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The United States has seen disappointing economic growth of at or less than 2 percent of gross domestic product per capita since the 2008 financial crisis, and some economic experts have suggested that the nation may be in a period of secular stagnation, or protracted slow growth, similar to what followed the Great Depression. They propose further monetary and fiscal stimulus, but those have proven to provide only a temporary boost for short-term growth. Traditional macro policy also will not boost long-term growth. While improving long-term growth is difficult, the best places to begin are with advances in areas such as tax reform, deregulation, and freer trade. These structural measures, along with efforts to reduce current high levels of policy uncertainty, might help boost sustainable, long-term economic growth.
Key points in this Outlook:
“You can’t always get what you want . . .”
—The Rolling Stones
Economists like Larry Summers and policymakers like Janet Yellen want faster, long-run US growth. However, there is little evidence that we or they know how to get it. The secular stagnation, or persistently slow growth, that emerged during the Great Depression in 1929 did not end until the onset of World War ll. And the postwar boom put lie to the causes of secular stagnation alleged before the war.
The five years since the US financial crisis have seen, like the 1930s did after the onset of the Great Depression, disappointing economic growth. The average growth rate of US gross domestic product (GDP) per capita during the 1930s was 1.09 percent, about half of the long-run pace of 2 percent and well below the 1960–90 pace across 114 countries of 1.8 percent per year.
After the 2008 financial crisis, US GDP per capita actually fell at an average rate of −1 percent year-over-year from January 2009 to September 2013. (But the pace has recovered, encouragingly, to an average level of about 2 percent since mid-2011.) Before the crisis, from January 2000 through December 2007, US GDP per capita had grown at an impressive 4.9 percent per year pace, due in part to a sharp rise in labor productivity growth after 1995.
The abnormally high precrisis US GDP per capita growth rate preordained that the postcrisis growth pace collapse, to −1 percent, would be a nasty shock and that the “recovery,” to just above a 2 percent pace, a disappointment in spite of its proximity to the long-run US average growth pace.
The Return of Secular Stagnation?
With disappointment about US postcrisis growth has come a revival of the theory of secular stagnation, first introduced in the late 1930s by Harvard economist Alvin Hansen. Hansen defined secular stagnation as a protracted period of slow growth that results from falling population growth, low aggregate demand, and a tendency to save rather than invest. Hansen’s stagnation model was a product of the Great Depression of the 1930s, much as the new secular stagnation theory for the US is a product of disappointing growth since the 2008 financial crisis.
Hansen’s theory focused on boosting long-run growth through increased investment rather than using monetary and fiscal measures to enhance short-run, cyclical growth. Hansen identified four factors underlying the expansion of investment: the rate of population growth, territorial expansion growth, growth of business and personal savings, and the shift from capital-absorbing to capital-saving innovations. In Hansen’s view, these factors had been largely exhausted during the Depression, when their growth was negligible. Further, during the Depression, fertility rates in the US were very low, causing Hansen to predict the stabilization of the population within a generation or two. The continental US had reached its limits, under Hansen’s view, with little investment and thus little technological change available to promote growth.
“After the 2008 financial crisis, US GDP per capita actually fell at an average rate of −1 percent year-over-year from January 2009 to September 2013.”
Like classical theorists such as Adam Smith and David Ricardo, Hansen regarded the pace of economic growth as the outcome of a race between diminishing returns to labor and growth-enhancing technological progress. Growth would eventually decline toward zero in this gloomy view unless technological progress kept boosting the productivity of labor and capital.
The stagnationist view of the US economy has resurfaced during the last couple of years as the US economy has failed to regain the rapid growth pace achieved before the financial crisis. In September 2013, Paul Krugman wrote, “There is a case for believing that the problem of maintaining adequate aggregate demand is going to be very persistent—that we may face something like the ‘secular stagnation’ many economists feared after World War II.” Krugman recommended fiscal policy stimulus and higher inflation, aimed at achieving a negative real interest rate, which in turn would presumably encourage investment and employment growth.
In November 2013 at the International Monetary Fund Economic Forum, Harvard economist Larry Summers followed in Hansen’s footsteps by hypothesizing that we may have entered a new era of secular stagnation. He argued that growth may remain below normal for many years to come, absent special policy measures. Summers said, “We may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential.”
Summers was really arguing that the natural interest rate, or the level of the real interest rate consistent with full employment, might be negative, forcing policymakers to engineer a steady inflation rate. With zero nominal interest rates, a steady inflation rate could produce a negative real interest rate equal to the inflation rate, which presumably would stimulate more investment and spending.
The Summers and Krugman arguments about the possibility of secular stagnation have highlighted fears of deflation. In an environment with zero nominal interest rates, a persistent falling price level (or deflation) produces a rising real interest rate that could further depress growth and enhance the threat of secular stagnation.
It is important to note that Summers’s argument about secular stagnation is actually derived from the disappointing results obtained using monetary and fiscal monetary measures to produce a cyclical recovery in the US economy. Of course, the positive impact of such measures is almost by definition temporary, causing a short-term rise followed by a drop in activity unless the measures are resumed.
In reality, the suggestion from Summers and others that secular stagnation may lie ahead for the United States is derived just by analogy with the experience after the Great Depression. Financial crises create bad economic conditions, which may have a persistent negative impact on growth.
The Problem with the Solutions
The most provocative thing about Summers’s recent presentation on secular stagnation is the presumption that we can or should alter traditional macro policy to address the issue. There is little evidence to support that approach.
Further, Hansen’s prediction about secular stagnation and its causes was upended by World War II which ended that period of secular stagnation. The onset of global war created a huge demand for weapons and caused the conversion of factories from peacetime use to the all-out production of tanks, guns, military vehicles, supplies such as rubber and ammonia, and other items necessary to fight the war. Additionally, war had the unfortunate byproduct of destroying a large portion of the capital stock in areas where hostilities were conducted. That destruction, coupled with the adoption of innovations developed during the war, created postwar booms in countries like Japan and Germany, where rebuilding of the capital stock both was essential and brought high intrinsic returns.
As we enter 2014, we are at a crossroads on the question of boosting sustainable growth. Monetary and fiscal measures to increase short-run or cyclical growth are largely played out—with fiscal policy in a consolidation phase, which entails less fiscal stimulus, and monetary policy having approached its limit as a means to stimulate the economy. However, a long-run growth-enhancement goal, suggested by the secular stagnation hypothesis, may be an especially poor guide to policy, since we know so little about effective ways to boost long-term growth.
As I have suggested, sustaining long-term growth is a race between diminishing returns to inputs of production and technological change that enhances productivity. In the postwar period, the United States has experienced significant changes to productivity growth (figure 1). While the pace of growth is clearly volatile, we can see some underlying changes.
In 1974, productivity growth dropped for reasons that have not been clearly identified, although many suspect that the sharp, relative price shocks entailed by the quadrupling of the price of oil had something to do with the fall. Subsequently, in 1995, productivity growth jumped to a higher level that was sustained largely for the following decade. Again, the reasons for this increase have not been clearly identified, but they may be tied to the information technology revolution that was playing out at the time and that continues today. In addition to these changing productivity episodes, the pace of growth has gradually trended downward, especially since the mid-1980s (figure 2).
Given diminishing returns to additional labor and capital inputs, sustainable long-run growth depends on steady increases in productivity, which is tied in turn to technological advancement and the learning that usually accompanies capital accumulation. The disconcerting fact is that we know relatively little about inducement of the steady technological improvement that is critical to generate capital investment, boost labor productivity, and raise employment and growth.
Like Alvin Hansen in the late 1930s, economists today have seized on the notion of secular stagnation to rationalize economic policies that do not have a demonstrable empirical impact on long-run growth. The basic rule about policy is that unless policymakers understand how a system works, policy should be used sparingly. Hence, growth policy can be counterproductive in the absence of a clearly defined link to technological change or growth of capital investment.
The measures Krugman, Summers, and others have proposed are suited to addressing cyclical growth problems more than secular long-run growth problems. The remedies offered today—engineering a 4 percent inflation rate to drive down real interest rates and, thereby, encourage capital formation and enacting government programs
driven by chronic deficit spending to boost growth—are not very promising or very different from the measures already proposed to manage weak cyclical growth in the post–financial crisis era.
The most disconcerting thing about Hansen’s secular stagnation theory was the ultimate, proximate remedy. The onset of World War II and the induced surge in capital spending and innovation, not to mention the destruction of the capital stock in Europe and Japan, created faster growth during and after the war in the United States and Europe. Needless to say, a global war has to be rejected as a viable means to revive capital spending and growth today.
Some Useful Measures to Consider
Some constructive and feasible ways to raise the possibility that long-run growth will remain at or above the 2 percent historical average include lowering policy uncertainty, ensuring lower and stable inflation, creating a more neutral tax system, fostering more and freer international trade, and deregulation. None of these measures come as a revelation, and all are apparently difficult to sustain.
Reducing policy uncertainty has been shown to be associated with a higher growth rate of as much as a percentage point in the United States. Much of monetary policy uncertainty is tied to the Federal Reserve’s commitment to lower the unemployment rate, a goal that may not be possible using monetary policy alone. The Fed should articulate a simple policy paradigm whereby it maintains a low and stable inflation rate to reduce uncertainty in the economy. On the fiscal policy front, policymakers would do well to end persistent budget and debt “crises” that sap investment and growth by further elevating policy uncertainty.
Tax reform aimed at creating a neutral tax system with lower and more uniform marginal tax rates imposed on the broadest possible tax base would boost growth during a period of fiscal retrenchment. Here again, while the idea is well known, its articulation and implementation have been difficult and discouragingly slow.
More and fuller international trade is another way to enhance growth. There is an extensive literature on the growth-enhancing benefits of freer trade. One hopes that the initiatives to maintain and enhance a freer trade pattern in Asia and Europe continue to be expanded and do not succumb to rising nationalist pressures to implement restrictive trade policies.
Deregulation contributes to less policy uncertainty and reduces the misallocation of resources caused by arbitrary government intervention. Unfortunately, we seem to be moving toward a more regulated economy, having aggressively regulated and reregulated the health care sector, which constitutes about 20 percent of economic activity, and the financial sector, which is responsible for allocating capital and encouraging growth.
A (Sort of) Rosy Outlook
All of this said, the United States still possesses one of the best environments for investment and growth. The rule of law that protects US property rights is uniquely strong. The US pace of growth as we enter 2014, while modest at about 2 percent, is better than the pace of growth in Europe and Japan. Additionally, the US policy outlook is considerably more certain than the outlook in China.
Some progress on any of the fronts mentioned, like tax reform, deregulation, and free trade, would do more to enhance long-run growth in the United States and globally than the attempt to engineer a 4 percent inflation rate or persistent deficit-financed government programs. Perhaps most consoling is the fact that despite predictions of secular stagnation—from classical economists like Adam Smith and David Ricardo to Alvin Hansen in the 20th century and now to Paul Krugman and Larry Summers in the 21st century—little evidence exists that economic stagnation persists for as long as its proponent suggest.
Also on the bright side, Joseph Schumpeter’s creative destruction is alive and well in the Silicon Valley, where rapid technological change continues to create immense opportunities for investment and economic growth.
Linking persistently low growth to a hazy concept like secular stagnation will not solve the problem any more than just naming a disease creates a cure for it. There are many steps, like undertaking tax reform and creating more predictable, less intrusive government policy, we can take to increase the likelihood that trend growth will return to pre–financial crisis levels, but these are necessary, not sufficient conditions.
The Rolling Stones said it best: “You can’t always get what you want. But if you try, sometimes you just might find you get what you need.”
1. See Robert J. Barro and Xavier Sala-i-Martin, Economic Growth (New York: McGraw-Hill, 1995). Real GDP per capita is employed as the benchmark of welfare growth as opposed to GDP growth alone. This is consistent with most long-run studies.
2. See Alvin H. Hansen, “Economic Progress and Declining Population Growth,” The American Economic Review 29, no. 1 (1939): 1–15, www.jstor.org/stable/1806983.
3. Paul Krugman, “Bubbles, Regulation, and Secular Stagnation,” New York Times, September 25, 2013, http://krugman.blogs.nytimes.com/2013/09/25/bubbles-regulation-and-secular-stagnation.
4. Lawrence H. Summers, “Policy Responses to Crises” (panel discussion, International Monetary Fund Annual Research Conference, Washington, DC, November 8, 2013), www.imf.org/external/np/res/seminars/2013/arc/index1.htm.
5. Robert J. Gordon, “Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds” (working paper no. 18315, National Bureau of Economic Research, Cambridge, MA, August 2012), www.nber.org/papers/w18315.
6. Mick Jagger and Keith Richards, “You Can’t Always Get What You Want.” Recorded by the Rolling Stones, 1969.
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