Industrial Poverty and Stagnation

My book Industrial Poverty: Yesterday Sweden, Today Europe, Tomorrow America will be officially available as hardcopy and e-book on September 10. This book basically asks a two-step question: Has the industrialized world entered a state of permanent economic stagnation? If so, is the state of stagnation self-inflicted?

I suggest that the answer is affirmative on both accounts. The consequence is dire for the two largest economies in the world:

  • Europe is stuck in a depression that is leaving one in five young man and woman with no other option than to live off welfare;
  • While the U.S. economy is improving, it is a recovery that leaves a lot to be wished for, primarily in terms of job creation and economically sustainable consumer spending.

The United States will continue to move, slowly, in the right direction, but without structural reforms to end large entitlement systems it will be very difficult to achieve more than 2-2.5 percent growth per year. That is just about enough to maintain a constant standard of living on an inter-generational basis.

A growing number of economists are expressing concerns about what will come after the Great Recession. One of them is Stanley Fischer, the number two guy at the Federal Reserve. From the New York Times:

Sounding a somber note even as the economic outlook in the United States brightens, the Federal Reserve’s No. 2 official acknowledged on Monday that global growth had been “disappointing” and warned of fundamental headwinds that might temper future gains. … Stanley Fischer … noted that although the weak recovery might simply be fallout from the financial crisis and the recession, “it is also possible that the underperformance reflects a more structural, longer-term shift in the global economy.” In a speech delivered on Monday in Stockholm at a conference organized by the Swedish Ministry of Finance, Mr. Fischer also conceded that economists and policy makers had been repeatedly disappointed as the expected level of growth failed to materialize.

My book is timely, in other words… To be perfectly honest, the reason why “economists and policy makers had been repeatedly disappointed” during the Great Recession is precisely that they do not primarily think in structural – or institutional – terms. One reason is the over-reliance on traditional econometric methods, which work well so long as there is no major upset to the overall structure of the economy. Another reason is the downgrading of genuine economic theory: today’s average graduate student in economics probably will never read an original text by theory-based scholars like Keynes, von Mises, Hayek, Lerner, Harrod or even Milton Friedman. Today’s academic economics puts the cart before the horse, deciding what tools to use first and then finding a list of problems those tool may apply to. What does not make the list is not of interest.

This is, obviously, an exaggerated stylization, but it is not more than that. Instead of using methodology that asks how soon the European economy will return to business as usual, economists need to begin to ask what reason, if any, the European economy has to return to full employment and growth. I have made my contribution. Stanley Fischer is opening for the same type of non-traditional analysis. Here is what he said, directly from the Federal Reserve website:

[The] Great Recession is a near-worldwide phenomenon, with the consequences of which many advanced economies–among them Sweden–continue to struggle. Its depth and breadth appear to have changed the economic environment in many ways and to have left the road ahead unclear. … There has been a steady, if unspectacular, climb in global growth since the financial crisis. For example, based on recent IMF data from the World Economic Outlook, which uses purchasing power parity weights, world growth averaged 3percent during the first fouryears of the recovery and as of July was expected to be 3.4 percent this year. The IMF expects global growth to reach 4 percent next year–a rate about equal to its estimate for long-run growth. This global average reflects a forecast of steady improvement in the performance of output in the advanced economies where growth averaged less than 1 percent during the initial phase of the recovery to an expected 2-1/2 percent by 2015.

Again, the best we can hope for is growth that – as I explain in my book – keeps our standard of living from a continuous decline. But let us also keep in mind that if we are going to expect Europe to grow by 2-2.5 percent next year, a minor miracle has to happen. A true end to welfare-state saving austerity would be a big step in that direction, but so far we have not seen more than verbal commitments to that. But even as this European version of austerity ends, it will take quite a while before the economy will recover. Confidence, like Rome, is not built in a day, and therefore I predict that Fischer will be too optimistic about Europe.

As we return to Stanley Fischer, he stresses the tepid nature of the global recovery:

With few exceptions, growth in the advanced economies has underperformed expectations of growth as economies exited from recession. Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. Indeed, research done by my colleagues at the Federal Reserve comparing previous cases of severe recessions suggests that, even conditional on the depth and duration of the Great Recession and its association with a banking and financial crisis, the recoveries in the advanced economies have been well below average.

Which is yet more evidence that my argument that this is a structural crisis is valid. But not only that: the structural crisis is of a kind that traditional economics has not yet grasped. The culprit is the welfare state, the depressing effect of which slowly emerged up to four decades ago. However, unlike other long-term trend suggestions, such as the Kondratiev cycle, my hypothesis about the welfare state has a realistic microeconomic underpinning. More on that at some other point; for now, back to Stanley Fischer:

In the emerging market economies, the initial recovery was more in line with historical experience, but recently the pace of growth has been disappointing in those economies as well. This slowing is broad based–with performance in Emerging Asia, importantly China, stepping down sharply from the post-crisis surge, to rates significantly below the average pace in the decade before the crisis. A similar stepdown has been seen recently for other regions including Latin America. These disappointments in output performance have not only led to repeated downward revisions of forecasts for short-term growth, but also to a general reassessment of longer-run growth.

Does the welfare-state explanation apply to the emerging economies as well? In some cases the answer is yes, with South Africa and Argentina as leading examples. I am not familiar enough with the Chinese economy to be able to tell what role the welfare state plays there, but I would be surprised if their talk from time to time about fighting social stratification has not led to an expansion of a government-based redistribution system.

But it really does not matter if the Chinese are expanding their welfare state, or are wrestling with a financial bubble. Neither is going to change the European economy, which – as we go back to the New York Times story – is showing yet more signs of perennial stagnation:

A report on Monday by the Organization for Economic Cooperation and Development warned that German economic growth might be slowing. Germany has been one of Europe’s rare bright spots, continuing to prosper even as countries on the periphery like Greece, Portugal and Spain struggle after the debt crisis of 2010-12.

Let’s take a closer look at that report on Friday. For now, let’s just note that it is good to see that more and more economists are taking a broader, less conventional look at the economy. Just as I do