A Global “Growth Map” for 2014
Michael Spence was awarded the Nobel Prize for Economics in 2001 and chaired the World Bank’s Commission on Growth and Development. His most recent book is “The Great Convergence: The Future of Economic Growth in a Multi-Speed World.”
THE UNITED STATES | The US is in what might be termed a partial recovery: growth at 1.5% to 2%, well below potential but a lot better than zero. This is being driven largely by the private sector, a flexible and dynamic economy and one that is shifting its resources at the margin toward the tradable sector where demand is not (or is less of) a constraining factor. Fiscal drag is significant and uncertain because the resolution of an ongoing sequence of budget standoffs is not known.
The largest missing piece in the evolving US growth pattern is investment, especially public sector investment, and that is likely to continue in this political environment. The alternative—shifting the portfolio of domestic aggregate demand for some period from consumption to investment paid for by taxes on income or large pools of wealth—won’t fly politically. That means growth will remain below potential for an extended period.
EUROPE | Thanks to the European Central Bank and its unused (but lurking in the background) Outright Monetary Transaction policy to bail out states on the verge of bankruptcy—and the German Chancellor’s backing of this important measure—the sovereign debt markets have stabilized for now.
Growth in Europe is a less attractive story. Nominal unit labor cost divergences (the south versus Germany) became huge in the pre-crisis period and are still distressingly high, though there has been some painful convergence except in Italy. The south of Europe, all of which is on the wrong side of the productivity divide, has no growth and employment engines: domestic demand is in retreat, stalling the non-tradable sector and productivity which significantly delays any expansion on the tradable side via accessing external global demand. The process threatens social and political cohesion. Citizens are bewildered about their future.
On both sides of the productivity divide, the current configuration leaves everyone with the threat of a distorted structure. The exchange rate is way too high for the south and arguably low enough to limit the growth of the non-tradable side of the German economy. Right now no one is winning in this game.
CHINA | China looks to be on a path to sustain 7 plus percent growth for another decade, assuming there is follow-up implementation of clearly stated system reforms designed to alter the growth pattern toward a more balanced development of the tradable (exports) and non-tradable sides (domestic consumption). Reforms promised by President Xi and Premier Li will lessen incentives or opportunities to push investment into low return territory so that capital will be allocated more by market determined prices, outcomes and innovation.
Policy makers abstaining (rightly) from using the wrong short run growth drivers, namely excess leverage and investment, may produce a short run lull in growth as new consumption by the household and the consumer kick in. That will be a little un-nerving, but in the end not a derailment.
CHINA’S POWERHOUSE MIDDLE CLASS | If the reforms proposed by President Xi Jinping are deep and successful in altering the growth pattern, the growth in the Chinese middle class will be enormous. The McKinsey Global Institute estimates that the middle class in China will grow from about 230 million now to 630 million in ten years. This is a side-effect of rising wages and household incomes, combined with policies designed to shift income to the household sector when it makes sense. It will surely create a huge and growing market and a tailwind for Chinese and global growth.
That said, income inequality is rising in China and is high enough to contribute to rising social tensions especially when juxtaposed with vast amounts of wealth accumulated at the upper end of the income and wealth distribution, in part because of politically connected, privileged access to market and investment opportunities. Reversing that pattern is clearly a high priority in the reform agenda.
OTHER EMERGING ECONOMIES | China’s growth will produce a tailwind for other developing economies. The announcement of the US Federal Reserve last Spring that it would “taper” purchases of Treasury bonds and mortgage securities that have been used to keep down long term rates has produced considerable turbulence in international capital flows and exchange rates in major emerging economies other than China, which maintains capital controls.
This has not so far proven destabilizing. But it was a wake up call for economies that were trending toward dependence on low cost capital, seeking an escape from the low interest rates in advanced countries. The delay of tapering is not likely to result in a reversion to running large current account deficits and relying on foreign capital to fund investment. As the Governor of the Reserve Bank of India put it when the tapering was delayed in September, this is a postponement, not a permanent condition. Rebalancing the current account may slow a number of emerging markets down in the short run. But with the China tailwind and reasonable growth in the US, a return to relatively high sustainable growth patterns is likely.
GLOBAL GROWTH AND CONVERGENCE | The long term convergence process of developing and advanced countries seems therefore set to continue, as will the growth in the size of the global economy as a whole.
Some aspects of global imbalances are being resolved in a reasonably coordinated way. The US growth pattern has caused exports to grow rapidly. More than half the growth and even some employment is coming from the tradable side of the economy. Imports are growing much more slowly because of the lingering negative demand shock of the financial crisis. The current account deficit is declining. Flipping the global imbalance coin over, China’s excess savings is declining in part because of steady appreciation of the currency and the current account surplus is coming down.
This is far from a full resolution of “global imbalances.” But the specter of a global economy crippled because of a massive shortage of aggregate demand is receding. This part seems to be happening as a natural side effect of the evolution of the growth patterns in the two major global economies.
Admittedly Germany is running a large current account surplus in percentage and absolute terms. With the unit labor costs so spread out in the Eurozone, almost everyone has an over or under-valued currency. In the German case, it is under-valued and that leads naturally to the surplus. This is not an ideal outcome for Germany as it leads to suppression of the non-tradable service sector and, if persistent, and unbalanced growth pattern. But the options for dealing with it are unattractive. They could attempt to lever up, generating more domestic demand. That, however, would lead to inflationary pressure which, if left to rise, would accelerate the productivity convergence process with the rest of Europe. But losing competitiveness on the tradable side will not appeal to Germany as an option, not to mention its historic aversion to inflation.
In this dimension, then, it appears that Europe will remain in a low and unbalanced growth pattern for some time, while the convergence in productivity and competitiveness runs its course. Without exchange rates and inflation, the options for rebalancing are limited, painful and slow. But this is not a permanent condition. Europe including the south can, and will, grow eventually.
UNEMPLOYMENT IN UNCHARTED TERRITORY | While the growth picture is varied across major economic entities, positive and improving for the most part, employment is a different story. We know from a growing body of research that very powerful labor saving technology combined with globalization is causing employment to diverge from growth especially in the tradable sector. In advanced economies, even healthy ones, the tradable side has been a limited generator of jobs over at least two decades.
Labor markets do not shift quickly for lots of reasons. Nominal wages are resistant to being reduced. Inflation is low and seems set to stay there. In general, in a low inflation environment with downward rigidity in nominal prices, it takes longer to achieve shifts in relative prices. But that is what technology and globalization are to some extent pushing economies to do. Labor markets can be and probably are out of equilibrium as the composition of labor demand shifts faster than the rather slower supply responses in areas like education and skills acquisition.
This won’t last forever, but it could take some time. The combination of lower than past growth and lagging employment are likely to produce a slow enough rebalancing as to leave serious residual problems in areas like extended youth unemployment. This requires a major coordinated multi-pronged policy effort, to keep the vulnerable young in the market and in a process in which skills do not atrophy.
And even when (or if) market adjustments catch up the forces causing structural change in the demand for various kinds of jobs, it is likely that the rise in the return to education, viewed as an investment in human capital, will be permanent. And there seems no immediate prospect of a reversal of the three decade downward trend in labor income as a fraction of national income. It may flatten out. No one knows with any certainty. This is uncharted territory at least in the modern post-war era. But the restoration of growth will not necessarily solve the challenges in the area of distribution, inclusiveness and social cohesion.
Two issues cast a shadow over the broad picture of a return to more balanced global growth.
BAD GOVERNANCE THREATENS GROWTH | One is the frustrating gridlock in many political systems and a growing pattern of polarization that can lead either to policy inaction or to large mistakes and damage. Reckless behavior is becoming too common: at best it creates unnecessary risk, at worst a lot of collateral damage. It is a source of frustration and puzzlement to responsible politicians, policy makers and citizens alike, everywhere. And its origins remain opaque.
But for the global economy and its various parts it is a headwind and a risk factor.
THE CLIMATE SHADOW | The second shadow is long-term sustainability. The growing army of advocates of reinventing growth patterns and shifting values so as to make the massive prospective growth of the global economy consistent with the natural resource base that we have, is gaining ground pretty much everywhere, with a little help from an angry and sometime violent Mother Nature. That is good news. The bewilderingly complex, decentralized, bottom up process that underpins this progress isn’t the conventional collective action model. But it seems to be working and to be better adapted to the realities of the challenge at this stage. One can reasonably hope that progress will accelerate as the current growth challenges are overcome and our necessary preoccupation with them declines.