Sat, Feb 06, 2016 - Page 9 News List

Slow start to the year is the global economy’s marshmallow test

By Jeffrey Sachs

The world economy is experiencing a turbulent start this year. Stock markets are plummeting; emerging economies are reeling in response to the sharp decline in commodities prices; refugee inflows are further destabilizing Europe; China’s growth has slowed markedly in response to a capital-flow reversal and an overvalued currency; and the US is in political paralysis. A few central bankers struggle to keep the world economy upright.

To escape this mess, four principles should guide the way. First, international economic progress depends on high international saving and investment. Second, saving and investment flows should be viewed as international, not national. Third, full employment depends on high investment rates that match high saving rates. Fourth, high private investments by businesses depend on high public investments in infrastructure and human capital. Let us consider each.

First, the international community’s goal should be economic progress, meaning better living conditions worldwide. Indeed, that goal has been enshrined in the new Sustainable Development Goals adopted in September last year by all 193 members of the UN.

Progress depends on a high rate of international investment: Building the skills, technology and physical capital stock to propel standards of living higher. In economic development, as in life, there is no free lunch: Without high rates of investment in know-how, skills, machinery and sustainable infrastructure, productivity tends to decline (mainly through depreciation), dragging down living standards.

High investment rates in turn depend on high saving rates. A famous psychological experiment found that young children who could resist the immediate temptation to eat a marshmallow, and thereby gain two marshmallows in the future, were likelier to thrive as adults than those who could not.

Likewise, societies that defer instant consumption in order to save and invest for the future are expected to enjoy higher future incomes and greater retirement security. When US economists advise China to boost consumption and cut saving, they are merely peddling the bad habits of US culture, which saves and invests far too little for the US’ future.

Second, saving and investment flows are international. A nation, such as China, with a high saving rate that exceeds local investment needs, can support investment in other parts of the world that save less, notably low-income Africa and Asia.

China’s population is aging rapidly and Chinese households are saving for retirement. The Chinese know that their household financial assets, rather than numerous children or government social security, is likely be the main source of their financial security.

Low-income Africa and Asia, on the other hand, are both capital-poor and very young. They can borrow from China’s high savers to finance a massive and rapid buildup of education, skills and infrastructure to underpin their own future economic prosperity.

Third, a high international saving rate does not automatically translate into a high investment rate; unless properly directed, it can cause underspending and unemployment instead.

Money put into banks and other financial intermediaries (such as pension and insurance funds) can finance productive activities or short-term speculation; for example, consumer loans and real estate.

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