Where is the world economy going?

The more one is certain about the state of an economy, the more one is likely to be wrong; the more one is certain about the state of an economy, the greater the media coverage. No wonder the public is confused.

I shan’t add to the confusion. In quick summary, the New Zealand’s economic growth seems to be slowing down but we don’t know whether it will go negative and economic activity contract.

* The Australian economy  is in the doldrums.

*Chinese economic growth seems to slowing down from an underlying 15 percent a year to 5 percent. That is not as bad as slowing down from 5 percent p.a. to minus 5 percent p.a., but many firms could still get caught out.

* The European economy remains sluggish; I am guessing it will remain so until it resolves the problems of Greece and some other Mediterranean economies.

* The US economy is a bit of a mixed bag; it has some of the characteristics of the 2007 economy just before the Global Financial Crisis when we knew something was wrong, although the current indications are that 2015 is not as problematic as 2007 was. The only certainty is uncertainty.

These summaries describe the state of the various business cycles, but each fluctuates about a long-term trend. The problem may be that it is changing, not only in China but in the world generally. There are some economists – including the eminent Larry Summers – who think that the world economy may be in secular stagnation and that GDP per capita will not grow much in the long term.(Secular stagnation has been a long term concern of the profession; among those who have pondered on it are David Ricardo, Karl Marx, John Maynard Keynes and Joseph Schumpeter.)

Discussion at the moment seems more around the consequences of secular stagnation, rather than why. I’ll hazard a couple of suggestions (without going into the subtleties which underpin them).*

The first is that there is not really world-wide economic stagnation. It is confined to rich countries as they offshore production to poorer economies. I wrote about this in my Globalisation and the Wealth of Nations. It involves a complicated underlying economic model, but it has the interesting prediction (for us in New Zealand) that the price of foodstuffs relative to the price of manufactures (the terms of trade) will rise. I think I would want to add to my 2006 book that most of the countries to which the business is being relocated do not have high-quality rule-of-law regimes and that will slow down the world economy as a whole.

The second explanation relies on economic growth arising from technological innovation. The American economist who has best studied this in the long run is Robert Gordon. He does not think that current innovations are nearly as significant as those which happened a century ago, (Surely the impact of electricity has been greater than the computer; it is far easier to conceive a modern economy without the latter than one without the former.)

There may be a slightly different explanation to why Gordon cannot find the productivity gains in recent years that he found earlier. Recall the number of ICT applications for which there is no business case (i.e. their owners cannot figure out how to make a profit) but which are valued by the user. In this case their value may not appear in the productivity statistics.

It is this profitability issue which worries Summers et al. Low productivity growth means there have been fewer opportunities to invest, with the consequences that interest rates (and hence profits) are driven down. Perhaps today’s low international interest rates are not just a part of the cyclical adjustment to the Global Financial Crisis but are because of the secular stagnation; in which case they may be with us for a while. That would mean a dramatic change to the nature of the world economy – to capitalism.

For instance, it would invalidate Thomas Picketty’s predictions of increasing inequality (but not the analytic model he developed). Hedge funds would find it more difficult to make profits. (Perhaps that is why they are turning to funding such government-funded projects as improving mental health based on social bonds; it is a basic principle of capitalism that when private projects are not available investors turn to plundering the taxpayer.) Another significant consequence – many would say, already evident – is that macroeconomic policy could not rely upon monetary policy in the way it has in recent years, because interest rates would be very low.

To add to the uncertainties a recent issue of the London-based Economist argued that the US economy may no longer be strong enough to be the banker of the world. It fears that come the next financial crisis (I don’t think it expects one soon), the US, the IMF Old Uncle Tom Cobley and All will not be able to bail the system out, even if the US policy response is more coherent than Congress would currently allow.

OUTC&A includes China. Its renminbi is subject to too many restrictions to act as a reserve currency (say in tandem with the US dollar). The Chinese have a saying ‘may you live in interesting times’. Uncertain ones certainly are.


* Footnote. A decade ago I would have worried about higher energy prices as a consequence of the rising cost of oil choking productivity growth. As I have argued earlier, fracking has delayed that