The specter of secular stagnation

Despite considerable technological innovation in recent years, many Western democracies have been plagued by sluggish growth and secular stagnation. There is no widespread consensus among economists on what causes the trend.

Erik Brynjolfsson at the World Economic Forum, 2014
Erik Brynjolfsson, professor at the MIT Sloan School of Management, believes GDP measurements are incomplete because they fail to account for free technologies that gradually replace paid alternatives. © dpa

In a nutshell

  • Low growth and productivity in developed nations could result from structural issues
  • Some experts believe that current economic tools cannot accurately measure growth
  • Systematic monetary stimulus poses both economic and political challenges

In 1938, Alvin Hansen, then-president of the American Economic Association, gave a pessimist talk predicting the United States would enter an era of economic sluggishness and unemployment after the Great Depression. Supply would simply follow aggregate demand, which would decline because of excess savings and the aging population. The phenomenon was named secular stagnation, but it was soon forgotten with the postwar economic boom. 

In 2013, former U.S. Treasury Secretary Lawrence Summers revisited the concept to apply it to the post-Great Recession era. The idea gave rise to a dense intellectual discussion to explain the sluggish GDP and productivity growth that have taken hold in nations of the Organisation for Economic Co-operation and Development (OECD), despite apparent innovation. The debate could have far-reaching implications.

Demand deficiency

Some, like Mr. Summers, believe stagnation is explained by a structural aggregate demand deficiency, when there is a gap between potential growth and actual growth. Income distribution has not benefited the middle class in rich countries. There, governments have had to rely on debt enabled by low rates, loose credit regulations, and oversaving by emerging economies and the very rich. Thus the global “savings glut” pushes down the natural interest rate, but also translates into weak demand (since well before the 2008 crisis) and investment. A further fall in interest rates could pare down excess savings, but rates have been very low for a while now, and nominal rates cannot fall below the so-called zero lower bound (0 percent). Since price adjustment does not work in such an environment, production adjusts to weaker demand. This in turn reduces incomes. 

Some see the stagnation paradox as a result of our inability to correctly measure productivity and economic growth.

The level of the natural interest rate – one that enables full employment – can become negative due to many factors: aging demographics, tighter debt limits for borrowers, economic inequality and deleveraging after a crisis. (The 2000s credit boom hid a deficient aggregate demand.) During a recession, employees made redundant tend to lose their human capital, making them less likely to find jobs and more likely to accept lower living standards. This depreciates aggregate demand even further. As a result, business prospects for profitable investment diminish.

The orthodox response to this situation is wage flexibility, but this type of policy is believed, in this view, to worsen the situation by creating a deflationary spiral. Inflation targets that are too low (what American economist and Nobel Prize Laureate Paul Krugman dubbed the “timidity trap”) lead to a permanently negative real interest rate. Targets need to be raised – an expansionary monetary policy approach. 

On the fiscal side, more government spending can stimulate aggregate demand and reduce inequality since lower-income households tend to consume more, boosting demand. Some, like Nobel Prize-winning economist Joseph Stiglitz, see an opportunity for investment in green infrastructure. These “aggressive” policies could close the gap between potential and actual growth. 

Missing growth

Others are more optimistic and see today’s stagnation paradox as a result of our inability to correctly measure productivity and economic growth. American-Israeli economist Joel Mokyr, for instance, thinks our measures of gross domestic product (GDP) and productivity are better suited to a wheat-and-steel economy than our modern high-tech economy. French economist Philippe Aghion suggests that, because standard GDP and productivity markers do not account for the increase in the quality of existing products, they fail to measure the full scope of economic growth. From this perspective, U.S. productivity was probably underestimated by approximately 0.6 points annually between 1993-2013. Meanwhile, inflation was probably overestimated, which indicates deflation.

Economists Hal Varian, Erik Brynjolfsson and Andrew McAfee also note that many services such as Google Maps or Wikipedia are free of charge. As such, they don’t appear in the GDP, although they effectively save consumers’ time and effort and generate services that increase living standards. Many goods, from compact discs to Michelin guides to dictionaries, have been replaced by free alternative services on smartphones.


Facts & figures

U.S. Federal Reserve interest rates from 2008 to 2020
On March 15, the U.S. Federal Reserve lowered its interest rate to near zero and said it would launch a $700 billion quantitative easing program to offset the economic disruption caused by the coronavirus pandemic. Three days later, another emergency credit program was rolled out to ensure liquidity in money market mutual funds. © macpixxel for GIS

Another theory posits that the growth to be reaped from recent innovations has not yet materialized. After all, it took more than a generation after the discovery of electric power to see its wonders reflected in productivity figures. Innovation needs to be diffused into existing structures before it can enhance productivity. And a new wave of AI-based innovation could also appear soon.

Some argue that the diffusion of innovation is currently hindered by several obstacles. French economist Gilbert Cette sees the immense potential for the growth of opportunities, but believes that sclerotic institutions, flagging entrepreneurship and improperly trained workers stand in the way. But overall, the future benefits from these new technologies make the abovementioned authors optimistic about future growth. (Of course, one can be less optimistic about the latest technological developments: productivity may be negatively affected by people spending hours watching cats or karaoke videos on Facebook, Instagram or YouTube.)


Some are much more pessimistic, however. For American economist Robert J. Gordon, several factors hold back productivity in the U.S.: low population growth and retired baby boomers (i.e., lower participation rates and fewer hours worked); no further productivity gain from education, which has plateaued; rising income inequality since the 1980s (the author believes growth has only benefited the top 10 percent earners); high levels of public and private debt, notably student debt, that would require deleveraging (and ultimately reduce demand); jobs losses due to global outsourcing and new technologies; and costly, albeit necessary, environmental regulations.

Secular stagnation is also associated with a long-standing decline in growth potential – a supply-side issue. After a surge, technological progress normalizes and returns to a slower pace. While pessimistic about the ability of government to overcome this new historical wave of sluggishness, Mr. Gordon suggests its negative effects could be mitigated with a mixed bag of policies, like raising the retirement age, legalizing marijuana, funding healthcare through higher VAT, or increasing tax rates on capital gains.


However, the discussion around secular stagnation too rarely deals with the role of growing government, even if rising public debt caused by increasing public spending is sometimes acknowledged as a source of lower future growth. But this phenomenon could partly explain slower growth because of higher taxes and tax uncertainty, which affect entrepreneurial opportunities. Overregulation has certainly enabled a profitable “business of complication,” but in the end it chips away at productivity. Bureaucratic inertia and a new bureaucratic mentality are also syphoning more and more resources away from innovation.

Secular stagnation is also associated with a long-standing decline in growth potential – a supply-side issue.

Increasingly generous welfare policies leading to parentalism – the expectation that everything will be provided by a nanny state  – may have damaged the risk-taking instincts of the population and their sense of discipline and effort. For example, despite abundant spending, there seems to be a gradual erosion of education standards in several countries. Less work is requested from pupils and students – from simple self-control to solving math problems or spelling properly – which obviously has an impact on productivity. 

Complacency culture

According to American economist Tyler Cowen, the rise of a complacent class in the U.S. may have killed the nation’s dynamic pioneer spirit, and thus its productivity levels. From “safe spaces” to “trigger warnings,” more and more Americans seem afraid of change and risk, settling for a bureaucratized society as long as they have Netflix and video games. This new state of affairs can also be explained by digital tools that match people together, from business hiring to forming couples. In practice, these applications end up segregating society and cities, reducing social mixing, and thus mobility, economic opportunities and, ultimately, the generation of new ideas. 

It is also noteworthy that more and more American men of working age exit the job market, staying with their parents and doing nothing in particular. According to Mr. Cowen, the outcome is fewer start-ups, less entrepreneurial success, less job mobility and fewer innovative companies. All this led to a drop in U.S. productivity from the 1970s and onward. It is as if there were a historical cycle, the good times planting the seeds of the bad. 

Money for nothing

But is this stagnation really secular, meaning structural? Economist Steve Hanke doubts it and stresses that slower actual growth can be partly explained by regime uncertainty and regulatory activity that slow down investment and growth. Excess regulation can also have a negative effect on competition, and, in turn, on innovation and productivity. 

Mr. Hanke denounces what he thinks amounts to restrictive monetary policy. Despite extraordinarily low rates and asset purchase programs, banking regulations and lending practices in the post-2008 era have generally led to the stagnation of money aggregates, stifling economic growth. French economist Henri Lepage even believes that asset purchase programs have made safe assets scarcer, leading to a drop in the “global money” supply (the monetary instruments based on safe assets), an essential ingredient for global investment. 

The debate around secular stagnation rarely deals with the role of growing government.

Claudio Borio, head of the Monetary and Economic Department of the Bank of International Settlements, sees the current stagnation in productivity as the result of misallocations generated by the credit boom in the 2000s. These misallocations – of labor especially – benefited low productivity sectors such as housing. Reallocations toward more productive sectors after the crisis then became more difficult, probably because of over-indebtedness and fragile banks. And expansionary monetary policy after the recession only creates new misallocations. From this perspective, there is no structural stagnation, only a drag in the financial cycle. In sum, expansionary monetary policy created a financial cycle, but then postcrisis corrections generated further distortions. Money is clearly not neutral in the long run and expansionary monetary policy is not a free lunch.

Future paths

Sluggish growth has certainly forced economists to rethink their discipline. In parallel, the 2018 resurgence of dynamism in the U.S. exemplifies how stagnation can be beaten. However, since the Trump administration resorted to both deficit spending and regulation reform, the case does not settle the issue. 

To some extent, this debate is another variation of the traditional opposition between interventionists and free marketeers. On one side, economists think the way out of this stagnation is more government spending and redistribution. On the other, experts see government intervention through monetary policy and fiscal imbalance as the culprit, and advocate savings, “normal” interest rates and a sounder business environment. 

However, there is much more at stake behind this academic debate than the future of economic policy. The pretext of secular stagnation could be used to corrupt monetary policy even further by promoting the idea that higher inflation is necessary and that savings are a curse. Systematic use of fiscal stimulus, in addition to compounding indebtedness, raises the question of democratic accountability in matters of spending. Pillars of economic and political progress could thus be eroded.

Given the current electioneering in Western democracies and recent academic trends, it is doubtful that a less interventionist approach based on sound money, sound regulation – and sound education – will be given due consideration, and even more so after the coronavirus crisis.

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