Make in India, largely for India.

AuthorRajan, Raghuram


The world economy is growing very slowly in the last couple of years and the IMF has repeatedly reduced its growth forecasts. In fact, after 6 years of a tepid post-Crisis recovery, the IMF titles its latest World Economic Outlook "Legacies, Clouds and Uncertainties". The legacies, clouds and uncertainties continue even after 6 years after Financial Crisis. Why is the world finding it so hard to resume the pre-Great Recession growth rates, let alone restore the levels of GDP which would have been achieved if the Great Recession had not happened? Typically, in most recessions, economies go down but come back much faster. However, in this case we see a slow world in terms of levels of GDP as well as growth rates many years from the Great Recession.

One answer to why the growth is so slow is the overhang of debt; when countries have lots of debt it prevents them from growing fast. Banks can't lend, households find it difficult to borrow and governments can't do Keynesian spending simply because they don't have the fiscal space. It could be one explanation for why there exists what the IMF Managing Director calls the 'New Mediocre'. The implication here is that growth is unacceptably low relative to potential and more can be done to lift it through a variety of stimulus policies especially given that so many economies are flirting with deflation. So, the conventional policy advice urges yet more innovative monetary interventions with an ever expanding set of acronyms like QE and QQE, as central banks try to inject stimulus. Then just monetary stimulus will not do, there should be a fiscal stimulus too. So, more and more governments are urged to do obvious things like building infrastructure. There are voices saying more than this, for example, structural reforms but they are typically deemed very painful and possibly growth-reducing in the short run. So, the accent is on monetary and fiscal stimulus, and as much of it as possible given the deadening effect of the debt overhang.

If there is one country which has tried this for a long time it is Japan. Japan has been in a quasi-recession for 20 years now, really hasn't got out of the Great Crash of early 1990s and it has done everything that has been suggested. Interest rates have been low for long, quantitative easing and massive debt-financed spending on infrastructure. Japan had very low levels of government debt to GDP. Today, it has the highest net government debt to GDP in the industrial world. Few would argue that despite doing all this Japan is free of its malaise. It is out there, scooting ahead; last two decades have not been good.

Secular Stagnation

There is now a different narrative of the pre-crisis period from this traditional view i.e. debt overhang to explain why the efforts at stimulating the economy back to the pre-Crisis growth paths have not been successful even six years after the Crisis. A common term, "secular stagnation" used by Larry Summers to describe this followed Alvin Hansen's speech in 1938 in the midst of the Great Depression, when the phenomenon of then slow persistent growth was called secular stagnation. Different economists focus on different versions of secular stagnation. Larry Summers emphasizes the inadequacy of aggregate demand, the Keynesian view, and the fact that interest rate can't be pushed below zero. Therefore we can't give more monetary stimulus than certain level in a period of low inflation. The possibility for financial instability prevents monetary policy from being more active. Coupled with that we don't have tools to stimulate but we also have headwinds to growth, specially ageing populations who want to consume less and the increasing income share of the very rich whose marginal propensity to consume is small. Those are the arguments that are made for very slow growth from the demand side.

Total Factor Productivity

There are others who argue that low growth from the supply side has been building for a long time. Prominent among those are Tyler Cowen and Robert Gordon who argue that the post-World War II years (30 years) of growth was extremely strong. This was because growth was helped by reconstruction in Europe, the spread of technologies such as electricity, telephones, and automobiles, rising educational attainments, and higher labor participation rates. Remember that women joined the workforce in a big way post World War II as well as restoration of global trade and increasing investments of capital. Everything was going in the right direction. Interestingly the one thing that was not going in the right direction was total factor productivity which was the highest during 1920-50 when world growth was relatively slow because of headwinds but since then productivity has been falling off. For those who think face book and social media are wonderful new inventions and the world has been more inventive and innovative in this period than ever before, think about the innovations that happened in the early part of the 20th century. There was a transition from horse drawn carriages to motor cars, from gas lit lamps to electricity, from coal filled irons which were heavy and required whole lot of labor for women to electric irons, and from washing clothes at the stream to washing machine. Compare those kinds of changes with twitter, facebook etc. and it can be seen that productivity growth was really quite large at that time. So, productivity growth has fallen and it is also being held back by headwinds such as plateau in education levels and labor participation rates, as well as a shrinking of labor force in some countries because of population ageing. This is particularly pronounced in Japan and, to some extent, it shows us what the industrial world might look like if all these forces play out, subject to very slow growth. Population ageing contributes to both the demand and supply side reasons for secular stagnation.

There is a tendency to save today because of the belief that our employment prospects and our children's employment prospects are not going to be bright and that the society will not be able to deliver on the social security promises it has made. Therefore, there is a tendency to save; more the saving, today's consumption demand will be lower. One could argue that the West has been heading this way for some time, secular stagnation has been in the works. Once there is secular stagnation happening, there is slow growth and then there are number of concerns. One, of course, is in the time of very high growth (30 glorious fast growth years after World War II) societies made lots of promises in Europe. Post World War II is when England got the pension system and unemployment insurance. In the US, Lyndon Johnson Great Society in the mid-1960s again promised of...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT