The Search for Growth in a Multi-Speed World

• The last few years have highlighted the declining potency of long-standing growth models. Today, some of the biggest world economies struggle to create ample, well-paid and secure jobs amid a secular re-alignment of the global economy. This is a challenge that will not be met easily or quickly. And, when it is met, the process will most likely be partial and uneven, accentuating differences and posing tricky coordination issues at the national, regional, and global levels.
• What is the most urgent economic priority shared by countries as diverse as Brazil, China, Cyprus, France, Greece, Iceland, Ireland, Korea, Portugal, the United Kingdom, and the United States? It is not debt and deficits; and it is not dealing with the aftermath of irresponsible lending and borrowing. Yes, these are relevant and, in a handful of cases, urgent. But the number one challenge facing these countries is to develop growth models that can provide more ample, well-paid, and secure jobs amid a secular re-alignment of the global economy.
• For both theoretical and practical reasons, this is a challenge that will not be met easily or quickly. And, when it is met, the process will most likely be partial and uneven, accentuating differences and posing tricky coordination issues at the national, regional, and global levels.
• The last few years have highlighted the declining potency of long-standing growth models. Some countries (for example, Greece and Portugal) relied on debt-financed government spending to fuel economy activity. Others (think Cyprus, Iceland, Ireland, the UK, and the US) resorted to unsustainable surges in leverage among financial institutions to fund private-sector activities, sometimes almost irrespective of underlying fundamentals. Still others (China and Korea) exploited seemingly limitless globalization and buoyant international trade to capture growing market shares. And a final group rode China’s coattails.
• Recent data from the International Monetary Fund highlight these models’ simultaneous loss of effectiveness. Global growth averaged only 2.9 percent in the most recent five-year period, well below the level for virtually any such multi-year period going back to 1971. While emerging economies have out-performed developed countries, both have slowed. Growth has been virtually flat in developed economies and, at 5.6 percent in the emerging world, is well below the 7.6 percent average in the previous five-year period.
• Highly leveraged systems in finance-dependent economies were the first to hit a wall, surprising many who had uncritically bought into the “Great Moderation” – the idea that macroeconomic and asset-market volatility had eased permanently. The bold policy action that countered the initial disorder prevented a global depression, but it encumbered public-sector balance sheets.
• As a result, highly indebted governments were the next to hit the wall. Some were pushed there by the high cost of containing the damage from banks’ irresponsible behavior. Facing immediate credit rationing and large output contractions, they could be stabilized only by exceptional official financing from abroad, and, in some extreme cases, by defaulting on past commitments (including to bondholders and, most recently, bank depositors).
• For other countries, including the US, medium-term issues came to the fore. But, rather than catalyzing sensible policy discussions, these issues played into polarized and polarizing politics, creating new and more immediate headwinds to economic growth.
• Meanwhile, a highly interdependent and (now) less dynamic world economy has been limiting the scope for external growth drivers. Accordingly, even countries with sound balance sheets and manageable leverage have experienced a growth slowdown.
• The consequences have become painfully clear, especially in Western countries. With insufficient growth to deleverage safely, social costs have been considerable. Alarmingly high youth unemployment, shrinking social safety nets, and under-investment in infrastructure and human capital are burdening current generations and, in a growing number of cases, will adversely affect future generations as well.
• In the process, inequality has risen further. And yet, despite the urgent need for major policy adaptations at the national level, and much better regional and global coordination, progress has been disappointing.
• With the political context undermining the right mix of short- and longer-term measures, national policymaking has stumbled into partial approaches and unusual experimentation. The focus has been on buying time, rather than on implementing a sensible transition to a sustainable policy stance. And potential national outcomes would be less uncertain if excessive inequality were not treated as an afterthought.
• The regional and multilateral dimensions are similarly inadequate. The absence of well-articulated common analyses and policy coordination has accentuated legitimacy deficits, encouraging leaders and publics to opt for partial narratives and eroding confidence in existing institutional structures.
• Given these trends, the search for more robust growth models will take much longer and be more complicated than many recognize – especially as the world economy pivots away from unfettered globalization and high levels of leverage.
• We should expect countries like the US to benefit from dynamic bottom-up entrepreneurship and traditional cyclical economic healing. Notwithstanding a dysfunctional Congress, the private sector will increasingly convert a paralyzing uncertainty premium, which impedes much investment, into a less disruptive risk premium. But, without a short-term economic turbo-charger, the recovery in growth and jobs will remain gradual, vulnerable to political and policy risks, and disproportionately beneficial to those with favorable initial endowments of wealth and globalized talents.
• Governments’ role will be different in countries like China, where officials will guide a shift from dependence on external sources of growth to more balanced demand. As this requires some fundamental domestic re-alignments, the rebalancing will be both gradual and non-linear at times.
• The outlook for other economies is more uncertain. Undermined by a lack of policy flexibility, it will take a long time for countries like Cyprus to overcome the immediate shock of crisis and revamp their growth models.
• Left to their own devices, these multi-speed dynamics would translate into higher global growth overall, coupled with larger internal and cross-country disparities – often exacerbated by demographics. The question is whether existing governance systems can coordinate effective intervention to counter the resulting tensions.
• Simultaneous progress on both substance and process is needed. Parliaments and multilateral institutions must do a better job at facilitating cooperative policy implementation, which will require a willingness to reform outmoded institutions, including political lobbying.
• No one should underestimate the growth challenge facing today’s global economy. The stronger sectors (within countries and across them) will continue to recover, but not enough to pull up the global economy whole As a result, weaker sectors risk being surpassed at an ever-faster pace. These trends will become more difficult to reconcile and keep orderly if governance systems fail to adjust.

A world of cheap money

• The low-rate world was not meant to last. In 2008-09, when central banks slashed short-term rates close to zero and started buying bonds to push down longer-term rates, everyone assumed these extraordinary measures would soon be unwound as economies recovered.
• But the extraordinary has become the norm. America’s Federal Reserve is still printing money to buy bonds and has made it clear that it will not raise short-term rates at least until unemployment, now close to 8%, falls to 6.5%. At the Bank of Japan Haruhiko Kuroda, the new governor appointed by the stimulus-minded prime minister, Shinzo Abe, this week announced a new phase of monetary easing to hit an inflation target of 2%: bond purchases will be stepped up to double the country’s monetary base. The Bank of England’s mandate has been tweaked to allow rates to stay lower longer. Even the European Central Bank (ECB) may be inching towards greater boldness. The message from the rich world’s central banks is clear: the era of ultra-loose monetary policy is here to stay.
• That has had a huge effect on financial markets.Japan’s Nikkei index is up by 40% since Mr Abe promised bold stimulus in November. America’s S&P 500 index and the Dow Jones industrial average are both at record levels. Frothiness is back as investors search for higher returns, whether in junk bonds, African government debt or the new “structured credit” products dreamt up by the same investment banks that sliced up mortgages in the bubble years (see article).
• Unfortunately, the effect on output has been more muted. America’s GDP is showing signs of accelerating. But Europe’s economies are flat or shrinking. Overall, rich-world growth is likely to be barely over 1% in 2013, little better than in 2012.
• Given the gap between financial froth and feeble growth, are central bankers doing the right thing? Supporters argue that cheap money is essential for economic recovery, particularly when (as in Europe and America) austerity-minded governments are tightening fiscal policy. Critics counter that low rates simply pump up asset bubbles, distort financial markets and risk inflation. The Economist is a supporter—but cheap money will work only if the medicine is administered properly and if governments change other things, too.
• The critics are right that cheap money has clearly had its biggest effect in finance, but its effect on other parts of the economy has not been as negligible as they suggest—especially in America, where households have responded to lower borrowing costs. House prices have been rising, the pace of mortgage origination is 40% higher than a year ago and consumer credit is growing: the pace of new car loans is at a six-year high.
• The link that has proved most elusive is between cheap money and corporate investment. Firms have taken advantage of the low rates to issue new debt, but they have used the cash to refinance loans or build up rainy-day funds. That may make sense for the firms concerned, but it provides a smaller boost to growth than building new factories. Businesses are still sitting on record piles of cash ($1.8 trillion in America’s listed firms alone). High share prices and low borrowing costs should eventually awaken bosses’ animal spirits. In America capital spending is accelerating. In Europe the prospects are gloomy, not only because of worries about the euro and growth but also because cheap money is regional: according to Goldman Sachs, rates for business loans in southern Europe are nearly four percentage points higher than in the north.
• That transatlantic gulf underlines the point of cheap money. It can help, but only if it is applied appropriately and with other remedies. Europe can learn from America in three ways.
• First, boldness pays. It is no accident that the most aggressive central bank (the Fed) has seen the biggest impact on spending by households and firms—nor that the most timid central bank (the ECB) has seen the weakest growth.
• Second, not all unconventional policies are equal. The Bank of England’s focus on buying government bonds helped households less than the Fed’s purchases of mortgage-backed bonds. Central banks should put their money where the problem is. In the euro area, that means reducing borrowing costs for firms in the crisis countries of the periphery.
• Third, and most important, monetary policy does not operate in a vacuum. If you simultaneously tighten fiscal policy (as Europe has done and America is now starting to do), it will soften the effect of cheap money. America has also restructured its banks far faster than Europe has, and its economy is less tightly regulated. It could certainly still use cheap money better—for instance, by boosting public investment in infrastructure, as Britain should too. But the Fed’s creativity has raised the odds of the experiment working. In Europe the combination of a timid ECB, harsh austerity and minimal structural reforms is not giving growth much of a chance.