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OPINION

Escaping stagnation

Escaping stagnation
November 25, 2013
Escaping stagnation

We should stress that these ideas are separate from the question of whether the financial crisis has reduced trend growth, because western economies were slowing even before then. Mr Summers noted that US unemployment was not unusually low in 2007. And in the UK, the IFS has said that real income growth was “very weak” in the five years before 2007, and companies were failing to reinvest all their retained profits in those years – corroborating Mr Bernanke’s theory of a dearth of investment opportunities.

All this poses the question: what hope is there for either a pick-up in trend growth, or at least for a decent cyclical upswing despite low trend growth? There are four possibilities, all doubtful.

- Investment picks up. Ideally, this would be the result of a pick-up in the rate of technical progress. But it might also happen if the depressed sentiment and credit constraints caused by the crisis have created a backlog of investment opportunities. Economists believe this to be the case to some extent; they forecast fixed investment growth of 6.2 per cent next year after a small drop this. However, it’s also possible that low real wages (which deter capital-labour substitution) and spare capacity will hold investment back.

- High unemployment means we can achieve a cyclical upswing merely by increasing labour utilization. There are now 2.47 million unemployed, plus another 2.31 million who are out of the workforce but want a job. Even if we assume these are only half as productive as existing employees, GDP would rise by eight per cent if these find jobs. And it would rise by more if the under-employed worked more hours, or if rising demand were accompanied by some productivity growth.

- If China rebalances its economy towards consumer spending, its current account surplus should shrink. This will reduce one source of deficient global aggregate demand. This, however, is likely to take many years. And the UK is unlikely to benefit much from it directly. Our exports to China last year were just £10.5bn – less than 0.7 per cent of GDP. It’s more likely that overseas trade will hold back the UK, thanks to weak growth in the euro area.

- We might get policy changes to boost the supply-side. Both left and right have some ideas here. However, work by John Landon-Lane and Peter Robertson has shown that national policies have in the past done little to change long-run growth. This warns us not to exaggerate the efficacy of policy changes, especially of the modest sort we’re likely to see.

On balance, barring some unforeseeable acceleration in technical change, it’s difficult to see a significant rise in trend growth. What’s more likely is a cyclical upturn around a weak long-term average. However, given that past cyclical upturns have very often been mistaken for improvements in the trend, this might not be so bad – for a while.