They show how capital inflows and falling interest rates can depress productivity growth and therefore long-run living standards. Lower rates, they say trigger booms in consumer spending and construction. This transfers labour and capital away from the manufacturing sector towards building and retailing.
So far, so unexceptional. But here’s the problem. Productivity growth tends to be faster in manufacturing than in these other sectors. For example, in the last 15 years, output per worker has grown twice as fast in manufacturing as in services – by 3.2 per cent a year against 1.5 per cent. A transfer of resources away from manufacturing will therefore reduce a country’s productivity growth.
A big reason for this is that manufacturers are much better than other sectors at learning from best-practice overseas: Harvard University’s Dani Rodrik has shown that productivity growth across countries tends to converge for manufacturing sectors but not for others. Quite why this should be is unclear. One possibility is that the force of international competition compels manufacturers to up their game. Another is that service industries are more sensitive to local culture, and so success in one nation can’t be transferred; this is why so many British retailers fail overseas. And a third reason might be just government restrictions; planning laws prevent UK retailers emulating the “big box” efficiencies of their US counterparts.
Whatever the reason, the result is the same. A shift in activity away from manufacturing reduces productivity growth. In this sense, there is a “financial resources curse” analogous to the well-known natural resources curse and Dutch disease; if a nation discovers easy access to financial capital, it can suffer in the same way that it often suffers from discovering natural resources.
Messrs Fornaro and Benigno think this describes the Spanish economy in the 00s. It imported capital from overseas (that is, ran a current account deficit) at low interest rates, saw construction activity rise as a share of the economy, and at the same suffered a fall in the level of total factor productivity. But it might also describe the UK. We too had current account deficits, falling interest rates, a consumer and construction boom and falling productivity growth. In the five years to 2007Q4, GDP per worker rose 2.3 per cent a year compared to three per cent in the previous five.
All this has two implications. First, it helps explain why the UK and other European economies have found it so difficult to “rebalance” away from construction and retailing towards manufacturing and exports. Doing so requires construction and retail workers to retrain and move – a process which takes time. Also, having been squeezed by the shift towards services and construction, manufacturing industry has been less able to benefit from learning by doing than it would otherwise have done. This limits the extent to which it can grow in future.
Secondly, all this suggests a reason not to blame the last Labour government for its alleged profligacy. If we’d had a tighter fiscal policy in the 00s and looser monetary policy – and given the inflation target the former implies the latter – then interest rates would have been even lower and the financial resource curse would therefore have been even worse.
