Sun sets on decades of high growth in US, Europe & Asia
In recent days we have had data which show weak late 2015 growth or shrinkage in the Euro Area and Japan, while last month it was reported that the US economy grew at an annualised rate of 0.7% in the final three months of the 2015. Coupled with the economic woes in emerging markets led by China, the prospect of persistent slower long-term growth rather than no growth in many significant countries, is rising.
Despite very low oil prices; interest rates as low as in Babylonian times 5,000 years ago, and massive bond buying by the central banks of the Euro Area and Japan to push down the values of their currencies and domestic interest rates, following similar monetary easing in the US, the global economy remains on a respirator. This bleak situation is nine years this month after HSBC bank announced multi-billion dollar losses from sub-prime mortgage lending in the United States — Finfacts report, Feb 2007.
On Monday Mario Draghi, president of the European Central Bank, gave a broad hint to a committee of the European Parliament in Brussels, that additional stimulus measures will be announced next month. “The ECB is ready to do its part,” he said.
In Tokyo Shinzo Abe, Japan's prime minister, warned that pension benefit payments could be reduced if investment losses grow at the Government Pension Investment Fund. Also on Monday Japan reported that growth for the full year of 2015 was 0.4%, following a year of zero growth in 2014. Price rises are close to zero compared with the central bank's target of 2%.
The Financial Times says that Japan’s potential growth rate remains so low — around or slightly below 0.5%, according to the Bank of Japan’s estimate — that any setback has the potential to tip the country into recession.
Thomas Hobbes (1588–1679), the English philosopher, wrote in 'Leviathan' of "continual fear and danger of violent death, and the life of man solitary, poor, nasty, brutish, and short." However, a century after Hobbes' death, the Industrial Revolution was taking off in England and in 1798 Thomas Malthus (1766-1834) in a 1798 essay warned that unchecked population growth would be catastrophic. The estimated global population in 1800 was 1 billion, now it is over 7 billion.
While sustained high economic growth is a recent phenomenon in the history of humanity, there is no inevitability that apart from war situations, one generation will enjoy a standard of living better than the one that preceded it.
According to The Economist, in the 43 years leading up to 1914, GDP (gross domestic product) in Argentina had grown at an annual rate of 6%, the fastest recorded in the world. In 1914 half of Buenos Aires’s population was foreign-born and the country ranked among the ten richest in the world, after the likes of Australia, the UK and the United States, but ahead of France, Germany and Italy. Its income per head was 92% of the average of 16 rich economies.
In Europe's so-called Golden Age of growth in 1950-1973, Greece was the star performer growing at an annual compound rate of 6.2% and both West Germany and Italy grew at a 5% rate.
The comparable rates for the US and UK were 2.4% and 2.5%.
From 1974 after an Arab oil embargo, the quadrupling of oil prices, and the shock of double-digit price inflation, several European countries lost control of their public finances. Italy has run an annual public deficit every year since 1945. In 1978 Ireland posted the biggest budget deficit of a developed country in the period 1970-2008, France's last surplus was in 1974 and the UK got an IMF bailout in 1976.
Last month Ben Leubsdorf of The Wall Street Journal wrote on the US economy:
The broadest measure of goods and services produced across the US economy, gross domestic product, exhibits ups and downs but on average has expanded at an inflation-adjusted annual pace of 2.2% since the recession ended in mid-2009, far below its 3.6% average during the second half of the 20th century, according to Commerce Department data.
“Some have suggested that a 2% growth rate is and will be the new normal for the economy,” said Sen. Dan Coats (R., Ind.) on 3 December when Fed chairwoman Janet Yellen testified before the Joint Economic Committee, of which he is chairman. “All of us should view these low economic expectations as unacceptable.”
But basic building blocks of sustained stronger growth are missing, at least for now. Productivity growth has slowed to a crawl since its information-technology-fueled surge more than a decade ago and an ageing population will mean slower workforce growth in the coming years. Fed officials this year stopped predicting growth would accelerate toward or beyond 3% in the near future, and most in December forecasted that growth will hover around 2% in the long run.
The Journal has noted that even though growth is slow, the expansion has lasted since June 2009 and the longest expansion before a recession hit lasted 120 months!
Noah Smith, an assistant professor of finance at Stony Brook University, writes that real GDP per capita rose at a 2.2% annualised rate between 1947 and 2000, and at a 1.4% rate since the end of the recession. Slower population growth, therefore, accounts for almost half of the growth slowdown.
Prof Charles Jones of the Stanford Graduate School of Business, wrote in a December 2015 paper:
For nearly 150 years, GDP per person in the US economy has grown at a remarkably steady average rate of around 2% per year. Starting at around $3,000 in 1870, per capita GDP rose to more than $50,000 by 2014, a nearly 17-fold increase.
The New York Times reported in September 2014 that:
Until around 1999, overall economic growth tended to correspond with growth in earnings for middle-income Americans. Since then, the two have diverged sharply.
The American Enterprise Institute says that the stagnant US median household income maybe explained by the trend in recent decades of an increasing share of no-earner, single-parent and single-earner households and a decreasing share of married and two-or-more-earner households. That major demographic shift has likely depressed median household income significantly in the last decade, even though it’s possible...that the income of individual working Americans could be rising.
In 2011 Moody's Analytics, the economics consultancy unit of the eponymous ratings agency, published data which showed that the richest 5% of Americans were responsible for 37% of consumer outlays in 2010
Finfacts wrote in 2009 that according to the late eminent economic historian, Angus Maddison (1926-2010), until 1800, about three fifths of the world’s commerce and production took place in and around China and India. So did much of the world’s scientific and technological progress, including the Chinese invention of paper, explosives, and printing, and medieval India’s launch of modern mathematics. In the early 1830s, when President Andrew Jackson sent the first US envoy across the Pacific to Siam (Thailand), Asia still accounted for over half of global GDP (gross domestic product).
China's Qing dynasty was overthrown after 267 years in power by a republican revolution in 1911. It was a colonial power with the Manchus from northeast China ruling the majority Han people. Technological advances stalled and in 1793, the emperor rejected the request of a British delegation led by George Macartney, an Irishman, to open diplomatic relations with the British.
Emperor Qianlong in a letter to King George III said:
We possess all things. I set no value on objects strange or ingenious, and I have no use for your country’s manufactures.
In 1978 China decided to launch economic reforms to open up its economy to foreign investment and average annual growth in 1979-2014 was about 10%.
In 1990, before economic reforms took hold, China accounted for a mere 3% of global manufacturing. In 2013, the value of China’s manufacturing on a gross value added basis was 35.1% higher than that in the United States. The US Congressional Research Service says that manufacturing plays a considerably more important role in the Chinese economy than it does for the United States and Japan. Also in 2013, China’s gross valued added manufacturing was equal to 28.9% of GDP, compared to 12.1% for the United States and 18.7% for Japan.
China was the world's leading manufacturer for about 1,800 years up to about 1840, when Britain became the world’s biggest manufacturer after its Industrial Revolution.
Prof Maddison's research showed that from the early 1500s until the early 1800s, China’s economy was the world’s largest. By 1820, it was one-fifth again as big as Europe’s and accounted for a third of world gross domestic product (GDP). But the next two centuries were tumultuous for China. The country experienced catastrophic decline between 1820 and 1950 and then, starting in 1978, a meteoric rise. Today, China is once again among the biggest economies of the world, having overtaken Japan in 2010.
In recent decades Chinese demand for commodities and its supply of manufactured goods has had a huge impact on other developing countries and western economies — in the latter helping to reduce inflation.
China is estimated to have used more cement between 2010 and 2013 than the US did in the entire 20th century.
As China rose, Japan faltered from the early 1990s after a huge property/banking boom and bust — while Japan's annual per capita growth of 1.6% in 2001-2010 compared with UK's 1.2%; Germany's 0.8%; US 0.7% and France's 0.6%, based on HSBC data, looks good, it masks a grim situation for about 40% of the workforce where there is no job security and years of no pay rises.
Demography and technology
Robert J. Gordon, a professor in the social sciences at Northwestern University, says that slowing real (inflation adjusted) GDP growth matters both because of its direct impact on the standard of living and also because of its indirect effect on net investment, which in turn feeds back to slower productivity growth. During the decade ending in 2014, US real GDP grew at only 1.55% per year, almost exactly half the growth rate of 3.12% per year achieved during the previous three decades, 1974-2004, and an even smaller fraction of the 3.62% per year performance of 1929-1974.
In his recently published book, 'The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War,' Gordon says America experienced an economic and technical revolution in the century after the Civil War. Electric lighting, indoor plumbing, home appliances, motor vehicles, air travel, air conditioning, and television transformed households and workplaces. With medical advances, life expectancy between 1870 and 1970 grew from forty-five to seventy-two years.
Gordon says that the life-altering scale of innovations between 1870 and 1970 can't be repeated and contends that American productivity growth, which has already slowed to a crawl, will be further held back by the vexing headwinds of rising inequality, stagnating education, an aging population, and the rising debt of college students and the federal government. He warns that the younger generation may be the first in American history that fails to exceed their parents' standard of living, and that rather than depend on the great advances of the past, we must find new solutions to overcome the challenges facing us.
Larry Summers, Harvard economist, and former Clinton Treasury secretary, comments in a review:
While as already noted, I find Gordon persuasive in his claim that the slowdown in productivity growth is not a figment of mis-measurement, the fact that measured median incomes will be stagnant does not mean that most people will not see rising standards of living over time. Incomes rise as people get further into their careers. And quality improvements and new products are improving life in ways that do not show up in economic statistics, though possibly less so than in the past. So it would be a mistake to regard our children as condemned to economic stasis even before considering Gordon’s various ideas for accelerating growth.
Economic frustration is a central challenge of our time. It is surely intimately connected with political dysfunction, loss of faith in institutions and much else. Like most things, it is best viewed with historical perspective. There is no better way to get that perspective than by reading Robert Gordon’s landmark work.
Larry Summers said last year that the strongest explanation for the current combination of slow growth, expected low inflation and zero real rates is the secular stagnation hypothesis.
It holds that a combination of high rates of saving, lower investment and increased risk aversion depresses the real interest rates that accompany full employment. The result is that the zero lower bound on nominal rates becomes constraining.
There are four contributing factors that lead to much lower normal real rates. First, increases in inequality — the share of income going to capital and in corporate retained earnings — raise the propensity to save.
Second, an expectation that growth will slow due to smaller labour force growth and slower increases in productivity reduces investment and boosts the incentives to save.
Third, increased friction in financial intermediation caused by more extensive regulation and increased uncertainty discourages investment.
Fourth, reductions in the price of capital goods and in the quantity of physical capital needed to operate a business — think of Facebook having over five times the market value of GM.
Ruchir Sharma, an emerging markets manager at Morgan Stanley, the US investment bank, in the current issue of 'Foreign Affairs' writes that the implications of ageing for the world economy are clear: a one-percentage-point decline in the population growth rate will eventually reduce the economic growth rate by roughly a percentage point:
Between 1960 and 2005, the global labour force grew at an average of 1.8% per year, but since 2005, the rate has downshifted to just 1.1%, and it will likely slip further in the coming decades as fertility rates continue to decline in most parts of the world. The labour force is still growing rapidly in Nigeria, the Philippines, and a few other countries. But it is growing very slowly in the United States — at 0.5% per year over the past decade, compared with 1.7% from 1960 to 2005 — and is already shrinking in some countries, such as China and Germany.
The implications for the world economy are clear: a one-percentage-point decline in the population growth rate will eventually reduce the economic growth rate by roughly a percentage point. [ ] I looked at population trends in the 56 cases since 1960 in which a country sustained economic growth of at least six percent for a decade or more. On average, the working-age population grew at 2.7% during these booms, suggesting that explosions in the number of workers deserve a great deal of the credit for economic miracles. This connection has played out in dozens of cases, from Brazil in the 1960s and 1970s to Malaysia in the 1960s through the 1990s.
Sharma says a 2% working-age population growth rate is a good benchmark as in three-quarters of the 56 cases, the working-age population grew faster than that average during the duration of the economic boom.
Over the next five years, the working-age population growth rate will likely dip below the 2% threshold in all the major emerging economies. In Brazil, India, Indonesia, and Mexico, it is expected to fall to 1.5% or less. And in China, Poland, Russia, and Thailand, the working-age population is expected to shrink.
Both China's and India's recently published GDP data are subject to scepticism but India with less of a demographic challenge has deindustrialised prematurely according to Prof Dani Rodrik, a Harvard expert on globlaisation. He says that as developed economies have substituted away from manufacturing towards services, so too have developing countries — to an even greater extent. Such sectoral change may be premature for economies that never fully industrialised in the first place.
Industrialisation shaped the modern world in ways beyond economic. It fostered urbanisation and the creation of new social categories and habits. It created a working class and a capitalist class, trade unions, and political movements that challenged the dominance of traditional agrarian elites. These social and political developments bequeathed us today’s modern states, based on mass franchise and (regulated) market economies.
China is no longer a global economic stabiliser and with its massive infrastructural program almost complete, many countries will not see a return to the days of high commodity exports.
Christine Lagarde, IMF managing director, said in a speech on 4 February:
As a group, emerging and developing economies now account for almost 60% of global GDP, up from just under half only a decade ago. They contributed more than 80% of global growth since the 2008 financial crisis, helping to save many jobs in advanced economies, too. And they have been the main driver behind the significant reduction in global poverty.
China alone has lifted more than 600m people out of poverty over the past three decades.
After years of success, however, emerging markets — as a group — are now facing a new, harsh reality. Growth rates are down, capital flows have reversed, and medium-term prospects have deteriorated sharply. Last year, for example, emerging markets saw an estimated $531 billion in net capital outflows, compared with $48 billion in net inflows in 2014.
Lagarde called for stimulus spending by developed countries that have budgetary flexibility, encouragement of FDI (foreign direct investment) and maintenance of low interest rates...but what if for example more spending on infrastructure in the European Union like bond-buying is only a short-term fix in the face of stronger long-term global headwinds?
Extracts from Robert Gordon's book: