Join our community of smart investors
OPINION

Everyday stagnation

Everyday stagnation
July 21, 2015
Everyday stagnation

The question is: why do so many people take such thankless jobs? It's for the same reason that hundreds of thousands of others have become self-employed handymen and freelancers who spend their hours waiting for work - because they can't find anything better.

 

 

All those cold callers give us a daily - well, hourly - reminder that the economy isn't dynamic enough to create sufficient productive and rewarding jobs. In other words, we are in an era of secular stagnation. This phrase has many meanings; it refers to the combination of slow productivity growth, weak investment and low innovation that have given us negative real interest rates. Even those who don't expect such negative rates to persist believe they will stay low. Bank of England governor Mark Carney said last week that the "equilibrium" real interest rate - the rate consistent with the economy operating at potential and inflation on target - "will continue to be lower than on average in the past".

Stagnation, though, hasn't only given us poor returns on cash. It has also depressed equity returns. One reason why the All-Share index has fallen in real terms since the start of the century is that the fear of stagnation has depressed profit expectations.

'Secular stagnation' might sound like high-falutin' pointy-headed economic jargon. But it is, in fact, the thing that gives us the twin irritations of cold-callers and miserable returns on our savings.

Which poses the question: why are we in it, and could we get out of it?

A recent paper by Gianluca Benigno at the LSE and Luca Fornaro at Barcelona's University of Pompeu Fabra points out that economies can fall in a stagnation trap. If people expect low growth they won't invest or innovate and this will cause low profits for other companies, thus exacerbating disincentives to invest. In this way, pessimism can be self-fulfilling.

The problem is that such pessimism might be justified.

One reason for this is that profit rates have fallen. The economics blogger Michael Roberts estimates that returns on capital in G20 countries have steadily fallen since the early 1970s. This has reduced incentives to invest or innovate.

In this sense, secular stagnation might be the rediscovery of one of the oldest ideas in economics - that of the stationary state. All the classical economists such as Adam Smith, David Ricardo and John Stuart Mill thought that increases in the capital stock would lead to diminishing returns and thus to lower investment and eventually an end to growth.

Why hasn't this happened earlier? It's because technical progress has offset diminishing returns. Some economists believe it will continue to do so. "There are a number of emerging technologies that provide tremendous scope for improvements in productivity," say Saara Tuuli and Sandra Batten, two Bank of England economists.

However, it's a long way from the laboratory to the marketplace. Companies will only invest in these new technologies if they expect to make a profit. And history suggests this might not be the case. Yale University's William Nordhaus has shown that only a "minuscule fraction" of the returns to innovative activity flow to companies: it is mostly consumers that benefit. And Charles Lee and Salman Arif, two US economists, have shown that rises in capital spending lead on average to lower profits.

It could be that investment and innovation are weak precisely because the tech crash and Great Recession have alerted companies to the facts that these often don't pay.

Indeed, optimism about potential technical progress might itself be a reason not to invest. If you equip a factory with robots costing £10m you'll be unable to compete in a few years with the next, better generation of robots that cost only £5m. In this sense, techno-optimism and secular stagnation, far from being opposing arguments, are in fact compatible.

So, what could change to lift us out of stagnation? Many believers in the idea - from Maynard Keynes to Paul Krugman - want governments to intervene in the economy more. This is unlikely to happen.

Another possibility is that any short-term increase in investment caused by increased animal spirits might - as in Benigno and Fornaro's theory - shift us from a low- to a high-investment equilibrium.

A longer-term hope is that there will eventually emerge a generation of entrepreneurs and business leaders who haven't been scarred by the tech crash and recession, and their greater (over-?) optimism could raise growth.

For equity investors, the stakes here are massive. If stagnation takes greater hold, we could face decades of negative returns of the sort Japan has suffered. If it doesn't, relief at the fading away of such a horrible risk could cause a big revaluation. In this sense, equities are more uncertain than the historic distribution of returns would suggest.