Last year, the concept of secular stagnation was reintroduced into the economics lexicon as a way of explaining the lack of growth in advanced nations. Apparently, we were facing a long-term future of low growth and elevated levels of unemployment and there was not much we could do about it. Now it seems more and more commentators and economists are jumping on the bandwagon such that the concept is said to be “taking economics by storm” – see Secular Stagnation: the scary theory that’s taking economics by storm. The only problem is that it first entered the economics debate in the late 1930s when economies were still caught up in the stagnation of the Great Depression. Then like now the hypothesis is a dud. The problem in the 1930s was dramatically overcome by the onset of World War 2 as governments on both sides of the conflict increased their net spending (fiscal deficits) substantially. The commitment to full employment in the peacetime that followed maintained growth and prosperity for decades until the neo-liberal bean counters regained dominance and started to attack fiscal activism. The cure to the slow growth and high unemployment now is the same as it was then – government deficits are way to small.
What exactly is secular stagnation? Some believe it means the response of potential output to a recession, such that firms stop investing in new productive capacity as their sales fall and the lack of investment clearly undermines the future growth path of the economy. I have written about that in several blogs – most recently – The myopia of neo-liberalism and the IMF is now evident to all.
So this is a situation where aggregate supply potential contracts as a result of an initial prolonged decline in aggregate spending and the economy shrinks in terms of how fast it can grow.
Others claim that is is not so much about a supply response (capacity shrinking) but an on-going and worsening aggregate demand (spending) respond which leads to stagnation in economic growth. The examples cited are a decline in the working-age population, which allegedly undermine spending and leave the economy “facing persistent shortfalls of demand” (see Paul Krugman, What Secular Stagnation Isn’t – October 24, 2014).
In March 1939, Keynesian economist Alvin Hansen published an article – Economic Progress and Declining Population Growth – the link takes you to JSTOR if you have access. It was published in the American Economic Review, Vol 29, No. 1, pp.1-15.
Hansen was worried about the decline in population growth in the US in the 1930s, which he noted marked the end of the rapid growth in the 25 years prior to the Great Depression.
He was loath to accept the line put by the Malthusians who thought a slowdown in population growth would be beneficial because it would alleviate scarcity of resources.
Instead, conceding some truth to that argument, Hansen said:
… it would be an unwarranted optimism to deny that there are implicit in the current drastic shift from rapid expansion to cessation of population growth, serious structural maladjustments which can be avoided or mitigated only if economic policies, appropriate to the changed situation, are applied.
His main argument is that with a slowdown in population growth, would reduce the scope for “widening” the market and reduce “inventiveness”, which, in turn, would reduce “the production of wealth”.
Growth begets growth and resource scarcities are pushed ahead by new invention and discoveries. That is why he considered the arguments by David Riccardo and Thomas Malthus in the C19th about the problems of too many people to be unnecessarily pessimistic.
He was writing at a time when he considered the “main problem of our times … is the problem of full employment” or lack of it. He considered the Great Depression had spawned “the problem of full employment of our productive resources from the long- run, secular standpoint”, which required an understanding of why economies:
… tend to make business recoveries weak and anaemic and which tend to prolong and deepen the course of depressions. This is the essence of secular stagnation-sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.
And so the term – secular stagnation – was born.
His focus was on capital formation (investment in productive capacity) and the role it played in securing rising national income levels with “full employment of the productive resources and therefore the maximum income possible under the then prevailing level of technological development.”
Large investment expenditures were considered necessary for sustained growth “to fill the gap between consumption expenditures and that level of income which could be achieved were all the factors employed”.
Of-course, the investment can be private and/or public. The point is that if consumers do not want to spend all their income (and the external sector is not making up the difference), then investment spending must be sufficient to fill the shortfall. If not, sales will fall short of expectations and production will decline and unemployment will rise.
He didn’t believe the cure for stagnation in investment would come from lowering interest rates, which is the belief that most people hold.
He clearly stated that:
I venture to assert that the role of the rate of interest as a determinant of investment has occupied a place larger than it deserves in our thinking.
The clue is that firms will not invest in new productive capacity no matter how cheap the funds to engage in that investment become if they do not expect to be able to sell the extra output.
The central bank can drive the interest rate down to low levels and firms will still not borrow and spend. The similarities with the situation today are strong in this regard.
The reliance on monetary policy to get the advanced economies out of the crisis was misplaced and reflected a poor understanding of what drives national income growth. Hansen clearly knew this in 1939 as did many other Keynesian economists.
It was the classical/neo-classical economists who were unable to let go of the loanable funds doctrine, which said that saving and investment are brought into balance with interest rate adjustments. So if consumers do not want to spend they must be saving and that extra spending can come from investment if interest rates fall.
The loanable funds doctrine remains a central part of the mainstream neo-liberal economic theory and is wrong to the core.
Relating this back to population growth, Hansen argued that a declining growth rate and hence an ageing population shifts the pattern of consumer demand away from, say housing, towards personal care services. The former “calls for large capital outlays, while the demand for personal services can be met without large investment expenditures”.
In other words:
… a shift from a rapidly growing population to a stationary or declining one may so alter the composition of the final flow of consumption goods that the ratio of capital to output as a whole will tend to decline.
So without rapid technological development which spawns new investment, Hansen believed the capitalist system would find it hard to maintain full employment as the population growth rate fell.
The economy would stagnate with inadequate investment expenditure. In this sense, he opposed the view that technology created unemployment. Indeed, he argued strongly that innovation provided a spur to investment spending, which allowed economic growth to persist.
He thought that the “problem of our generation is, above all, the problem of inadequate private investment outlets. What we need is not a slowing down in the progress of science and technology, but rather an acceleration of that rate.”
His point – consistent with his Keynesian leanings – was that the market system left to its own devices would stagnate and no market forces would promote a correction. Keynes had clearly demonstrated the capacity and propensity of the capitalist system to bog down in steady-states (where there are no forces for change) which delivered persistently high mass unemployment.
Keynes showed that in instances such as this the only way out was for an external (to the market) spending injection to be made to the economy – that is, government spending, which would kickstart the private economy.
And this is exactly what happened about the time Hansen was promoting the idea of secular stagnation in 1939.
Hansen’s pessimism or worries about the market system drifting into secular stagnation were solved within the year by the onset of the Second World War and the related war expenditures.
He knew full well (in his article) that “continued governmental spending to the point of full employment” was possible but risked inflation if the growth was pushed beyond the capacity of the economy to absorb the extra spending. He acknowledged that the same argument (about the dangers of inflation) “could equally well be directed against private investment once the upper danger zone has been reached”.
The massive public spending associated with the war effort – earlier in Germany and a bit later in the allied nations, ended the Great Depression with a bang (sorry).
And as Matthew Yglesias notes in his article – Secular Stagnation: the scary theory that’s taking economics by storm – thoughts of secular stagnation were forgotten after the war. Why? He doesn’t elaborate.
But the answer is that the advanced nations understood that they could maintain full employments in peace time by ensuring that the government deficits were sufficient to fund the desire of the non-government sector overall to save (that is, not spend its total income).
Hansen also didn’t foresee the return to more robust population growth in the Post WW2 period. But economists of the day clearly understood that economic growth could be maintained by appropriate fiscal policy interventions.
Nothing has changed on that score yet economists are now talking about secular stagnation as if it is something we are helpless to remedy.
At last year’s IMF conference Lawrence Summers, presumably trying to remain relevant invoked the idea again to explain why the major economies were languishing in low growth (or still in recession as in the case of Europe) at the time.
A number of economists have jumped on the bandwagon – which is a train to nowhere when you think more clearly about the issue.
They all highlight how the ‘recovery’ from the latest crisis has been very different to previous recessions – much slower and weaker and that monetary policy seems to be ineffective despite massive bond buying programs by central banks.
As Matthew Yglesias highlights:
Even today, the unemployment rate remains on the high side even as the Federal Reserve has held interest rates near zero for much longer than anyone initially thought possible.
None of this should surprise anyone who really understands how the monetary system operates and the way in which people behave when confronted with mass unemployment and loss of income.
Hoping for a banking-led credit recovery – as central banks increased bank reserves – fundamentally misunderstood the role of reserves and the fact that banks do not lend them to consumers or firms.
Monetary policy was never going to be sufficient to resolve the spending shortfall created in the early days of the GFC.
The other major change in this recession compared to previous recessions has been the dominance of neo-liberal thinking and its eschewal of public deficits.
There are overlaps with the early days of the Great Depression when the British Treasury view dominated. Please read my blog – Macroeconomic constraints render individual action powerless – for more discussion on this point.
The cuts in wages and reliance on monetary policy then failed dramatically and the Depression deepened in most nations. It was only the massive aggregate spending boost that ended it a decade or so after it began.
While Hansen thought that population growth would drive investment necessary to keep total spending growing, we have better alternatives now that we better understand the ecological limits on growth and how many people the planet can support in a sustainable fashion.
Cities are already clogged and transport systems are failing. The last thing we want is for massive new housing investment which place people miles out of the city and reliant on cars to commute etc, in the absence of sound public transport systems.
The Washington Post (October 31, 2014) considered the secular stagnation theory – This is why the economy has fallen and it can’t get up – and recyled the graph that Lawrence Summers introduced, which shows actual real GDP growth and the various (declining) estimates of potential GDP produced by the US Congressional Budget Office as the crisis endured.
The graph is reproduced here:
The Washington Post article thinks the significance of the graph is that:
… absent a bubble or stimulus, there might never be enough demand to keep us out of a quasi-recession, or worse
And that the “secular stagnation could turn deficient demand into deficient supply” via the process of hysteresis.
The writer claims that this would occur:
… because the long-term unemployed could become unemployable, and too little investment today could create bottlenecks that prevent the economy from growing as much tomorrow.
This is only correct if we continue to rely on the private market for salvation.
I have written about this before (it was a major part of my PhD in fact). For example, most recently – The myopia of neo-liberalism and the IMF is now evident to all – for more discussion on this point.
The Washington Post author understands that the world economies:
need … more infrastructure spending, and less tut-tutting about the deficit that, unlike our anemic recovery, isn’t an urgent problem. We need to realize that just waiting for catchup growth is the new waiting for Godot—and we can’t afford for it to not show up.
Exactly, except that the fiscal deficit can never really be a problem unless the government is stupid and pushed it beyond the capacity of the economy to absorb the extra nominal spending.
The secular stagnation hypothesis only avoids being a non sequitur if we exclude the most important insight from the analysis – that the government can always spur growth through increased spending.
The secular stagnation claims are only getting oxygen because we still are caught up in the neo-liberal spell.
The long-term unemployed are not a constraint on growth if the government chooses to intervene.
While private sector investment, which is governed by profitability considerations can be insufficient (during and after a recession) to expand potential output fast enough to re-absorb the unemployed who lost their jobs in the downturn, such a situation does not apply to a currency-issuing government intent on introducing a Job Guarantee.
The point is that the introduction of a Job Guarantee job simultaneously creates the extra productive capacity required for program viability.
The spending capacity of currency-issuing governments is not constrained by expectations of future aggregate demand in the same way that pessimism erodes the spending decisions of private firms who are guided by profitability considerations.
From the research I have been involved with for many years, the majority of jobs identified as being suitable for low skill workers would be in the low capital intensity areas of work, although this would vary across the specific need areas (transport amenity; community welfare services; public health and safety; and recreation and culture etc).
The upshot is that the government has both the financial and real capacity to invest in and procure the required capital in a timely manner. Pessimism, which constrains private sector investment in productive capacity in the early days of recovery, doesn’t enter the picture.
Please read my blog – A Job Guarantee job creates the required extra productive capacity – for more discussion on this point.
It is obvious that today’s situation where the advanced economies have struggled to restore growth by relying on self-correcting market forces is the same problem Keynes and Hansen faced in the 1930s.
The cure is the same cure that was discovered with the onset of WW2 – government spending can replace reluctant private spending.
Without fiscal intervention, the private market can get stuck in equilibrium states (where all decisions are being ratified by actual outcomes) which involve very high levels of unemployment.
So firms come to expect very low growth and reduce the rate of capacity creation while consumers adopt very cautious spending patterns. The resulting output and income generation reinforces these expectations and there is no dynamic to prompt a change. Firms have enough productive capacity and the economy gets stuck in this high unemployment state.
The problem is compounded in the Eurozone because, ignoring the ridiculous fiscal constraints imposed by the Stability and Growth Pact, the Member State governments are financially constrained by the fact they use a foreign currency and the central bank (which issues that currency) is unwilling to underwrite fiscal deficits.
Currency-issuing nations are not constrained in that way at all. Its fiscal constraints are all voluntarily imposed and within the structure of the existing monetary system could be eliminated immediately.
The Eurozone constraints are inherent in the structure of their monetary system and would require some changes to the Treaty – a torturous process. A Eurozone nation would be better advised to abandon the Euro and reinstate its own currency – something it could do in a very short time period if it had the political will.
But a currency-issuing nation could immediately create stronger economic growth with a Job Guarantee followed by other spending initiatives.
The claim that slow growth is due to a secular stagnation only survives because the economics debate is captured by the neo-liberal Groupthink.
The growth would have returned more or less as usual after the downturn if governments had have expanded their deficits sufficiently and not tried to reduce them prematurely.
European governments should in almost all cases have significantly larger deficits (double or larger in some cases) to address the medium- to longer-term effects of the crisis. If the ECB guaranteed all debt issuance in the Eurozone, there would be no need for such austerity.
What all this means is that governments should do everything within their capacity to avoid recessions.
Not only does a strategy of early policy intervention avoid massive short-run income losses and the sharp rise in unemployment that accompany recession, but the longer term damage to the supply capacity of the economy and the deterioration in the quality of the labour force can also be avoided.
A national, currency-issuing government can always provide sufficient aggregate spending in a relatively short period of time to offset a collapse in non-government spending, which, if otherwise ignored, would lead to these damaging short-run and long-run consequences.
The “waiting for the market to work” approach is vastly inferior and not only ruins the lives of individuals who are forced to disproportionately endure the costs of the economic downturn, but, also undermines future prosperity for their children and later generations.
MMT and different modes of production
A note to regular readers. Some of the comments recently have been about the need to shift to socialism and abandon the destructive tendencies of capitalism. Apparently, this means that Modern Monetary Theory (MMT) somehow misses the point.
Not at all. MMT provides an understanding of how monetary systems operate irrespective of whether the means of production (capital) is privately owned (Capitalism), state owned (Socialism) or not “owned” at all (Communism).
The same issues arise – including those that we have discussed in today’s blog.
That is enough for today!
(c) Copyright 2014 William Mitchell. All Rights Reserved.