The Great Economists
Page 32
Greater devolution of taxation powers to local governments decentralizes decision-making authority, which can boost investment. It has worked in Germany and China, where local banks and authorities have better knowledge of their regions. But it can also create inefficient competition among localities and generate duplicative activities that are protected by local vested interests.
Increasing private investment is needed, so clarity about policies and transparent regulations matter. As one example, some companies are deterred from making sizeable infrastructure investments, which can otherwise be attractive owing to their fixed returns, by regulatory changes. Others worry about Brexit, which adds to uncertainty over Britain’s future economic relationship with the European Union.
Increasing public investment can help to boost private investment, as government expenditure in infrastructure can have a ‘crowding in’ effect. In other words, government investment can make private investment more efficient, for example good telecoms infrastructure increases the returns to a pound invested by a private company. Yet, public investment since 1997 has averaged just 2.4 per cent of GDP, which is 1.1 percentage points below the average for the G7 advanced economies.
As mentioned before in the Keynes chapter, the debate concerns whether the government should take advantage of very low interest rates to borrow and increase public investment. Keynesians would support separating government investment from current budgetary spending because investing today will generate greater returns in the future.
It’s not just government policy, of course, that matters for investment. The Bank of England also identified misallocation of capital as a related issue. To invest, businesses need financing. It’s less of a problem for large firms, but the vast majority of the country’s businesses are small. A financial system dominated by banks that have been focused more on repairing their balance sheets than on lending is an impediment. Turning to capital markets is less easy because of the small size of Britain’s debt markets for companies. It’s an issue that the US does not face since most lending comes not from banks but from bond or stock markets, where companies issue debt or shares to raise funds. It’s also an issue for the EU, which is trying to reduce reliance on bank lending through the creation of a new Capital Markets Union that aims to promote a larger and more integrated debt market in the European Union.
There’s no question that investment is important, and it’s related to the structural issues that underpin the productivity puzzle in the UK. The topic of low wages was discussed in the Joan Robinson chapter. Lower pay means that some companies hire workers instead of installing more units of capital, which depresses investment.13
The OECD has looked at this issue and finds that weak output growth is a drag on productivity. That brings us full circle in that output per worker or machine can’t increase strongly if overall economic growth remains subdued. Importantly, wages are related to productivity. The OECD says that, because labour productivity has been ‘exceptionally weak’ since the crisis, real wages and per capita GDP or average incomes have largely been flat. So it’s not just the economy as a whole that suffers, but individuals too.
Even if concern about the recent decline in output per worker is less of one because jobs have been preserved, the longer-term trend is still a great source of worry since productivity matters for economic growth. For instance, the sustainable way for us all to enjoy higher incomes requires increasing productivity. The causes of low productivity are not entirely unknown, and the consequences affect our future standards of living. So, if the productivity puzzle has become more prominent on the policy agenda, then that helps the government to focus on what really matters for the long-term standard of living in the UK.
Solow on the slow-growth dilemma
What would Robert Solow have suggested as a solution to the slow-growth dilemma?
Ensuring that investment stays buoyant is particularly urgent after a financial crisis and recession. Solow has argued that long-run growth prospects can be affected by an economic downturn. This has been an issue for Europe for many years. He observed:
as suggested for instance by the history of the large European economies since 1979, it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience. In particular the amount and directions of capital formation is bound to be affected by the business cycle, whether through gross investment in new equipment or through the accelerated scrapping of old equipment.14
Low investment tends to follow a financial crisis in which banks were not lending and firms were not keen to invest. This can have lasting effects on the growth potential of an economy. So, business cycles, which are considered to be short- or medium-run events, can alter the long-term prospects of an economy. This was seen in Japan after its early 1990s crash and is now a worry in the aftermath of the 2008 financial crisis for the US, UK, the euro area and other developed economies.
Solow also points out that related high unemployment, which is an issue for the euro area after the 2010 crisis that erupted with a bailout for Greece, can have an impact on an economy’s future as joblessness could cause it to be stuck on a lower growth path for a long time: ‘I am also inclined to believe that the segmentation of the labor market by occupation, industry and region, with varying amounts of unemployment from one segment to another, will also react back on the equilibrium path.’15
This is the well-known concept of hysteresis, whereby long stints in unemployment render workers’ skills obsolete. It impedes them from rejoining the labour market and thus reduces the number of productive workers, meaning that unemployment will remain higher than before the crisis and hurt the country’s growth potential. The lingering high rates of unemployment in the euro area, particularly youth unemployment, which has been in double digits in some countries for nearly a decade, highlight this concern of Solow’s. Workers are crucially important in economic growth models, as they are not just the labourers but also the innovators.
Thus, Solow would most likely agree that more investment to boost growth is needed. In his model, technological progress, the crucial ingredient in economic growth, could be impeded through low investment: ‘much technological progress, maybe most of it, could find its way into actual production only with the use of new and different capital equipment. Therefore the effectiveness of innovation in increasing output would be paced by the rate of gross investment.’16
Reversing the decline in investment, especially since the 2008 crisis, takes on a new urgency, since as Solow observed: ‘the way remains open for a reasonable person to believe that the stimulation of investment will favor faster intermediate-run growth through its effect on the transfer of technology from laboratory to factory’.17
In short, whether we face a slow-growth future depends on increasing investment and decreasing unemployment, because both of these factors affect the innovation and technology improvements that underpin economic growth, as per Solow’s model. Since technology determines the prospects of an economy, how much is invested in capital and people matters a great deal. Those productive factors determine how innovative an economy can be, and thus its economic future, or its new equilibrium path. In Solow’s view:
The new equilibrium path will depend on the amount of capital accumulation that has taken place during the period of disequilibrium, and probably also on the amount of unemployment, especially long-term unemployment, that has been experienced. Even the level of technology may be different, if technological change is endogenous [determined by the amount of capital and workers in the economy] rather than arbitrary [where innovations happen from time to time in a less deterministic way].18
The new path of economic growth, whether it is fast or slow, is within the control of the government and shaped by the decisions of firms and workers, so it is not just the inevitable outcome of an ageing society or other factors. Some of Japan’s economic stagnation is thought to be related to its demographics since its population is th
e oldest and fastest ageing in the world. Its heavy investment in robotics is perhaps one way of using technology to supplement a shrinking workforce. Instead of workers producing output, they may be substituted by robots producing that output. But that also raises the prospect that robots will lead to unemployment in certain sectors. Automated production of goods and services might just be used to replace retiring workers, but it could force some out of a job too.
Solow would view the possibility that we face a slow-growth future as depending on how investment and workers fare, since they determine the productivity growth of the economy. Investment by governments (which hinges on the austerity debate from the earlier chapter on Keynes) or private firms can help restore the capital stock that has plummeted since the crisis which would help to reduce the likelihood of a slow-growth future. Government can make it more attractive to invest by providing tax incentives to promote innovation or improve infrastructure. So long as investment can be increased, then Solow would not view a slow-growth future as inevitable. His model is based on growth deriving from capital accumulated through investment and productive workers, so policies to support both of those factors of production would generate more output.
It’s challenging, as seen in Japan, and some factors like demographics are difficult to alter, but the above suggestions can help and the advent of new technologies could be game changing. Solow would probably view the debate over whether the technologies of the digital era are as productive as the steam engine or electrification of the earlier industrial revolutions as being related to investment. If the computer age is to increase productivity and so lead to a stronger phase of economic growth, it will require investment in not just R&D but also people’s skills and firms’ practices to embed those technologies into how businesses operate.
The basic tenets of Robert Solow’s model of economic growth point the way forward. As the saying goes, demography is not destiny. After all, as I write this, Solow is an active economist working well into his nineties.
Robert Solow is not only a scholar but also understands the importance of contributing to public discussions of economic issues. He once wrote an essay entitled ‘How Economic Ideas Turn to Mush’. He observed that it was challenging to convey complicated ideas outside one’s profession. Once an economic idea reaches the public, it has been changed in one way or another.19 Solow offers this advice to economists:
Try to formulate an economic problem in a very clear, focused way. Try to answer one question at a time, and insist on that. And above all – this is really what’s difficult – at least I know that I tend to forget it: Don’t omit qualifications. Never claim more than you actually believe or can justify. What makes that hard is that what people want – especially if they’re being fed it in sound bites on a television program or in a two-sentence quotation in The Wall Street Journal – what they want is something very definite. They don’t ever want those qualifications. And you must never let them off that hook. The interesting thing is that I think it’s useful. An economist trying to talk to the general public gains respect by insisting on the qualifications, by not appearing as a pundit, as someone who knows all the answers.20
Solow may also be one of the few academics who appreciates the importance of work–life balance. Each summer he decamps to Martha’s Vineyard, a popular seaside retreat for those living in Massachusetts, where he works on his research and also sails.21 He had spent some of his million-dollar Nobel Prize money on a jib for his boat. Even in his leisurely pursuits, Solow sees parallels with the life of an economist:
Apart from the activity itself, the main thing I like about sailing is that it teaches you that the water and the wind out there don’t give a damn about you. They’re doing whatever the laws of physics tell them to do and your problem is to adjust as best you can. And learning to adjust, to adapt, is not a bad thing for economists to learn either: Adapt to changes in the world … You’ve got to fit your model to the world, not the world to your model.22
Epilogue: The Future of Globalization
Economic prosperity has been linked to globalization. The rapid global economic growth of the post-war period was accompanied by the fast expansion of international trade and investment. As we buy goods and access information, often without regard to national borders, it’s unlikely that globalization will be rolled back. But trade expansion and the opening up of markets are stalling. The global trade system covering nearly all nations’ exports and imports under the World Trade Organization (WTO) is fragmenting into a set of accompanying regional and bilateral free trade agreements. This colossal challenge to the future of globalization and the growth of the world economy would benefit from the ideas of the Great Economists.
A couple of dramatic events in the past few years have highlighted a backlash against the uneven gains from globalization. Although there are numerous differences between Britain’s decision to leave the European Union and the ascendancy of political outsider Donald Trump to the White House, the two events reveal a number of things about the electorate’s discontent with the status quo, including globalization.
In a historic referendum in June 2016, Britain became the first sovereign nation to vote to leave the European Union. Some of the surveys of voters suggest that a backlash against globalization played a role in Brexit, alongside dominant themes such as sovereignty and immigration. The UK government has insisted that Britain will maintain its global outlook, which will constitute a different set of policies than its current trading relationships with EU and non-EU countries, and will certainly be important to future prosperity.
Across the Atlantic, in the closely fought 2016 US presidential election, Republican candidate Trump had identified international trade as one of the problems confronting America that he would fix in order to ‘Make America Great Again’. In his inauguration speech, Trump made it clear that, in his administration, economic policy would be driven by the principle of ‘America First’. He said it means there are two rules: ‘Buy American, Hire American’. Of course, as in Britain, the disaffection of the US electorate is not just with trade. But the targeting of globalization in response to economic challenges reflects an underlying discontent with the uneven benefits from opening up to the global economy. Populism fuelling anti-establishment sentiment poses a challenge to current economic policies.
Trump’s predecessor, Barack Obama, attributes some of the discontent to globalization:
Globalization combined with technology combined with social media and constant information have disrupted people’s lives in very concrete ways – a manufacturing plant closes and suddenly an entire town no longer has what was the primary source of employment – and people are less certain of their national identities or their place in the world … There is no doubt [this] has produced populist movements both from the left and the right in many countries in Europe … When you see a Donald Trump and a Bernie Sanders – very unconventional candidates who had considerable success – then obviously there is something there that is being tapped into: a suspicion of globalization, a desire to rein in its excesses, a suspicion of elites and governing institutions that people feel may not be responsive to their immediate needs.1
So, is globalization in trouble? What would the Great Economists make of this backlash against it? And, most importantly, what would they advise to best help the losers from it?
The changing face of free trade
There has been a shift away from multilateral trade deals that apply to all WTO members, which encompass the near totality of trading nations. There is still a push for free trade agreements that reduce tariffs, and to adopt other measures to ease trade and investment, but these are increasingly in the form of regional and bilateral trade agreements. Europe has trade and customs agreements either agreed or pending with some eighty countries, all but a handful of them with other WTO members, which reflects the importance of continued liberalization and opening up of overseas markets for trade beyond the current coverage of the WTO.
Let’s remind ourselves what tariffs encompass and why they are economically inefficient. Tariffs are the charges that governments impose on imports and exports. They are effectively a tax, so can distort prices. Because tariffs add a cost, and thus reduce economic efficiency, they can be a drag on growth. Free trade agreements (FTAs) such as the EU’s single market, aim to eliminate most of them. But, a number of governments use tariffs to protect their industries from competition from bigger global rivals until they are more mature. Labour groups also want protection for domestic jobs. So, tariffs are more than just an economic decision to impose a tax. There are often political motives behind their imposition.
There are also non-tariff barriers (NTBs) to add to the mix. These are the other ways to be protectionist without imposing tariffs, such as through insisting on standards for certain industries that can restrict imports. For instance, Thai prawn exporters found it hard to meet American standards for the type of net that allowed them to sell to the US. Regulations matter even more for the services sector, which is the biggest part of the British, American and most other major economies. This is the main reason for the push by the EU for an international agreement on services. The Trade in Services Agreement (TiSA) has the potential of opening up the biggest part of the global economy and becoming a major element of the next big round of multilateral trade liberalization under the WTO. TiSA was launched in 2013 and attempts to open up the services market, which comprises 70 per cent of global and EU GDP but only 25 per cent of world and EU exports. In other words, trade in goods may have been liberalized under the current WTO regime, but for major economies the biggest part of their national output, which is services, faces barriers in global markets.