Chapter 7 of ‘In Open Seas’

In the last 200 years, world per capita incomes (measured by market output) have risen over ten times on average– more so in the most affluent countries. In the previous 200 years they are thought to have risen about 10 percent. Can the miracle growth of the last two centuries continue? Stein’s law says that ‘if something cannot go on forever, it will stop’. But when? Perhaps ‘soon’, at least for the affluent economies.

Secular stagnation is the notion that affluent economies are moving into a low economic growth stage for a long period, if not forever. (For economists, ‘secular’ means the ‘long term’, of indefinite duration.) Are we there yet?

There are some economists who think that the world economy may already be in secular stagnation and that GDP per capita will not grow much in the long term. Indeed, secular stagnation has been a common concern of the profession; among the greats who have pondered on it are Thomas Malthus, David Ricardo, Karl Marx, John Maynard Keynes and Joseph Schumpeter. However, there is no consensus among today’s economists that the rich economies face the prospect of long-term stagnation compared to their experiences of the last two centuries. There is even less consensus on why it may happen.

It is generally accepted that international real (adjusted for inflation) interest rates are low compared to the past and are likely to remain low for some time. In principle, low interest rates ought to stimulate an investment boom, but none is evident. That seems to suggest that in rich countries businesses do not see growth opportunities.

Business sees opportunities in poorer countries, although they may be hesitant to invest there because of political instability. Many poorer economies are growing faster than the rich ones. However, even the economic growth of the star performer, China, is slowing down. Japan too, was once growing very quickly but it slowed to the rich economies’ rate once it caught up. This suggests the rapid growth occurred by Japan as a poor country adopting rich countries’ technologies. Once that had and Japan was using the top ones, its economy slowed down to their rate.

Another concern is that much of today’s growth is dependent upon ultimately unsustainable financial behaviour. There is bound to be at least another major financial crash sometime in most readers’ lifetimes and that will almost certainly set back the international (or individual countries’) growth track.

Mechanisms Ending Growth

Why might growth rates in rich economies stagnate? Here are some possible explanations. They are not exclusive.

First, the shift from the non-market economy to the market economy – evident in the rise of food preparation (and consumption) outside the home, that home dressmaking is much less common and that more of childcare occurs outside the family – may be near exhausted. New Zealand has already very high labour force participation by women – among the highest in the world. Can we squeeze any more blood out of the kitchen?

Second, if economic growth has been as dependent on consuming natural resources, as the previous chapter explored, then we may be reaching the point where such exploitation is ending, especially if we stop using as sumps for polluting waste air (greenhouse gases and smoke emissions), fresh (waste and runoff) and sea water (including plastic bags) – the alternatives are more expensive measured in GDP terms.

Third, it is possible there is a slowdown of new growth-promoting technologies compared to the last two centuries. As Chapter 4 discussed, economists think that a major drive of economic growth has been technology rather than capital accumulation. This may explain why poorer countries are still growing. They are upgrading their technologies to rich-country levels. When they reach that level, they will grow at the rich-country rates.

American economist Robert Gordon, who has done more research in the area than anyone else, argues that today’s innovations are not comparable to those of a century ago – like electricity and the internal combustion engine. We may know whether he is right in a hundred years, although there certainly seems to be an ongoing multitude of new innovations if not as dramatic as the ones Gordon cites.

Why? One possibility is that the technologies at the back of the warehouse (Chapter 4) are less exciting than the one’s near the front which have already been discovered. I am not sure about that. One suggestion is that those at the back are harder to get at, since the researcher has to work their way through all the technologies at the front of the warehouse, so one needs to know a lot more nowadays.

A third possibility is that the new technologies do not give a commercial return. For instance, the contribution to wellbeing of new pharmaceutical drugs, costly to generate, may far outstrip their contribution to GDP. (Not in Narrow Seas mentions the impact of efficient contraception which hardly appears in GDP but made a dramatic impact to wellbeing.)

A variation on the social valuable innovations which don’t give commercial returns is infrastructure, which is often cited as generating a high return to the economy. Generally the return does not go directly to the investor but is spread widely, which is why private investors tend to be uninterested (unless there is a public subsidy). While public-debt-constrained governments have difficulties funding infrastructure without raising taxation, motorists sit fuming in a traffic jam unwilling to pay the taxes to improve roads.

A fifth possibility is there are increasingly severe difficulties measuring conventional economic growth as we shift from the product economy to the service economy.

A sixth is that the degree of monopolisation seems to be increasing in key sectors with the incumbents resisting new entrants. This may be because they are often ‘common carriers’ (natural monopolies) with the technologies favouring only one significant provider. (Examples are the immensely profitable Facebook and Google whose revenue comes more from advertising than the services they provide to users – similar to newspapers.) That may slow down economic growth by stifling genuine innovation. (I certainly think that natural monopolies should be regulated in the public good. If that generates economic growth as well as improving wellbeing, so be it.)

A seventh possibility is that secular stagnation is a rich-economy phenomenon because the rich countries offshore production to poorer economies. I wrote about this in my Globalisation and the Wealth of Nations. Essentially, the ability of poor countries to produce many of the same products using lower paid workers switches economic growth in their favour, whereas in the past circumstances favoured the now-rich producers. Even so, there remain opportunities for affluent countries to provide advanced precision products, as Germany’s capital goods exports to China demonstrates.

The world’s regional balance of economic activity is always changing, which must imply some regions are in relative decline. Once Northern England was more affluent that Southern England (which is why many New Zealander’s nineteenth-century ancestors came from the south). Booming parts of the US are now rust-belts. The South Island once had a larger population than the North Island. Over the long run, there are changes in the relative rankings of economies by per capita GDP. Observe that in Europe and the US economic development moved from increasingly congested centres to the periphery (in Europe from Britain to Finland and the Mediterranean; in the US from the Northeast and Midwest to the South and Pacific West). Now, the same processes move industry offshore, so when Japan reached rich country status some of its industries moved on to South Korea, Taiwan and South East Asia.

The underlying economic model suggests that the developing country shifts its labour out of its low-productivity farm sector into a medium-productivity manufacturing sector which exports to the rich. (The cognoscenti will recognise here a ‘Lewis’ model of growth; West Indian Arthur Lewis was the first non-European Nobel Laureate economist.)

A final theory is that a lot of economic growth is a kind of Ponzi scheme, especially that which depends upon the financial sector. It argues that investors are benefiting today from trading worthless financial paper with others who expect similar returns in the future. One day they will not be delivered. Such arrangements may not be illegal, but they are painful when they collapse. Much of the 2008 Global Financial Crisis can be explained this way. (Economic growth depending on environmental depletion is also a kind of Ponzi scheme.)

Secular stagnation may have begun towards the end of the twentieth century – perhaps as the result of a slowing down of the rate of technological innovation which could be commercialised (although others of the explanations above may have also contributed). The financial sector speculative boom in the first decade of this century disguised the sluggishness. The GFC ended the boom.

A Stagnant New Zealand?

The full model of the offshore movement of manufacturing to poorer countries (the seventh possibility) has an interesting prediction, especially for New Zealand. These new manufacturing countries will suffer a food deficit because their agricultural sectors will not be able to deliver all the food demanded by the more-affluent city workers. The price of foodstuffs then rises relative to the price of manufactures.

That has been already happening over the last forty-odd years because of industrialisation in East and South East Asia. The rising prices have been to New Zealand’s benefit (because it gets paid more for the same production). In contrast, the food terms of trade had been generally falling in the twentieth century before the 1980s.

This adds to the promise for the New Zealand economy. The foundation of New Zealand’s prosperity has been its resource base – especially, land, sun and water – which it has processed and exported. Is New Zealand running out of the resources to fully reap the gains?

What if Economic Growth is Dependent Upon Environmental Depletion?

To return to the second possible explanation. Suppose past economic growth has been partially dependent upon depleting the environment (as well as innovation). There are two major ways the depletion happens.

One is that there is a resource – such as coal – which gets mined out. This may be thought of as converting a not-priced non-market resource into a priced market one (relating to our first possible explanation of why we may be facing secular stagnation).

A variation on this is that a resource may be used as a sump – sewerage and runoff into water, carbon dioxide into the air. The implication is that if we had a wider measure of economic activity it would include a measure of environmental depletion analogous to capital depreciation in GDP. Thus far it has proved difficult to calculate in a convincing way. Moreover, it would make little difference to current measures of material wellbeing (consumption). Rather the wellbeing would stagnate and fall in the future – sounds like a Ponzi scheme.

But environmental depletion may impact on material wellbeing. Suppose it was decided to remedy the sumps or even just to stop using them. That would divert resources which could be used for increasing consumption. Some people would say that would increase their psychic wellbeing. Fair enough. (Robert Fulghum’s All I Really Need to Know I Learned in Kindergarten says ‘Put things back where you found them; clean up your own mess’.) Whatever such actions would do for psychic wellbeing, the material economic outcome would appear as secular stagnation.

A slightly different issue is that much of New Zealand’s capital investment has been shoddy – leaky and earthquake prone buildings for example. Like remedying of environmental depletion, remedying poorly built structures will involve redirecting economic activity from adding to material consumption to consolidating past gains.

The Implications of Secular Stagnation

Predictions are hard to make, particularly about the future. So we do not know whether international secular stagnation is something to really worry about, or just another passing fad. However, I should not be surprised if economic growth among the rich countries is markedly lower in the future than it has been in the past. The secular stagnation scenario sees a continuous slow down but we should not rule out crashes followed by a very slow recovery as happened in 2008 and after.

The clue for me is real interest rates. Those in the US, which set world rates, dropped from 5% p.a. in the 1980s, to 2% p.a. in the 1990s, and to just 1% p.a. in the 2000s. Since the Global Financial Crisis occurred, they have averaged a negative 1% p.a (yup, nominal interest rates have been below the rate of inflation). They may recover but that is not what the forward looking long-term interest rate on US government bonds says. Low interest rates are indicative of a lack of investment opportunities relative to available savings.

There is a terrible inertia in human thinking when it is not chasing frivolous fashion. There is real danger we will not adapt to the new circumstances which may be, if there is secular stagnation or much slower growth, totally different from the experiences (particularly in rich countries) over the last two centuries.

Adding to the inertia of thinking about economic growth is that the growth rate and the profit rate are inextricably entwined. Low long-term growth means low long-term profitability. In the short-term business can squeeze wages, shifting the share of total income towards profits, but that cannot go on for ever. There is a basic long-run mechanism that drives profit rates towards interest rates plus a risk premium. That is why some of the great stagnationist thinkers saw an end of capitalism. Thus far capitalism has survived despite such predictions, because of its ability to morph into new forms, overcoming the inertia, or perhaps because technological innovations has kept generating new commercial investment opportunities – up to now.

Even so, practical inertia will not prevent the public rhetoric pressing for growth will remain prominent. It is largely unaffected by evidence and research, so why should new circumstances and evidence change its approach?

The Risks of Overestimating Interest Rates

The danger is that we base our future on the past growth rate; if it is markedly lower we will make poor decisions. Suppose real interest rates remain near zero but individuals plan their retirement on their savings based on a real return of 5 percent p.a. (low compared to the rate many investment advisers talk about). They are going to have a low-income retirement relative to their working-age income and their plans (their New Zealand Superannuation benefit is not going to grow much either).

They may convince themselves they can get a higher return by investing in high risk schemes. But not everyone can get a higher-than-average return on their investment. Ergo, some are going to get lower returns. In a low-growth, low-return economy some of those involved in risky investment are going to lose a lot of their savings. (Not you of course, someone else.) People who lose their savings are usually incensed, forgetting that it was they who decided to invest in high-risk schemes. That some schemes proved fraudulent or near-fraudulent heightens the anger. But other investments fail through bad luck or events outside the control of the investment manager, especially if they were betting on higher growth rates than the actual outcome.

The same trap applies to business. If their plans are based on expected growth and there is long-term stagnation, the firms will over-commit themselves and fail. That does not mean there are no business opportunities during secular stagnation – picture theatres were built during the Great Depression – but there are fewer.

Similarly for government investment, except that failure results in higher taxes or public debt. It is fashionable to argue the case for public infrastructure but the underlying case is a cautious one. There is a need for catchup of a backlog, and some new infrastructure may be vital to wellbeing – addressing the three (fresh, waste and storm waters), for instance. But such investment gives a financial return (in higher tax revenues to the government) only if there is economic growth.

So, any transition from the high material growth rates of the past two centuries to lower (or zero) ones will not be easy. Possibility the usual economic rules of the last eighty-odd years are going to be stood on their head posing quite a challenge.

How We Might Cope with Slow Economic Growth in the Future?

Thinking about the economic future one cannot avoid making some assessment of the likely course of material economic growth. If it is going to be slower than rich countries have been used to – there may even be secular stagnation. How are we to cope?

Chapter 2 argued we should shift the economic focus from material economic growth to wellbeing. But that does not mean that all the traditional concerns have become obsolete.

People still need jobs as a part of their involvement in their community and sense of worth. Thus avoiding stressful unemployment (which includes underemployment) and promoting quality job creation should be an important public policy priority.

Inequality is dealt with in a later chapter. There will be significant gains in aggregate wellbeing by lifting the relative incomes of those at the bottom. Economic growth which fails to change the relativities is of little relevance.

Diversity should be celebrated, with tolerance and respect. No group is privileged, but attention should be paid to the smaller ones. I have spent my entire life as a minority of one – so have you, if you have an independent sense of your self-worth. There is a current fashion to promote a society based on love. That seems to me to be a bit excessive in the case of some people, but we should be kind to them.

At our level of affluence, material consumption is not as important as the quality of life. That gives great significance to health care in all its dimensions. That care needs resources (as well as kindness). But we need to break away from assessments like ‘adopting my policies is worth so many billions of dollars’ which plays into the hands of those overemphasising GDP.

The same approach should be applied to safety – both personal and physical. It is not an area I know a lot about, although the law and order brigade seems to know even less.

Opportunity, or as Amartya Sen describes it, achieving capabilities is a key element of the good society and of individual wellbeing. A crucial element of that capability for each of us is creativity and achievement. There are so many social impediments to many New Zealanders being able to achieve what they are capable of. That is discussed in future chapters including the way education system has been captured by commercial considerations aimed at lifting GDP. The result is that people’s access to developing their capabilities has been limited. It is a repeat of an earlier theme. Prioritising material output in an affluent society damages wellbeing.

Finally in the list is sustainability. Earlier generations bequeathed to my generation opportunity and wellbeing. We owe the same to later generations.

Observe that the above list of objectives applies whether the affluent society is in a growth boom or in secular stagnation.

The list does not rule out the market economy, nor the need for a high-level – but sustainable – material output. But we should not confuse any analysis of growth with wellbeing; as the Maslow hierarchy makes clear, we should not be obsessed with GDP in the way that neoliberal policies have been.

Nor does the analysis reject an honourable role for business. It contributes to wellbeing in a number of ways. This is its purpose, not the pursuit of material output, as sadly Rogernomics thought. Business needs to be humble about what it can do, as we all need to be.