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The World Economy’s Impossible Demand

Mareeg.com-WARSAW – The global economy’s glory days are surely over. Yet policymakers continue
to focus on short-term demand management in the hope of resurrecting the heady
growth rates enjoyed before the 2008-09 financial crisis. This is a mistake. When
one analyzes the neo-classical growth factors – labor, capital, and total factor
productivity – it is doubtful whether stimulating demand can be sustainable over the
longer term, or even serve as an effective short-term policy.

Consider each of those growth factors. Over the next 15 years, demographic changes
will reverse, or at least slow, labor-supply growth everywhere except Africa, the
Middle East, and South Central Asia. Europe, Japan, the United States, and
eventually China and East Asia will face labor shortages.

Although large-scale migration from labor-surplus regions to deficit regions would
benefit recipient economies, it would almost certainly trigger popular resistance,
especially in Europe and East Asia, making it difficult to support. Increasing the
labor-force participation rate, especially among women and the elderly, might ease
tight labor markets, but this alone would be insufficient to counter the decline in
working-age populations.

The world economy cannot count on higher investment levels either. The global
investment/GDP ratio, especially in advanced economies, has been gradually declining
over the past 30 years, and there is no obvious reason why it would pick up again in
the medium to long-term. Until recently, falling investment in the developed world
had been offset by rapid increases in investment in emerging markets, mostly in
Asia. But high rates of investment there are also unsustainable. As in Japan,
China’s investment rate (running at almost 50% of GDP since 2009) will decline as
its per capita income rises.

The third engine of growth, total factor productivity, will also be unable to
maintain the relentless gains witnessed from the late 1990’s to the mid-2000’s.
During this time, the global economy benefited from the confluence of several unique
developments: an information and communications revolution; a “peace dividend”
resulting from the end of the Cold War; and the implementation of market reforms in
many former communist and other developing economies. Moreover, global growth
received a further boost from the completion of the Uruguay Round of free-trade
negotiations in 1994 and the overall liberalization of capital flows.

It is difficult to point to any growth impetus of similar magnitude – whether
innovation or public policy – in today’s economy. No new technological revolution
appears to be on the horizon. The World Trade Organization produced only a limited
agreement in Bali in December, despite 12 years of negotiations, while numerous
bilateral and regional free-trade agreements might even reduce world trade overall.

Worse, in the wake of the 2008 financial crisis, sluggish growth and high
unemployment in developed countries have fueled demands for more protectionism.
Thus, the financial liberalization of the 1990’s and early 2000’s is also under
threat.

The far-reaching macroeconomic and political reforms of the post-Cold War era also
seem to have run their course. The easy gains have already been banked; any further
structural change will take longer to agree and be tougher to implement.

Thus, with supply-side factors no longer driving global growth, we must reassess our
expectations of what monetary and fiscal policies can achieve. If actual growth is
already close to potential growth, then continuing the current fiscal and monetary
stimulus will only create more bubbles, exacerbate sovereign-debt problems, and, by
reducing the pool of global savings available to finance private investment,
undercut long-term growth prospects.

Instead, policymakers should focus on removing their economies’ structural and
institutional bottlenecks. In advanced markets, these stem largely from a declining
and aging population, labor-market rigidities, an unaffordable welfare state, high
and distorting taxes, and government indebtedness.

The list of growth obstacles in emerging markets is even longer: corruption and weak
rule of law, state capture, organized crime, poor infrastructure, an unskilled
workforce, limited access to finance, and too much state ownership. In addition,
markets of all sizes and levels of development continue to suffer from
protectionism, restrictions on foreign capital flows, rising economic populism, and
profligate or poorly targeted welfare programs.

Marek_Dabrowski
Marek_Dabrowski

If these problems can be addressed, both globally and at the national level, we can
end the dangerous fiscal and monetary expansionism on which the world economy has
come to rely and allow growth to be sustained over the long term – though at lower
rates than in recent years.

Marek Dabrowski, a professor of economics, was First Deputy Minister of Finance
under Poland’s first post-Communist government and is a former president of the
Center for Social and Economic Research (CASE) in Warsaw.

: Project Syndicate

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