Dr Siddhartha Roy explains why under performance and sluggish growth continue to haunt economies like the US, the UK, the EU and Japan
If we wish to clearly understand the long- term structural issues that are currently affecting advanced economies, we should consider the concept of ‘potential growth’. Potential growth is the rate at which an economy could potentially grow, ie, what capacity output growth would be when economic resources are used more efficiently.
When the difference between actual and potential output is negative, it implies that capacity output growth is low, which is an indicator of under-utilisation of capacity or under performance; consequently, it also signals lower investment requirements for the future. According to Organisation for Economic Co-operation and Development, in 2016, the output gap was negative for the US, the UK, the Euro area (countries that have adopted the Euro) and several advanced economies.
It has been nine years since the financial meltdown of 2008. Why does underperformance and sluggish growth continue to haunt economies like the US, the UK, the EU and Japan? This column focuses on two causes, both of which have long-term implications.
Secular stagnation refers to stagnation of demand. In a normal business cycle, crest and trough follow each other within a few years. In the case of secular stagnation, demand takes its own time to recover.
To break this cycle, it's important for investments to go up. The US corporate sector is driven by the success of companies like Microsoft, Google and Apple. These show a very high level of retained earnings, indicating an absence of investment avenues. The capital investment in new growth areas is relatively low. New technology areas for such companies are more intellectual capital intensive; the requirement for investment in physical capital is limited. Thus, the mismatch between savings and investment continues. As a result, in the US, the corporate sector is a net lender to the government sector. In comparison, the corporate sector in India is a net borrower.
Given this scenario, the only sector which can take the lead to break the low growth, low interest and low inflation 'secular stagnation trap' is the government. It has to undertake major infrastructure projects, supported by an accommodative fiscal policy, so as to bring down transaction costs, improve competitiveness and employment.
Let's examine the other cause of stagnant growth: low productivity growth. Before proceeding further, it is important to introduce the concept of total productivity growth. How much a worker produces per hour or his or her productivity depends on the capital and labour on one hand and technical progress and innovations on the other. Economists have a methodology of netting out the latter, ie, the impact of innovations, better systems and technological progress; this is called total factor productivity. Historical studies have shown that this is the main contributor to productivity growth in advanced economies. In the period 1920- 70, American total factor productivity grew by 1.89 percent per annum; during 1970-94, the growth was 0.57 percent per annum, and thereafter, with the spread of IT, internet and better communications technology, it rose to 1.03 percent in the period 1994-2004. Strikingly, between the years 2004 and 2014, it dropped to 0.4 percent. This sluggish pace of productivity will have an adverse impact on long term economic growth.
Productivity is the biggest factor affecting America's living standards. When businesses are more productive and efficient, they expand, leading to growth in employment and wages.
For many advanced economies, this constitutes a deep structural malady, hence it could take several years for them to get out of the low GDP growth trajectory. There are other factors that will add negative impacts such as Brexit, border tax, anti-immigration measures and high non-performing assets of banks in the EU. With advanced economies showing stagnancy, there is substantial opportunity for emerging countries like India to access cheap funding and investment from advanced countries that are looking for returns. This is the flip side to the advanced economy conundrum, the silver lining that can benefit emerging economies.