The global economy is performing well below its potential on growth and on distribution because of three mismatches:
- Between aggregate demand and aggregate supply;
- Between investment needs and investible funds; and
- Between the promise and the pitfalls of technological change.
First, aggregate demand is deficient relative to aggregate supply. When looking at output gaps, as the IMF has done, the picture is one of persistent underperformance of the global economy, seen to be in the range of 1.5% to 2% of GDP more than five years after the Great Recession (IMF 2015, Zhu 2015). Indeed, growth in emerging market economies has now slowed as well, led by falling commodity prices and a slowdown in world trade. Some, namely those with fiscal space, have resorted to bolstering domestic demand, often favouring consumption over investment, while others without this possibility face the choice of either low growth or larger deficits that affect the debt sustainability outlook, especially if interest rates rise from their unnaturally low levels.
Second, huge investment needs, especially in the rapidly urbanising emerging and developing economies, are going unmet in the face of exorbitantly large pools of liquidity, much earning suboptimal returns. The holdings of pension funds, sovereign wealth funds, and asset management funds are estimated by some to exceed $60 trillion, or almost as much as global GDP (Blaine 2014). Beyond project risks lie the regulatory and institutional risks that limit investments in, for instance, Africa – where the World Bank estimated the investments gaps at close to $100 billion (World Bank 2010). With yields low since 2009 and yield curves that are relatively flat, long-term finance should be readily available, were risks to be more manageable.
Third, the promise of new and disruptive technology to raise overall productivity comes with the challenge of labour displacement and concentration of the gains in fewer hands. The outlook for transformative technologies is very bright according to those who monitor these developments closely (see McKinsey Global Institute 2015). These technologies can improve lives everywhere and economise on the earth’s resources. However, the current speed and scope of automation is indeed alarming (Frey and Osborne 2013), though others have offered tempered views (Autor 2014). The speed with which routine (codifiable) jobs are being destroyed is presently exceeding the rate of new job creation. This trend, noted by some in the aftermath of the financial crisis (Boeri and Garibaldi 2012), seems to be persistent in the advanced economies. The consequences of automation on and distribution inequality have been well documented (Autor 2014), leading to fiscal strains and social discontent. The challenge is how best to manage and navigate the transition, which can be quite long.
Our recent work
As we outline in a recent White Paper (Spence et al. 2015), the challenges represented by these mismatches intersect and interact, and play out differently in the short, medium and long term. One normally thinks of aggregate demand deficiency as a short-term challenge of the business cycle, but the current mismatch at the global level has lasted more than seven years since the start of the 2008 Crisis. A low level of aggregate demand inhibits investment, which is the foundation of increases in medium-term production potential of the world economy. The unbridged gap between investment needs and sources of finance also lowers investment, which in turn lowers aggregate demand in another twist of the spiral, contributing to slower growth now and headwinds for productivity in the medium and longer term. Deficient labour demand, as the result of weak aggregate demand overall, either lowers wages or causes unemployment if wages are rigid — worsening the distribution of income in either case. This trend towards greater inequality will only worsen as the consequence of long-run trends in labour-displacing technologies. While over the long run these trends can be beneficial, labour displacement and increased returns to capital and skill will sharpen income inequality. Greater income inequality can further exacerbate aggregate demand deficiency and lower economic growth performance (Ostry et al. 2014).
These three self-reinforcing mismatches are an indication not only of market failure, but also of the failure of governments to address the challenges they pose. We believe that concerted public action is needed on at least three fronts to improve the performance of the global economy on growth and on distribution.
First, global aggregate demand must be expanded. However, there has been little appetite for use of fiscal stimulus as a demand lever. In part, this lack of action reflects political stalemates (the case of the US), while in other parts of the advanced world it reflects unprecedented high debt levels. However, if the global economy were a firm with excessive debt levels but brighter prospects, and given very low interest rates, we would expect to see debt restructuring programmes to lower debt levels and revitalise growth. In our view, there seems to be an excessive focus on certain macroeconomic indicators, such as the debt-to-GDP ratio, which is especially misleading when the denominator is performing poorly. The weaknesses in fiscal accounts emerging after the financial crisis of 2009–2010 were more a result of declining tax revenue than of countercyclical spending sprees (Arbatli et al. 2014). Individual countries must, of course, look at their respective tax systems, including tax take and tax avoidance, as well as the balance between government consumption and government investment. Breaking with tradition, the IMF (2015) has urged countries in a reasonable debt position to spend more on infrastructure. Recent ‘multiplier evidence’ from the IMF points to the extremely positive effect of infrastructure spending in advanced economies to spur growth, especially when output gaps are large and there is excess capacity in many economies, as is the case today. Recent evidence shows that the multiplier from additional fiscal stimulus would be significant for the global economy, especially if coordinated in the way the G20 coordinated stimulus packages that were undertaken in 2008–2009 (see IMF 2014).
Second, the gap between the excessively large pools of capital and the huge unmet infrastructure needs must be bridged. A central question is one of risk mitigation, in which case we need to look at the role of governments and multilateral mechanisms in fostering the recycling of surplus capital. Market participants point to the excess demand for debt issues that carry risk mitigation features, such as bonds that involve the World Bank and other multilaterals. Thus, an underused mechanism has to be expanding and leveraging the balance sheets of multilateral development banks and using their ability to objectively undertake project analysis that would identify bankable projects for private investors. The Juncker Plan has expanded the role of the European Investment Bank into the market for investment lending. The Chinese-inspired Asian Infrastructure Investment Bank seeks to remedy the market failure of inadequate investment in cases of seemingly high potential returns. Since there is a large number of bankable projects, one has to question whether the international community has done enough to mobilise funds for investment, especially in emerging markets and developing economies, and whether multilateral institutions are using their balance sheets aggressively enough, or indeed whether their balance sheets are large enough. In this vein, we note that the Global Infrastructure Facility entrusted to the World Bank Group is too small and that talk of new sources of climate financing are still incipient (World Bank 2015).
Third, the distributional downside of rapid technological advances and global integration must be addressed by putting in place mechanisms that ensure wider and intergenerational sharing of the benefits of productivity increases. Whether the labour-displacing consequences of new technologies push for lower wages or unemployment, concentration of the gains in a few hands may not only be ethically objectionable, but it is also socially unsustainable (Commission on Growth and Development 2008). A core medium-term growth strategy must be to improve the distribution of human capital by building up the education and health of low-income households. Comprehensive and active labour market policies, including retraining, can help. In addition, directly targeted policies are needed that enhance productivity, especially in small-scale enterprises in developing countries, which are the mainstay of employment for large numbers of poor people (Kanbur 2014). The experience of Latin America in keeping inequality in check offers important lessons for the rest of the world. A combination of supply-side policies in education, better integration of labour markets through infrastructure, and cash transfers conditional on keeping children in school led to falling inequality over a decade and a half, in the face of the same technological and globalisation trends which raised inequality elsewhere in the world (Lustig et al. 2011). While clearly part of a medium-term strategy, if these approaches succeed they will also boost aggregate demand as income is redistributed towards the higher-consuming bottom end of the scale.
These three areas of concerted public action — boosting global demand (with an emphasis on investment and essential services), unblocking the flow of surplus funds towards unmet investment needs, and mitigating rising inequality — are mutually reinforcing. The analytical arguments behind them are strong. Public policy solutions are possible to deal with many economic challenges if political consensus can be achieved on tackling them, both nationally and globally. What is needed is global vision and political will that can make them a reality and thus restart the global economy so it can meet its potential on growth and on distribution (Spence et al. 2015).
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