May 11, 2016
In a recent article aptly titled, “The Global Growth Funk,” Nouriel Roubini does what he does best: makes the case that the global economy is going to hell in a handbasket, and there is little that can be done about it. This is how he earned the nickname “Dr. Doom.” There is much to agree and disagree with in his analysis. But I think there is some overreach here, and some overdeterminism.
One of these is a technical point, but it’s important. Roubini writes:
Moreover, a protracted cyclical slump can lead to lower trend growth. Economists call this “hysteresis”: Long-term unemployment erodes workers’ skills and human capital; and, because innovation is embedded in new capital goods, low investment leads to permanently lower productivity growth.
This is true, and it is one of the most tragic results of the European authorities’ forced austerity and unnecessary prolongation of financial crisis (from 2010 through most of 2012). This is what gave Spain the 20 percent unemployment and 45 percent youth unemployment that it still has today, and even worse unemployment for Greece. Because of very bad policy choices, driven in large part by a political agenda, Europe has an unemployment rate today that is twice the level of the United States.
But as for “permanently lower productivity growth,” there is still a question of how much lower and how permanent? The IMF forecasts that Spain will have unemployment of 16.4 percent in 2019; at the same time, the Fund estimates that Spain will be above its potential GDP in 2019. This means that Spain will have reached “full employment” with more than 16 percent of its labor force unemployed. Similarly, the IMF projects Greece to have unemployment of 18.9 percent in 2020; but the economy will be running at just 1.2 percent below its potential GDP.
These estimates do not make a lot of sense, and they should not be accepted. As shownhere, there are a number of reasons not to believe IMF estimates of potential GDP, including the ones that are revised downward in the past. These include the methodology by which they are constructed, as well as their plausibility.
Roubini also seems to accept some of the implications, which are prevalent in IMF papers, that “structural reforms” are necessary to return to higher growth rates.
[W]ith so many factors dragging down potential growth, structural reforms are needed to boost potential growth. But such reforms are occurring at suboptimal rates in both advanced and emerging economies ….
While some of the structural reforms that the IMF has supported are reasonable, e.g., more competition in pharmaceuticals or a better tax collection system in Greece, the most important ones tend to be dubious or even harmful: e.g legal changes in Spain that reduce the bargaining power of unions, cuts in pensions, health care spending, and government employment.
The world economy is indeed slowing and there are many downside risks. But most of the headwinds have obvious solutions, including expansionary fiscal policy in the rich countries that make up most of the world economy. Former Treasury Secretary Larry Summers, not known for being a radical, had this to say last year, even before the IMF lowered its forecast for the world economy:
The central banks of Europe and Japan need to be clear that their biggest risk is a further slowdown. They must indicate a willingness to be creative in the use of the tools at their disposal. With bond yields well below 1 per cent it is very doubtful that traditional QE will have much stimulative effect. They must be prepared to consider support for assets that carry risk premiums that can be meaningfully reduced. They could achieve even more by absorbing bonds to finance fiscal expansion.
The last sentence refers to central banks creating money for expansionary fiscal policy. This is not only costless at present, but adds nothing to the net debt burden of the government for the future, since — as in the U.S. — interest payments on loans made by the central bank are returned to the Treasury.
When we talk about the slowdown of the world economy, this is where we should be looking: to the obvious, simplest solutions.