What the world must do to kickstart growth

/in

April 7, 2014

The post-crisis panic might be subsiding but medium-term prospects are problematic

The world’s finance ministers and central bank governors gather in Washington this week for the biannual International Monetary Fund meetings. While there will not be the sense of alarm that dominated the convocations in the years after the financial crisis, the unfortunate reality is that the medium-term prospects for the global economy have not been so problematic for a long time.

The IMF in its current World Economic Outlook essentially endorses the “secular stagnation” hypothesis, noting that the real interest rate necessary to bring about enough demand for full employment is likely to remain depressed for a substantial period. This is made manifest by the fact that inflation is well below target throughout the developed world and is likely to decline further this year. Without robust growth in, and greater demand from, these markets, growth in emerging economies is likely to subside. That is even without considering the political challenges facing countries as diverse as Brazil, China, South Africa, Russia and Turkey.

In the face of inadequate demand, the world’s primary strategy is easy money. Base interest rates remain at floor levels throughout the developed world and central banks signal that they are unlikely to rise soon. While the US is tapering quantitative easing, Japan continues to ease on a large scale, and the Eurozone seems to be moving closer to this. This is all better than the tight money that in the 1930s made the Depression the Great Depression. But it has problems as a growth strategy.

We do not have a strong basis for supposing that reductions in interest rates from very low levels have a big impact on spending decisions. Any spending they do induce tends to represent a pulling forward rather than an augmentation of demand. We do know they strongly encourage economic actors to take on debt; that they place pressure on return-seeking investors to take increased risk; that they inflate asset values and reward financial activity. And we cannot confidently predict the ultimate impact on markets or the confidence of investors of the unwinding of central bank balance sheets.

While monetary policies lower capital costs and so encourage spending that businesses and households judge unworthwhile even at rock-bottom interest rates, many elements of investment exist that can be increased and that also have high returns but are held back by misguided public policies.

In the US the case for substantial investment promotion is overwhelming. Increased infrastructure spending would reduce burdens on future generations, not just by spurring growth but also by expanding the economy’s capacity and reducing deferred maintenance obligations. For example: can it be rational in the 21st century for the US air traffic control system to rely on paper tracking of flight paths? Equally important, government could do much at no cost to promote private investment including authorizing oil and natural gas exports, bringing clarity to the future of corporate taxes, and moving forward on trade agreements that open up foreign markets.

Japan, with the increase in value added tax on April 1, is engaged in a major fiscal contraction at a time when it is far from clear whether last year’s progress in reversing deflation is durable or a reflection of one-off exchange rate movements. A return to stagnation and deflation could rapidly call its solvency into question. Japan takes a dangerous risk if it waits to observe the consequences before enacting fiscal and structural reform measures to promote spending.

Europe has moved back from the brink, with defaults or devaluations now remote as possibilities. But no strategy for durable growth is yet in place and the slide towards deflation continues. Strong actions to restore the banking system so that it can be a conduit for a robust flow of credit, as well as measures to promote demand in the countries of the periphery where competitiveness challenges remain, are imperative.

If emerging markets’ capital inflows fall off substantially, and so they move further towards being net exporters, it is hard to see where in the developed world can take up the slack by accepting trade balance deterioration. So measures to bolster capital flows and exports to emerging markets are essential. Most important are political steps to reassure about populist threats in a number of countries, such as where authoritarian governments give signs of disregarding contracts and property rights, and provide investor protection and backstop finance. In this regard passage by the US Congress of authorisation for the IMF to enhance its ability to provide backstop finance, is imperative.

Creative consideration should also be given to ways of mobilising the trillions of dollars in public assets held by central banks and sovereign wealth funds largely in the form of safe liquid assets to promote growth.

In a globalised economy, the impact of these steps taken together is likely to be substantially greater than the sum of their individual impacts. And the consequences of national policy failures are likely to cascade. That is why a global growth strategy framed to resist secular stagnation rather than just muddle through with the palliative of easy money should be this week’s agenda.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary

Fiscal Policy and Full Employment

/in

Fiscal Policy and Full Employment, April 2, Center for Budget and Policy Priorities, April 2, 2014.  Read the speech here.

Income Inequality

/in

“Income Inequality,” The Lang & O’Leary Exchange

Education and the Economy

/in
  • “Education and the Economy,” March 6, 2014, Citizen Schools, New York, NY

    • ‘Potemkin money’ is wrong way to help Ukraine

    /in ,

    March 9, 2014

    The west should make modest promises and then strive to deliver more than the country expects

    Events in Ukraine have underscored the importance of effective external support for successful economic and political reform. The international community is finally responding with concrete indications of support.

    At one level the situation in Ukraine is unique – a product of the country’s sensitive location between Russia and Europe. At another, however, it is merely the latest example of a phenomenon that recurs all too often. A government that is illegitimate or at least highly problematic is brought down. The world community seeks to support economic reform. A new government, purportedly more democratic and legitimate, is installed in its place. Think, for example, of the transition that occurred after the Berlin Wall fell; or after the Arab uprisings; or in more isolated cases such as East Timor or Rwanda.

    As a general rule, outsiders acted with the best of intentions in offering their support. But the results have often fallen short of their aspirations. I have seen close to a dozen cases over the past quarter-century where the precedent of the Marshall Plan was invoked. None was as successful as the original. This reflects the truth that functioning institutions cannot be imposed from the outside. Countries and their peoples shape their own destinies. Still, there are important lessons for the design of support programs.

    First, immediate impact is essential. New governments will not last unless they deliver results that are felt on the ground. Outside support can be made conditional on progress towards reform but the conditions need to reflect political reality. Assistance must be delivered promptly so that its impact quickly becomes visible.

    For example, social safety nets need to be strengthened before subsidies on items such as food and fuel are removed – not afterwards, as has too often been the case in the past. The international community needs to understand that, even when the conditions they impose are economically rational, they may be more than the political process can bear. It is no use for international agencies to blame the country they are trying to assist when this results in the adoption of bad policies. Such moments are surely a time for political concerns to trump technocrats’ fears.

    Second, avoid “Potemkin money” – the tendency to announce huge assistance packages that grab the headlines but belie the inevitable truth that much of the cash will take time to arrive. The result is disappointment followed by disillusionment as recipients realise that not all assistance can materialise quickly or meet urgent local needs. It bears emphasis that the original Marshall Plan was announced without any figures or fact sheets. In Ukraine the west should make modest promises – and then strive to deliver more than the country has been led to expect.

    Third, be realistic about debts. Ukraine’s debt-to-income ratio is low compared with those of the crisis countries of the European periphery. Honouring these obligations may be worthwhile, given the benefits of financial stability.

    However, Ukraine’s private creditors have for some years received risk premiums of 500 basis points or more. Careful consideration should be given to rescheduling or restructuring the country’s debts.

    Debt relief can provide a strong signal of political support – as it did in Poland in 1989. Countries in crisis should be wary of taking on debt to finance projects that will not generate the cash flows necessary to repay it. In such cases, donors should offer support in the form of grants rather than loans.

    Fourth, honest management is as important as prudent policy. Policy makers have traditionally focused on the latter. But that is a mistake. Theft of public resources is a major source of poor economic performance.

    The international community should do everything it can to recover ill-gotten gains from former Ukrainian officials and to put in place procedures that will prevent future skulduggery. The benefits would be political, as well as economic.

    Fifth, countries need to pursue broad policies in a way that benefits Ukraine. For example, Congress needs to demonstrate that the US is as committed as the rest of the world to providing full funding for the International Monetary Fund. America should also move to allow crude oil and natural gas exports to flow more freely. Over time, this would contribute to Ukraine’s autonomy and economic strength. All of this goes for Europe, too – which is far closer to Ukraine and has an even greater stake in the country’s future prosperity. The possibility of a closer partnership with the EU is a North Star that can guide Ukrainian reformists.

    Respect for these principles does not ensure success. But ignoring them almost guarantees failure. Given what is at stake with Russia in Crimea, that gloomy outcome must be strenuously avoided.

    The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary. Follow on Twitter @LHSummers

    Higher Education

    /in

    “Higher Education,” SB Nation, March 6, 2014

    The Inequality Puzzle

    /in

    “The Inequality Puzzle,”Democracy: A Journal of Ideas

    US Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound

    /in

    “US Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound,” National Association of Business Economics, February 24, 2014. Read the speech here.

    America Risks Becoming a Downton Abbey Economy

    /in , ,

    February 16, 2014

    Inequality will have to be addressed, with free markets playing a pivotal role

    Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.

    The share of income going to the top 1 per cent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.

    President Barack Obama is right to be concerned. Those who condemn him for “tearing down the wealthy” and engaging in un-American populism are, to put it politely, lacking in historical perspective. Presidents from Franklin Roosevelt to Harry Truman railed against the excesses of a privileged few in finance and business. Some have gone beyond rhetoric. Confronted with rising steel prices, John Kennedy sent the FBI storming into corporate offices and is widely thought to have ordered the authorities to audit executives’ personal tax returns. Richard Nixon used the same weapon in 1973, announcing tax investigations “of the books of companies which raised their prices more than 1.5 per cent above the January ceiling.” All were reacting in their own way to a phenomenon that Bill Clinton has described best: “Although America’s rich got richer . . . the country did not . . . the stock market tripled but wages went down.”

    Given the widespread frustration with stagnant incomes, and an increasing body of evidence suggesting that the worst-off have few opportunities to improve their lot, demands for action are hardly unreasonable. The challenge is knowing what to do.

    If income could be redistributed without damping economic growth, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately this is not the case. It is easy to think of policies that would have reduced the earning power of Bill Gates or Mark Zuckerberg by making it more difficult to start and profit from a business. But it is much harder to see how such policies would raise the incomes of the rest of the population. Such policies would surely hurt them as consumers by depriving them of the fruits of technological progress.

    It is certainly true that there has been a dramatic increase in the number of highly paid people in finance over the last generation. Recent studies reveal that most of the increase has resulted from an increase in the value of assets under management. (The percentage of assets that financiers take in fees has remained roughly constant.) Perhaps some policy could be found that would reduce these fees but the beneficiaries would be the owners of financial assets – a group that consists mainly of very wealthy people.

    It is not enough to identify policies that reduce inequality. To be effective they must also raise the incomes of the middle class and the poor. Tax reform has a major role to play. The current tax code is so badly designed that it is very likely to be having the effect of reducing economic growth. It also allows the rich to shield a far greater proportion of their income from taxation than the poor. For example, last year’s increase in the stock market represented an increase in wealth of about $6tn, of which the lion’s share went to the very wealthy.

    It is unlikely that the government will collect as much as 10 per cent of this figure. That is because of a host of policies that favour the rich, such as the capital gains exemption, the ability to defer tax on unrealized capital gains, and the fact that gains on assets passed on at death are not taxed at all. Similarly, the corporate tax system allows value to flow through it like a sieve. The ratio of corporate tax collections to the market value of US corporations is near a record low. The estate tax can be more or less avoided with sophisticated planning.

    Closing loopholes that only the wealthy can enjoy would enable taxes to be cut elsewhere. Measures such as the earned income tax credit can raise the incomes of the poor and middle class by more than they cost the Treasury, because they give people incentives to work and save.

    It is ironic that those who profess the most enthusiasm for market forces are least enthusiastic about curbing tax benefits for the wealthy. Sooner or later inequality will have to be addressed. Much better that it be done by letting free markets operate and then working to improve the result. Policies that aim instead to thwart market forces rarely work, and usually fall victim to the law of unintended consequences.

    The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary