A specter is haunting the treasuries and central banks of the West — the specter of secular stagnation. What if there is no sustainable recovery from the economic slump of 2008 to last year?
What if the sources of economic growth have dried up — not temporarily, but permanently?
The new pessimism comes not from Marxists, who have always looked for telltale signs of capitalism’s collapse, but from the heart of the policymaking establishment: former US secretary of the Treasury Larry Summers under former US president Bill Clinton, and chief economist of almost everything at one time or another.
Summers’ argument, in a nutshell, is that if the expected profitability of investment is falling, interest rates need to fall to the same extent. However, interest rates cannot fall below zero (in fact, they may be stuck above zero if there is a strong desire to build up cash balances). This could result in profit expectations falling below the cost of borrowing.
Most people agree that this could happen at the depth of a slump. It was to avert this possibility that central banks began pumping money into the economy after 2008.
The novelty of Summers’ argument is the claim that “secular stagnation” began 15 to 20 years before the crash.
True enough, interest rates were falling, though not as fast as the fall in expected profit on new investment. So, even in the so-called boom years, most Western economies were kept afloat not by new investment, but by asset bubbles based on increasingly unsustainable leverage.
The generalized version of this proposition is that secular stagnation — the persistent underuse of potential resources — is the fate of all economies that rely on private investment to fill the gap between income and consumption. As capital becomes more abundant, the expected return on new investment, allowing for risk, falls toward zero.
However, this does not mean that all investment should come to an end. If the risk can be eliminated, the investment engine can be kept going, at least temporarily.
This is where public investment comes in. Certain classes of investment may not earn the risk-adjusted returns that private investors demand. However, provided that the returns are positive, such investments are still worth making. Given near-zero interest rates and idle workers, it is time for the state to undertake the rebuilding of infrastructure.
Those who know their history will recognize that Summers is reviving an argument advanced by the US economist Alvin Hansen in 1938.
Owing to a slowdown in population growth, and thus lower “demand for capital,” the world, Hansen said, faced a problem of “secular, or structural, unemployment … in the decades before us.”
The prolonged boom that followed World War II falsified Hansen’s projection. However, his argument was not foolish; the assumptions underlying it turned out to be wrong. Hansen did not anticipate the war’s huge capital-consuming effect, and that of many smaller wars, plus the long Cold War, in keeping capital scarce. In the US, military spending averaged 10 percent of GDP in the 1950s and 1960s.
Population growth was boosted by a war-induced baby boom and mass immigration into the US and Western Europe. New export markets and private investment opportunities opened up in developing countries. Most Western governments pursued large-scale civilian investment programs: Think of the US interstate highway system built under former US president Dwight Eisenhower in the 1950s.