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Beware of the Consequences of Low Growth

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Thursday, 25 May 2017 11:29 AM Current | Bio | Archive

Sadly -- and unnecessarily -- the persistent and prolonged failure to deliver higher and more inclusive growth has become a defining characteristic of the last decade in advanced economies.

The harmful effects have extended well beyond economics and finance to include worrisome institutional, political and social consequences.

Indeed, we are seeing some of these factors play out this week in the heated debate over President Donald Trump's first budget.

Without higher and more inclusive growth, the proposal is a fiscal non-starter, an institutional detractor, politically infeasible and socially destructive. Yet too much of the ongoing work on growth  seems to fail to internalize fully the five main lessons from too many years of disappointments. As such, the analysis risks being either unnecessarily fatalistic or harmfully unrealistic.

For the last 10 years, the advanced world has been stuck in a troubling low growth equilibrium -- sub-2 percent annually.

Making matters worse, the vast majority of the benefits of this already too low growth have accrued to the rich, which is worsening an alarming trifecta of income and wealth disparities and inequality.

This unusual period has taught us the first important lesson -- that advanced economies face not just cyclical headwinds, but also meaningful structural and secular ones.

Moreover, in the absence of a sense of crisis, the required policy response is hampered by the difficulties that liberal democracies with short election cycles encounter when pursuing structural reforms -- a common feature of which is that the costs are immediate while the benefits come over time.

The second lesson is that it can take an agonizingly long period for policy makers and academics -- along with an overwhelming accumulation of on-the-ground evidence -- to change mindsets, models and operating approaches. Most damaging in this regard is resistance to the notion that, with the quest for high inclusive growth extending well beyond cyclical considerations to also include structural and secular factors, advanced economies could -- and should -- derive important lessons from the experience of developed countries. Even today, economists don't have a good understanding of what has been driving the rather unusual and unexpected behavior of productivity, investment and wage determination.

Third, it turns out that low and insufficiently inclusive growth entails a range of unpleasant consequences:

  • Economically, it results not just in forgone growth today, but also downward pressure on future potential and, therefore, future prosperity.
  • Institutionally, it fuels an erosion of trust and a loss of faith in "expert opinion," while also augmenting the pressure on the very few entities (in this case, central banks) that are able to respond, albeit using imperfect tools.
  • Financially, the resulting policy experimentation -- such as ultra-low and, in Europe, negative interest rates, and large balance-sheet operations -- buys time, but does little to deal with the structural bottlenecks. Meanwhile, their prolonged use, and the resource misallocations that result, risk longer-term collateral damage and unintended consequences.
  • Socially, a growing number of people feel a mix of disillusionment, marginalization, alienation and anger.
  • The politics of anger start influencing electorates, encouraging single-issue voting and an anti-establishment sentiment that upends traditional political structures.

Fourth, it turns out that the consequences are not just national, but also regional and global.

Low and insufficiently inclusive growth places considerable pressures on regional and global economic and financial constructs, with growing risk of fragmentation, as more participants lose trust in the implicit contracts that underpin them.

This doesn't just concern Brexit and, more generally, the challenges facing both the European Union and the euro zone. It is also about an international order that gives enormous privileges to the advanced countries (the core) in exchange for the expectation of responsible management.

The core gets to issue the world's reserve currencies (thereby exchanging bits of paper for goods and services produced by others), receives other countries' outsourced savings, and has de facto veto power in multilateral institutions. But the other side of this equation -- the expectation of responsible management -- has been shaken by a global financial crisis that originated in the core, recurrent European crises, an unbalanced policy response that is overly reliant on central banks and, more recently, anti-regionalization and anti-globalization rhetoric.

With no combination of smaller advanced countries and the developed world both able and willing to replace the malfunctioning global construct, the inclination is to build pipes that both bypass and lessen exposure to the core. You can see this playing out in China with the proliferation of bilateral payments agreements, the formation of the Asian Infrastructure Investment Bank and the New Development Bank, and the ambitious One Belt/One Road initiative.

The hope is that these efforts will end up reinforcing a revitalized global order. The risk is that they will fragment it.

Fifth, and perhaps most surprisingly, financial markets have become extremely comfortable brushing off all this unusual fluidity and uncertainty. This is made possible by the availability of ample liquidity and is underpinned by three beliefs that have proven remunerative on a recurrent basis: that growth, while low, is relatively stable and, therefore, predictable; that central banks will remain both able and willing to repress bouts of instability; and that the large sidelined liquidity, including the cash held on corporate balance sheets, will eventually find its way into the marketplace.

When combined, the main consequences of these factors are to make the low-level growth equilibrium increasingly fragile and unstable over time; to take to excess the decoupling of financial markets (and risk taking) from the real economy; to weaken forces of mean reversion; to increase tipping dynamics; and to open up a larger range of extreme outcomes, and not just negative ones.

The faster all this is internalized by policy makers and academics, the quicker the realization that growth fatalism is not just the wrong answer, but is dangerous, too. This is not to say that advanced economies do not face major challenges on account of demographics and technological issues, to cite just two. They do. But an important part of the recent growth shortfall is a self-inflicted wound that we can now better analyze, understand and solve. And the need to do so is getting more and more urgent.

The longer the advanced economies delay in delivering higher and more inclusive growth, the greater the risk that their futures will include costly recessions, unsettling financial instability and even messier politics. Fortunately, as detailed in previous columns, what is holding us back is no longer an economic engineering problem. The four main elements of the solution are gaining greater acceptance. Adding to the good news is that what is required need not be a policy "big bang;" a small bang would suffice.

More than ever, the basic issue is political implementation. And the advanced world's political class is running out of time to step up to their economic governance responsibilities.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”

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Sadly -- and unnecessarily -- the persistent and prolonged failure to deliver higher and more inclusive growth has become a defining characteristic of the last decade in advanced economies.
Beware, Consequences, Low, Growth
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2017-29-25
Thursday, 25 May 2017 11:29 AM
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