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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
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As one year of sluggish growth spills into the next, there is growing debate about what to expect over the coming decades. Was the global financial crisis a harsh but transitory setback to advanced-country growth, or did it expose a deeper long-term malaise?

Recently, a few writers, including internet entrepreneur Peter Thiel and political activist and former world chess champion Garry Kasparov, have espoused a fairly radical interpretation of the slowdown.

In a forthcoming book, they argue that the collapse of advanced-country growth is not merely a result of the financial crisis; at its root, they argue, these countries' weakness reflects secular stagnation in technology and innovation. As such, they are unlikely to see any sustained pickup in productivity growth without radical changes in innovation policy.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
iPhone 5.

Economist Robert Gordon takes this idea even further. He argues that the period of rapid technological progress that followed the Industrial Revolution may prove to be a 250-year exception to the rule of stagnation in human history.

Indeed, he suggests that today's technological innovations pale in significance compared to earlier advances like electricity, running water, the internal combustion engine, and other breakthroughs that are now more than a century old.

I recently debated the technological stagnation thesis with Messrs Thiel and Kasparov at Oxford University, joined by encryption pioneer Mark Shuttleworth.

Mr Kasparov pointedly asked what products such as the iPhone 5 really add to our capabilities, and argued that most of the science underlying modern computing was settled by the 1970s. Mr Thiel maintained that efforts to combat the recession through loose monetary policy and hyper-aggressive fiscal stimulus treat the wrong disease, and therefore are potentially very harmful.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
Harvey, a homeless man, begs for money along 14th Street in Washington.

These are very interesting ideas, but the evidence still seems overwhelming that the drag on the global economy mainly reflects the aftermath of a deep systemic financial crisis, not a long-term secular innovation crisis.

There are certainly those who believe that the wellsprings of science are running dry, and that, when one looks closely, the latest gadgets and ideas driving global commerce are essentially derivative. But the vast majority of my scientist colleagues at top universities seem awfully excited about their projects in nanotechnology, neuroscience, and energy, among other cutting-edge fields.

They think they are changing the world at a pace as rapid as we have ever seen. Frankly, when I think of stagnating innovation as an economist, I worry about how overweening monopolies stifle ideas, and how recent changes extending the validity of patents have exacerbated this problem.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
Mateus Silva, 25 and unemployed, and his wife Leonor, upturn their caravan while city police officers arrive to evict him in the Nossa Senhora de Fatima neighborhood.

No, the main cause of the recent recession is surely a global credit boom and its subsequent meltdown. The profound resemblance of the current malaise to the aftermath of past deep systemic financial crises around the world is not merely qualitative.

The footprints of crisis are evident in indicators ranging from unemployment to housing prices to debt accumulation. It is no accident that the current era looks so much like what followed dozens of deep financial crises in the past.

Granted, the credit boom itself may be rooted in excessive optimism surrounding the economic-growth potential implied by globalisation and new technologies.

As Carmen Reinhart and I emphasise in our book This Time is Different, such fugues of optimism often accompany credit run-ups, and this is hardly the first time that globalisation and technological innovation have played a central role.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
Josefina Florian Mendez (front R) is embraced by a supporter after she was evicted from her apartment in Madrid.

Attributing the ongoing slowdown to the financial crisis does not imply the absence of long-term secular effects, some of which are rooted in the crisis itself. Credit contractions almost invariably hit small businesses and start-ups the hardest.

Since many of the best ideas and innovations come from small companies rather than large, established firms, the ongoing credit contraction will inevitably have long-term growth costs.

At the same time, unemployed and underemployed workers' skill sets are deteriorating. Many recent college graduates are losing as well, because they are less easily able to find jobs that best enhance their skills and thereby add to their long-term productivity and earnings.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
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With cash-strapped governments deferring urgently needed public infrastructure projects, medium-term growth also will suffer.

And, regardless of technological trends, other secular trends, such as ageing populations in most advanced countries, are taking a toll on growth prospects as well.

Even absent the crisis, countries would have had to make politically painful adjustments to pension and healthcare programmes.

Taken together, these factors make it easy to imagine trend GDP growth being one percentage point below normal for another decade, possibly even longer. If the Kasparov-Thiel-Gordon hypothesis is right, the outlook is even darker - and the need for reform is far more urgent.

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Why developed economies are suffering

Last updated on: December 12, 2012 08:31 IST
Unemployed men lie down in sleeping bags.

After all, most plans emerging from the financial crisis assume that technological progress will provide a strong foundation of productivity growth that will eventually underpin sustained recovery.

The options are far more painful if the pie has ceased growing quickly.

So, is the main cause of the recent slowdown an innovation crisis or a financial crisis?

Perhaps some of both, but surely the economic trauma of the last few years reflects, first and foremost, a financial meltdown, even if the way forward must simultaneously treat other obstacles to long-term growth.

The writer,  a former chief economist of the IMF, is professor of Economics and Public Policy at Harvard University. Project Syndicate, 2012

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