Bracing for structural recessionExpectations of a turnaround in the global economy are waning. Major economies in Europe along with Japan have taken all possible monetary easing actions including sending interest rates into negative territory, but their economies have failed to come back to life.
Several months back, there was hope that the global economy would do better this year. Those hopes have been dashed after the year started off on rocky note with routs in the stock and currency markets. Years of disappointments leading to a recession deeper and longer than many had expected raise alarms that there must be something more serious behind the stubborn lethargy of the global economy.
In 2013, former U.S. Treasury Secretary Lawrence Summers refloated the concept of secular stagnation endangering the most industrialized economies of the world during an International Monetary Fund conference to diagnosis the frustratingly slow economic recovery. He revisited a theory first put forward by economist Alvin Hansen in 1938. Hansen argued that the U.S. economy lost growth momentum and would enter a structural stagnation as it had used up all the growth ingredients with investment stagnating and population growth and territorial expansion slowing. His pessimistic theory was debunked after the U.S. economy roared back thanks to large-scale infrastructure spending under the New Deal programs and monetary expansion.
Unfortunately, Summers’ skeptical view may be true. With the world economy at its limits, growth will likely stay under the 3 percent that it maintained over the last few years. As productivity stagnates, inputs of labor and capital resources are generating little fruit. The working population is stashing away earnings for their prolonged post-retirement lives instead of spending. Savings by Germans — known to be rigorously frugal — reached a sum triple that of their gross domestic product by 2010, up from double in 1970. Aging societies are a problem not only in advanced economies but also in emerging economies including China and Latin America.
There is no incentive to invest capital with little growth momentum and an increasing propensity to avoid risk-taking. Investments in tangible assets contribute less to growth due to increasing automation and IT innovations. Even when lucrative Internet giants like Google and Facebook increase their investments, they won’t need as much capital as the traditional industries based on factories.
When investments hovers below savings, the actual interest rate becomes low. To achieve full employment, the real interest rate could be less than zero. This happens when nominal yields are below the inflation rate. Many economies in Europe and that of Japan pay real interest rates in the negative zone even with depressed inflation, suggesting their economies are already stuck in a structural recession.
There are two policy options to address the dangers of structural stagnation from reduced investment. One is monetary easing to stimulate investment. But with interest rates already so low, the policy effect remains minimal. High debt levels, poor investor and consumer confidence and a slip in the integrity of financial institutions pose added problems. Eased liquidity or poor interest yields can help encourage investment in riskier assets and inflate the asset market to mitigate excesses in savings. But this can serve the rich alone and augment volatility in the financial markets, which breeds greater danger.
The other option is to use fiscal policy to absorb some of the cash liquidity in the private sector. But governments are already up to their necks in debt after combating the 2008-2009 financial crisis. The option of the government issuing debt to have the central bank sell over-the-counter has been discussed but could be dangerous.
Talk of structural stagnation mostly refers to the advanced category of economies. But Korea, with per capita income nearing $30,000, also should be vigilant. The pace of our society’s aging and lack of growth momentum is actually more serious for Korea. Instead of resorting to short-term actions, the country must upgrade the supply-end and encourage investment through restructuring and deregulation to achieve fairer and more effective redistribution of resources. Secular stagnation can arrive silently, without the thunderous clamor of a financial crisis. Vigilance can often be a strong impetus to elicit changes for the better.
Translation by the Korea JoongAng Daily staff.
JoongAng Sunday, Mar 27, Page 19
*The author is the head researcher at LG Economic Research Institute.