mentioned, and Japan seemed to be emerging as the pre-eminent economic rival of the United States. In other words, there’s a lot we don’t know about the economic future. What we do know is that if something doesn’t change from the recent trend, the 21st century will be a gloomy one.”