I spent a very interesting couple of days at the OECD Forum this week, during which its latest Economic Outlook was published. Like many others, the OECD has concluded that the world economy is set for a period of low growth. The usual post-recession boom hasn’t happened. Economies have returned to growth but at rates that are nowhere near enough to compensate for the losses they suffered after the crash.
The OECD’s projections for the major economies are dire. It doesn’t expect any of the G7 to manage 2 percent growth this year. It’s a little more optimistic about next year but not much.
One of the main reasons for the world economy’s failure to produce a rebound is sluggish productivity. Since the recession, productivity growth has slowed down almost everywhere.
For all of them, the recession has slowed productivity growth down to a crawl. The difference between the two decades is sharp. Whatever the cause of the disease, the UK has experienced acute symptoms. Its productivity growth has gone from second highest in the G7, between 1995 and 2005, to second lowest during the last decade. As Chris Dillow reminded us earlier this week, output per worker-hour is still lower than it was at the end of 2007.
And, says the OECD, low growth begets low growth:
The prolonged period of low growth has precipitated a self-fulfilling low-growth trap. Business has little incentive to invest given insufficient demand at home and in the global economy, continued uncertainties, and a slowed pace of structural reform.
Negative feedback-loops are at work. Lack of investment erodes the capital stock and limits the diffusion of innovations. Skill mismatches and forbearance by banks capture labour and capital in low productivity firms. Sluggish trade prospects slow knowledge transfer. These malignant forces slow down productivity growth, constraining potential output, investment, and trade. In per capita terms, the potential of the OECD economies to grow has halved from just below 2 per cent 20 years ago to less than one per cent per year, and the drop across emerging markets is similarly dramatic. The sobering fact is that it will take 70 years, instead of 35, to double living standards.
The way to break this cycle, it concludes, is for governments to take advantage of record low borrowing costs to invest in infrastructure:
Governments today can lock in very low interest rates for very long maturities to effectively open up fiscal space. Prioritized and high-quality spending generates the capacity to repay the obligations in the longer term while also supporting growth today. Countries have different needs and initial situations, but OECD research points to the kind of projects and activities that have high multipliers, including both hard infrastructure (such as digital, energy, and transport) and soft infrastructure (including early education and innovation). The right choices will catalyse business investment, which, as the Outlook of a year ago argued, is ultimately the key to propelling the economy from the low-growth trap to the high-growth path.
Furthermore, it reckons that, in most developed economies, investment would boost growth to such an extent that government debt-to-GDP ratios would some down. Borrowing would increase the level of debt, of course, but economies would grow faster than the rate at which the debt accumulated.
Based on 4 different models, OECD economists believe that co-ordinated investment would boost output while either reducing debt-to-GDP or not increasing it by much.
Of course, with the current zeitgeist being all about deficit reduction, the riposte from governments is bound to be, “What if it doesn’t?” What if we increase debt and the economy still doesn’t grow?
Jason Furman remarked that there has been a shift in the positions of politicians and economic advisors since the financial crisis. Politicians, he said, used to go into the candy store, want everything and borrow more than they could afford. Nerdy economists in organisations like the OECD and IMF would try to restrain them by warning of the risks. Now, he says, the positions are reversed. The OECD and IMF are urging politicians to invest in infrastructure but now governments don’t want to go into the candy store. Even if they are told it will reduce debt-to-GDP, they are still reluctant to invest. His comments are on this video at about 21 minutes in.
It’s also important to remember that the OECD isn’t suggesting governments should simply continue to run deficits. The increased borrowing would be specifically aimed at improving infrastructure. This approach would see investment spending increasing at the same time as day-to-day spending deficits were reduced. Such a policy would not be that far from what Labour, albeit very quietly and timidly, was advocating at the last election.
The IMF is also encouraging governments to invest and warning that the recovery could stall if they don’t. At the moment, though, austerity is where it’s at. Governments don’t want to go back to the candy store, even though the candy is now cheaper than it has ever been.