The Main Issues of the Secular Stagnation Debate

It has been some years since the financial crisis of 2007–08 and subsequent recession, yet the recovery of economic growth is still anemic relative to the years leading up to the crises. The gap between potential GDP and real GDP has closed, but only because potential GDP estimates have been continually revised downward. Despite years of near-zero interest rates, real gross domestic investment growth continues fall since its initial recovery in 2010 (see Figure 1). However, identification of these trends have been pinpointed as occurring before the financial crisis. According to Summers (2015), looking back to 2003–2007 “no one will argue that performance was extraordinary” despite low interest rates, and prior to that the “2001 recession required a near brush with the zero bound.” Data presented by Kotz and Basu (2016) indicate a declining annual growth rate of GDP averaging between 4 and 5 percent, but falling precipitously since the early 1990s.

Figure 1: Real Gross Private Domestic Investment

Concerns about these trends have given rise to a working theory within mainstream economics called secular stagnation. The term was originally coined by Alvin Hansen (1939), but was recently revived by Larry Summers in a 2013 speech to the IMF. The argument from the former Treasury secretary and others is that secular stagnation is a chronic disease for which symptoms have been obfuscated until now due asset bubbles, e.g. dotcom and housing bubble. Summers and other New Keynesian economists have framed the debate around interest rate policy, maintaining that the equilibrium between saving and investment is now below the zero lower bound; meaning that negative real interest rates are needed to get the economy back to full employment. This in effect makes the zero lower bound a real constraint for the Fed to revive the economy on its own.

So what’s the cause? There are many hypotheses. The main driver is a persistent deficit of demand. There has been a disturbing reflectance by businesses to invest. Moody’s reports “the amount of cash held by US non-financial companies totaled $1.84 trillion at the end of 2016” despite the fact that these companies can expense their capital investment in addition to writing off any interest. Consumers have also been unwilling or unable to spend. This likely has two related causes: (1) a debt overhang, and (2) inequality. As wages have been stagnating since the 1970s, households have been borrowing more to maintain their standard of living. Household debt-to-GDP reached an all-time high of 95.5 percent in the fourth quarter of 2007 (see Figure 2). Household debt-to-GDP has since decreased to 78.2 percent as of the second quarter of 2017. Easy money policy by the Fed combined with the housing bubble overleveraged households. When the housing bubble burst in 2007, households were left with severely depreciated assets. The downturn caused losses in jobs and incomes causing many to lose those assets while still saddled with debt in many cases. Meanwhile, most of the recent economic gains have gone to people at the top of the income distribution who save more and have generally a lower marginal propensity to consume. The trend in real personal consumption expenditure appears to be declining (see Figure 3) while income inequality has been steadily rising (see Figure 4).

Figure 2: U.S. Households Debt to GDP

Figure 3: U.S. Real Personal Consumption Expenditure Growth

Figure 4: U.S. Income Gini Index

Another hypothesis advanced by Gordon (2012) and others is that the boost in growth by the internet and computer technology has not had the same impact as the great inventions of the Industrial Revolution such as the steam and gas engine, the assembly line, or the telephone. Since then, technology has been basically an improvement on these technologies such as communication. Therefore, large gains in productivity like we have seen in the past are unlikely to occur again at least in the near term. These are in essence supply-side factors which Summers admits cannot be dismissed out of hand, but argues the tell-tell sign of demand shocks is when “quantity goes down and price does as well…During the current episode, inflation rates both contemporaneously and prospectively have declined-suggesting the importance of demand” (Summers, 2014).

However, the main argument of Gordon (2014) is that the demise of high growth originates from four major headwinds[GE2] , not technology: demographics, education, inequality, and government debt. Gordon points to research from Hall (2014) which has “shown that about half of the 2007–14 decline in [labor force] participation is due to the aging of the population as the baby boom generation retires.” The other half is due to purely weak economic conditions. Martin et al. (2014) argue this should not be surprising. In studying prior recessions they find that “output typically does not return to pre-crisis trend following recessions, especially deep ones.” The Great Recession was so deep and long-lasting that it may have had a permanent impact on growth, and thereby declining prospects for the long-term unemployed confirmed by a falling labor force participation rate (see Figure 5). His second headwind is education. The suggestion is that America and other developed countries are paying the price for years of inadequate investment in education. The U.S. is 16th in college completion rates and, related to the growing debt problem mentioned above, students are being saddled with “over $1 trillion in student debt combined with the inability of 40% of college graduates to find jobs requiring a college education, spawning a new generation of indebted baristas and taxi drivers” (Gordon, 2014). We also touched on inequality above, but Gordon also argues “corporations are working overtime to reduce wages, reduce benefits, convert defined benefit pension plans to defined contribution, and to use Obamacare as an excuse to convert full-time jobs to part-time status” (Gordon, 2014). Storm (2017) makes a similar case through the process of dualization: “The intentional creation of a structurally low-wage-growth economy, post 1980, has not just kept inflation and interest rates low and led to ‘traumatized workers’ accepting ‘mediocre jobs’ in the stagnant sector — it has also slowed down capital deepening, the further division of labor, and the rate of labor-saving technical progress in the dynamic core” (Storm, 2017). This[GE3] is evidence by the falling share of workers income (see Figure 6). A second factor, Storm argues, is that

the ‘technology push’ originating from the rapid advancement of ICT, AI and robotics — but the technological revolution reinforced the dual nature of the growth process, as it led to labor shedding by the dynamic sector, forced ‘surplus workers’ to find jobs in the stagnant sector and depressed productivity growth in the stagnant sector (Storm, 2017).

Gordon’s final and least convincing headwind is government debt-to-GDP. There is simply no real evidence for it as Herndon et al. (2013) have shown in their critique of Reinhart and Rogoff (2010) who previously proffered this explanation. Rogoff (2015) has since expanded this theory of post-crisis decline to a private and public debt super-cycle. Again this is less convincing as taxes have stayed steady, and interest rates are still historically low. Where Rogoff (2015) is on the right track is private debt-to-GDP which has, alarmingly, only subsided to just under 200 percent from its 2009 peak of 213.4 percent (see Figure 7).

Figure 5: U.S. Labor Force Participation Rate

Figure 6: U.S. Employees’ Compensation Share of Domestic Income

Figure 7: U.S. Private Debt-to-GDP

Krugman (2014) argues that secular stagnation “is not the same thing as the argument” advanced by Gordon, which is that “the growth of economic potential is slowing, although slowing potential might contribute to secular stagnation by reducing investment demand. It’s a demand-side, not a supply side concept.” This seems like hairsplitting. And I have to agree with Summers, supply-side factors cannot be dismissed and no doubt are contributing to dualization, as Storm argues, while less convincing causes are government debt-to-GDP. As with most things, the truth lies somewhere in the middle. Secular stagnation is an overdetermined phenomenon in my view with an intentionally structured low-wage growth economy, inequality, low population growth, and creeping private debt overhang all contributing to deficient demand. But I do agree with Krugman (2014) in that “it has some seriously unconventional implications for policy .”

Following the research by Gordon (2014) and Storm (2017), federal policy along the lines of the Nordic Model could help with alleviating the uneven development of different sectors. The combination of active labor market policies, which includes public-service employment, could reduce search frictions and retrain and educate workers into to better performing sectors of the economy. This would serve the interests of the businesses who complain they are unable to locate qualified individuals by socializing education. In addition, if labor can be organized in such a way that coordination between wage-increases and productivity can be managed, that would go a long way, perhaps, in reducing the class warfare being waged by capitalists. However, if capitalist cannot be brought to the table in a cordial manner, a more appropriate policy might be a federal job guarantee program. The job guarantee would eliminate involuntary unemployment, place a demand floor under consumption, stabilize inflation, and address many of the other social needs of our society. A more audacious and, perhaps, controversial policy would be to simply socialize investment as envisioned by John Maynard Keynes. Since, as Krugman argues, there is a deficient demand in investment, and since non-financial corporations have persistently been unwilling to invest domestically, socializing investment and the gains from that investment would be one of the most prudent policies we could hope for.

References

Doba, B. (2013). “Emissions-GDP Relationship in Times of Growth and Decline.” June 2013 Centre for Climate Change Economics and Policy Working Paper №136 Grantham Research Institute on Climate Change and the Environment Working Paper №116. Retreived from http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/02/WP116-emissions-gdp-growth-and-decline.pdf

Gordon, R. J. (2014). “The turtle’s progress: Secular stagnation meets the headwinds.” Secular Stagnation: Facts, Causes, and Cures, A VoxEU.org eBook (Editors Teulings, C. and Baldwin, R.). London, UK: CEPR Press.

Herndon, T., Ash, M. and Pollin, R. (2014). “Does high public debt consistently stifle economic growth? A critique of Reinhart and Rogoff.” Cambridge Journal of Economics, 38: 257–279.

Kotz, D. M. and Basu, D. (2016). “Stagnation and Institutional Structures.” Working Paper.

Krugman, P. (2014a, Aug. 15). “Secular Stagnation: The Book.” The New York Times. Retreived from https://krugman.blogs.nytimes.com/2014/08/15/secular-stagnation-the-book

Krugman, P. (2014b). “Four observations on secular stagnation.” Secular Stagnation: Facts, Causes, and Cures, A VoxEU.org eBook (Edited Teulings, C. and Baldwin, R.). London, UK: CEPR Press.

Martin, R. F., Munyan, T. and Wilson, B. A. (2014, Nov. 12). “Potential Output and Recessions: Are We Fooling Ourselves?” IFDP Notes, Board of Governors of the Federal Reserve System. Retreived from https://www.federalreserve.gov/econresdata/notes/ifdp-notes/2014/potential-output-and-recessions-are-we-fooling-ourselves-20141112.html

Reinhart, C. and Rogoff, K. (2010). “Growth in a Time of Debt.” American Economic Review, vol. 100, №2, 573–8.

Storm, S. (2017). “The New Normal: Demand, Secular Stagnation and the Vanishing Middle-Class.” Institute for New Economic Thinking, Working Paper №55.

Summers, L. H. (2014). “Demand Side Secular Stagnation.” American Economic Review: Papers & Proceedings 2015, 105(5): 60–65.

Doctoral student of Economics at the University of Massachusetts Amherst. Commentary, research and more at aaronmedlin.weebly.com

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