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How to Survive Slow Growth, Part 1

With Larry Summers, Zachary Karabell, and Anne Kreuger

With China slumping, energy prices collapsing, and nervous consumers sitting on their hands, growth has ground to a halt almost everywhere, and economists, investors, and ordinary citizens are starting to confront a grim new reality: the world is stuck in the slow lane and nobody seems to know what to do about it.  Listen in as Larry Summers, Zachary Karabell, and Anne Kreuger discuss the dangers, risks, and opportunities of slow growth and what, if anything, there is to do about it. 

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To learn more on the subject, check out the March/April 2016 issue and these related links:

The Age of Secular Stagnation By Larry Summers

Learning to Love Stagnation by Zachary Karabell

This podcast has been edited and condensed. A rush transcript is below. Music credit: FreeMusicArchive.org / The Stealing Orchestra & Rafael Dionisio, Podington Bear

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Allawala: This is Foreign Affairs Unedited, and I’m Katie Allawala.

The first decade of the twenty-first century was a time of unprecedented economic growth. The rich world got richer, and the developing world raced ahead: by 2007, the emerging-market growth rate had hit 8.7 percent, and economists began to speak of “convergence,” when the impoverished so-called rest would finally catch up to the West. Then came the fall.

Today, with China slumping, energy prices collapsing, and nervous consumers sitting on their hands, growth has ground to a halt almost everywhere, and economists, investors, and ordinary citizens are starting to confront a grim new reality: the world is stuck in the slow lane and nobody seems to know what to do about it.

The new issue of Foreign Affairs, just now out on newsstands, looks at how we got here and how we can get out. We’re tackling the same theme on the podcast, and first up is Larry Summers, President Emeritus of Harvard, U.S. Secretary of the Treasury from 1999 to 2001 and Director of the National Economic Council from 2009 to 2010.

Summers: Secular stagnation is a chronic excess of savings over investment leading to low interest rate, weak demand, slow growth and a tendency towards lowflation or deflation interrupted by periodic episodes of economic strength, but episodes of economic strength that rest on a weak financial foundation.

Allawala: That’s Larry Summers explaining an idea first put forward by the American economist Alvin Hansen in the 1930s to explain the stagnation of that decade.

As Summers writes in his article in the new issue of Foreign Affairs, in this view, the economies of the industrial world suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. That excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.

He further explains that, when significant growth is achieved—like in the United States between 2003 and 2007—it comes from dangerous levels of borrowing that translate all those excess savings into unsustainable levels of investment—for example, the housing bubble.

And it isn’t just in the United States where this is a problem. And it isn’t just in the last few years.

Summers: It’s something that you see throughout the industrial world and it's something that's been gathering force for a long time. If you look over the last 25 years, the generation now, there's been a pretty steady decline in real interest rates in almost all the industrialized countries, and that, in my judgment is a reflection of what's happened to saving and what's happened to investment. And it means we're in a very different kind of macroeconomic configuration than we have been traditionally.

Allawala: To begin to address the problem, Summers explains that central banks have to start looking at it correctly. 

Summers: Well, I think central banks have done important things and there's more for central banks to do. I think it's crucial that they recognize that the primary problem is slow growth and lowflation, not some kind of overheating. I think that to direct policy, to a threat of overheating is to court very, very real risks. If the Fed were to carry through on its plan to raise rates four times during 2016, I think there's a better than 50:50 chance that it would send the economy into recession.

Allawala: Summers notes that he doesn’t think that the Fed will be able to carry through on its plan, but it is still a chilling thought.  

Summers: Beyond the question of what central banks do, there's a great deal else that needs to be done to promote demand. Fiscal policy is one crucial aspect. We can borrow money at less than 3% in currency we print ourselves. Materials costs have never been lower. Construction unemployment rates are very, very high. What better time to fix La Guardia airport? What better time to renew America's infrastructure?

Allawala: So what’s the problem? Well, this is where demand comes in.

Summers: So to this encouragement of private investment, whether it's through more appropriate regulatory policies, whether it's through measures to support the flow of credit, we need to recognize that the principle thing holding back firms in this economy is not that capital's too expensive, it's never been cheaper. It's not that wages are too high, they're relatively low by historical standards. It is that they simply don't have the demand for their products and that's why a focus on demand has to be very important going forward.

Allawala: In addition to infrastructure investment, in his article, Summers suggests several possible methods to increase demand, such as regulatory reform and business tax reform, accelerating investments in renewables, and measures to raise the share of income going to those with a high propensity to consume, for example support for unions and increased minimum wages.

As to whether an expansionary fiscal policy would unsustainably increase deficits, Summers is doubtful. 

Summers: First, I would note that the IMF, hardly a reckless bunch of spenders, has actually calculated that in industrial countries, given current circumstances, programs of infrastructure investment would reduce debt-to-GDP ratios because they grow the economy and grow tax collections. Second, I would emphasize, and this is something that's completely understood within corporations, that deferred maintenance, unfunded liabilities are just as much a burden on future generations as debt. But here's the difference. When we issue debt, it only compounds at 0%, 2% or 3% nominally in a currency we print ourselves. Whereas, when we defer maintenance those costs can double in five years as a consequence of the deferral. So from the point of view of protecting my children's generation from too large a liability, putting too large a burden on them, we would do much better to repair and renew our infrastructure, than we would, to avoid borrowing at 2%. We would do much better to focus on growing the economy, than we would to focus on a mindless austerity.

Allawala: Given all this, we asked Summers why he thinks we're not on the verge of a major new package of public investment.

Summers: One element is that traditional thought still has a great deal of sway, with many people. The idea that the private sector is tightening its belt, so government should tighten its belt, is a very powerful political cliche. Second, I think this is the more serious thing, is that there is substantial skepticism. Some of it with good reason, about the ability of government to execute effectively on a public investment program. And that's why I put very substantial emphasis on taking the steps necessary to enable the private sector to strengthen our infrastructure by, for example, moving beyond a call. By for example, strengthening telecommunications. It doesn't all have to be a government program, but what we do need is an emphasis on investment leg growth.

Allawala: The slow growth world might be daunting, but Summers appears optimistic.

Summers: Secular stagnation is a risk. It is no necessity. It is a problem that can be solved. Indeed, generating more supply potential, is really hard. Generating demand for goods that people want that the economy is capable of producing, that should be a relatively easy problem. I'm an optimist. 

And for all of our challenges and problems, I would rather face the challenges and opportunities that the United States has, in today's world, than the challenges and opportunities faced by any other major country.

But I'd like to have their airports.

Allawala: We just heard from Larry Summers on secular stagnation. Our next guest writes in his recent article, titled “Learning to Love Stagnation,” that, from Wall Street to K Street to Main Street, pessimism about the global economy has become commonplace -- that, although the world economy may have finally emerged from the financial crisis of 2008, according to conventional wisdom, it remains fragile and unsteady, just one disruption away from yet another perilous downturn. Foreign Affairs’ Jonathan Tepperman sits down with Zachary Karabell, Head of Global Strategy at Envestnet and author of that quote, to learn more.

Tepperman: Zach, let me start with a very difficult and unpredictable question. Why should we love stagnation?

Karabell: Well, look, to be fair, it was your title, not mine.

Tepperman: But an excellent one, I have to say.

Karabell: But it's a great title. It's more that everybody's expectation is more money leads to more stuff, leads to a better life. And one of the things I wanted to draw attention to is we're very focused, and have been for decades, on the income side of our living equation, and we're not particularly focused on how much things cost. And so, if you assume that you need more money to purchase and to acquire what you need in life, then, obviously, not having more money or having less money is a bad thing. And that's why stagnation creates such negative reverberations because it's, legitimately, at least in the past, associated with, "You have less money, you have less stuff." But, I think the world is shifting such that that is not necessarily the case now.

Tepperman: And tell me why, because it seems like a fairly obvious equation, as you just put it. Governments know that the more money you have, the more stuff that you can buy, but if stuff becomes less expensive, you can make your dollar stretch farther. That's why they measure cost of living. But what does that not account for?

Karabell: So, let's step back. Think about it for a minute. Let's say you earn $1,000. And that's your annual income. And if I said to you, "That's gonna be your annual income in 10 years," you almost certainly would react to that negatively. Like, "Oh, that's it. I'm stagnating, nothing's going on." If I said to you, "You're gonna have a 50% increase in your wages over the next 10 years", so you earn $1500 a year. But, the cost of whatever you're gonna buy is gonna go up equivalently, or more, then you actually have less money, but no one thinks about that because, in the past, it was was never the case, really, net-net that wages were flat and costs went down. Wages went up and costs went up. I think we're living in a world now where the net effect of technology and globalized production is that the cost of most of life's necessities is decreasing.

Tepperman: Now I get why that would be a problem with consumers because, intuitively, having more money seems like a good thing. But you argue that it's governments that are making this mistake as well, correct?

Karabell: Oh, yeah. Every government number, and every government in the world has a mandate, essentially, to produce more GDP, to produce more national income. Nobody can get up anywhere, whether it's China, whether it's the United States, whether it's Venezuela and say, "Under my administration, your costs are gonna go down, but our economy is gonna be stagnant." 'Cause no one would believe the former, and they would all criticize for the latter. And so, there's really no way for governments to minimize GDP and maximize cost savings.

Tepperman: Now you argue in your piece that it's not just a mistake of perception. That is, the excessive focus on growth doesn't just fail to capture the entire picture, but it's actually pernicious, and that there are dangerous effects of the governments only looking at part of the picture. Tell me what you mean by that.

Karabell: Again, this gets into this argument which I've also, as you know, written about, about some of the distortions of GDP. So, a natural disaster increases GDP, but it's not something we think is societally beneficially. If we just destroyed a city and rebuilt it, that'd be great for GDP, but it would be lousy for human experience. In a similar fashion, you don't get GDP credit as a government for massive cost savings. And it's very difficult to get governments to encourage programs, and this isn't just true of the United States, it's true of anywhere, that lead to savings because it's GDP reductive. Even the Congressional Budget Office, because of its own strictures, can score the future costs of an infrastructure bill. It cannot score the presumptive future savings of a bill. Now it does that legitimately. You don't want some politician getting up and going, "Look, I know this is going to cost $10 billion, but trust me it'll save $15 billion in the future". But it does mean that we also are hamstrung in that there are certain outlays of current income that will lead to lesser outlays of income 10 years in the future. Very hard for governments to make those under the current conditions.

Tepperman: Japan is the great example that you cite in your piece to show how you can live quite well while your economy fails to grow over the course of, in Japan's case almost, two decades. But Japan of course had the great advantage of going into its period of stagnation at a high. Is the implication there that you need to be wealthy to be able to afford to live comfortably while you're stagnating?

Karabell: It's certainly true that incredibly poor countries might have a hard time, although, even there, if the cost of energy, the cost of appliances, the cost of homes, the cost of clothing, the cost of food, if all of life's necessities are rapidly decreasing in cost.

Even healthcare, the actual delivery of it can be much cheaper. It's distorted by political systems. But drugs are not, drugs cost a lot 'cause drug companies need to make a profit in the United States. A lot of those drugs don't necessarily cost a lot, so almost everything we need has decreased in cost. That benefits Nigeria just as much as it benefits Norway.

Tepperman: Apart from stagnation, the big obsession of Americans at the moment, understandably is, economically, is with inequality. What's the relation between growth and/or stagnation in equality?

Karabell: Inequality is, I think in many ways, a byproduct of an economic system that isn't managing to provide enough people with enough stuff. All I'm trying to argue is that providing enough people with enough stuff doesn't only come with income, or doesn't have to come with more income.

You can find other ways other than the growth model. Now a lot of those have failed, but one thing we're going into in the 21st Century, which none of us will have had any experience of, and I don't think any society currently except for Japan has begun to experience is, what happens when there's a demographic either plateau or decline, what exactly is the need for growth if you're gonna have fewer people to feed tomorrow than today? In which case you may not need growth to insure prosperity. And what Japan is facing now is, "You know what, we're not growing. We're shrinking demographically, and we've ceased to really increase meaningfully economically". And yet, life spans are good. Quality of life is high. There's a certain degree of social concord.

Tepperman: And yet even the Japanese government isn't able to enjoy that. And as we've seen Shinzo Abe's... His core promise as Prime Minister has been his claim that he can increase...

Karabell: Yeah, Abenomics is gonna increase growth. Again, no government in the world can get up and say there's gonna be no economic growth.

Tepperman: So given that, given that reality, a politic reality, what is the most important take away of your piece of your argument for governments?

Karabell: Well first of all, it is within reason, meaning to the degree that you can focus and focus the electorate and focus your constituencies on quality of life and not purely cost of living. You may find that there are other programs and other ways of getting things done that maybe more effective and more productive. And if you can focus on that and then focus on solutions to that, some of which may be non-GDP productive, non-income, non-growth, that would be a good outcome for our society.

Allawala: That was Jonathan Tepperman talking to Zachary Karabell.

As we were putting together our slow-growth issue, we conducted a poll in which we asked experts whether they agreed or disagreed that most of the world's major economies are facing a sustained period of slow to no economic growth, and that there's nothing governments can do about it. The experts resoundingly disagreed. In fact, 18 out of the 24 disagreed or strongly disagreed. One of those was Anne Kreuger, who is Senior Research Professor of International Economics at the School for Advanced International Studies and was First Deputy Managing Director of the IMF from 2001-2006. She wrote that many governments are simply unwilling to undertake the necessary structural reforms. I talked to her about the kinds of reforms she had in mind.

Krueger: Well, the reforms vary from country to country. In many countries, as we've gotten richer, we have imposed more and more expectations of what we want on people and sometimes, they've gone a little bit ahead of what the society can really undertake.

Allawala: That’s Kreuger.

Krueger: In the United States, for example, the number of regulations governing business and people doing business has gone up enormously in the past eight or 10 years. I saw one place where they were documenting that something like 39% of all workplace jobs now require licensing of some kind; Hairdressers, manicurists, etcetera, etcetera. And as we increase those kinds of things, it puts more of a burden on especially young start-up firms and so on. And that leads to a reduction in the number of small businesses starting up, and small businesses are normally a major source of growth.

Allawala: In fact, according to Brookings’ Robert Litan, the reduction in the number of start ups in the United States has been striking. As he explains in a recent Foreign Affairs article, the ratio of new firms to all firms, or the “start-up rate,” has been steadily decreasing. In 1978, start-ups—which he and his colleague Ian Hathaway define as companies less than a year old—accounted for nearly 15 per­cent of all U.S. firms; by 2011, that figure had slipped to just eight percent. And, for the first time in three decades, business deaths exceeded business births.

Litan suggests that, in addition to immigration reform, the United States should make it easier for people who are not wealthy to invest in start-ups and it should regularly update federal regulations, which can pose unnecessary barriers to entry for new firms.

Of course, it isn’t just the United States facing slow growth, and Kreuger points out that the contributing factors in each individual country can be very different.

Krueger: I like to think of economic growth as a process in which as you remove one bottleneck, you get some growth, but then that creates other complexities and things in the economy that have to be addressed if you're going further. And some authorities at different stages of development have done differently.

Allawala: In other words, there is never just one spur to economic growth. It is a process of adjustment and readjustment. And some countries can do that better than others.

Some countries that weren't doing very well, and they've undertaken fairly sizeable reforms and they've done much better. And I have in mind, just simply because they come to mind, not because it's the most noteworthy, Australia and New Zealand, which in the late 1980s, were going rapidly toward the bottom of the OECD League in terms of per capita income and stuff and have done very well over the past 20 or so years, 25 years, and most of that has been a result of removing some of the restrictions on business.

Allawala: The costs of getting it right--or not-- will likewise vary.

Krueger: Well, I think first off, it's gonna vary by country. It's not the same everywhere. And the idea that all countries would remain marred without undertaking reforms for the next five or ten years seems to me a little bit strong.

Right now, for example, China's obviously facing a slow-down in growth, and everybody's very concerned about it and for good reason, I think. But on the other hand, there's certainly a reasonable probability, if not a strong probability, that within a year or so, they'll have that sorted out. They won't ever go back to their 13% growth, I don't think that's possible, but the growth would become stronger there.

Allawala: Kreuger points out that it is worth remembering periods during which other countries faced economic stagnation.

Krueger: So I don't wanna say that we're gonna face that long a period of it, but I think it varies by countries. You never know. Some of the countries in the past that were performing very badly have been the ones that then became the star performers for the next group of years. And I have in mind, Japan in the 50s, Taiwan and Korea in the 60s and so on.

Allawala: And in the case of China, Krueger isn’t counting out a rebound.

Krueger: Well, the first thing to be said is that this is an extremely complex set of issues, and they've done very amazingly to me... Well, so far, in being able to start to develop before they became life-threatening, so to speak. Obviously, they have some now that they're working on and that they're recognizing. I think they have made a few more mistakes in this past year and a half or so than they were making earlier on, but that's partly due to the increased complexity of the economy. And I guess I'd be surprised if within a year or two, they haven't begun resumption of the policies that work for growth.

Allawala: That was Anne Kreuger leaving off the first episode in our two-part series on slow growth in China. We’ll be back in two weeks. Until then, let us know what you think of the show. Leave a review on iTunes or email us at editor@foreignaffairs.com. Your feedback and suggestions will really help us as we think through future episodes. 

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