Global growth continues to disappoint. The recent annual meetings of the IMF and the World Bank in Lima struck a gloomy note, with growth forecasts lowered yet again. Economic recovery in advanced economies remains hesitant, with successive forecasts of a stronger rebound failing to materialize. In emerging economies, which initially had shown resilience in the wake of the global financial crisis, growth has weakened as well, with 2015 marking the fifth consecutive year of declining growth. Barring a few bright spots, the slowdown in growth is quite generalized.
Recoveries from major financial crises can be protracted. But almost 8 years after the global financial crisis, is a slow and uneven cyclical recovery still the right conceptualization of the persistent weakness of the global economy? Analyses increasingly point to the need to move beyond traditional business cycle models and see the problem instead as a deeper, longer-term slowing of growth. The persistence of weak growth even with very loose monetary policies has evoked fears of secular stagnation.
While there is growing recognition that the growth slowdown is more than a cyclical phenomenon, driven by deeper and longer-term factors, opinion remains divided on the policy response. Some have focused on persistently insufficient aggregate demand and pushed for additional macroeconomic measures to lift demand, especially calling for fiscal expansion since monetary policy in many cases is already stretched to the limit. Others have put the focus on structural factors that impede investment, employment, and productivity and called for stepping up structural and institutional reforms. This is not as stark as a typical Keynes versus Hayek debate, but the two viewpoints reflect substantively different positions on the core elements of a strategy to revive growth. Indeed, at times they come across as a binary demand- versus supply-side debate.
The two viewpoints, especially in their more strident formulations, represent a false dichotomy. The growth agenda needs to include elements advocated by both sides of the debate. Rather than see the agenda as macro (demand) versus structural (supply), it should be viewed as macro-structural, as both macroeconomic and structural policies are needed.
Not only actual growth has declined; potential growth has as well. Based on current trends, the IMF’s April 2015 World Economic Outlook projected potential growth in advanced economies at 1.6 percent in 2015-20, compared to 2.3 percent in the 2001-07 pre-crisis period. For emerging economies, potential growth was projected at 5.2 percent in 2015-20, compared to around 7 percent in 2001-07. The drop in potential growth reflects a combination of longer-term factors including declines in capital, employment, and productivity growth. There is a need to boost demand to lift actual growth and eliminate continuing output gaps, but there is also a need to boost the supply side to reverse the decline in potential growth.
Demand- and supply-side policies can be mutually supportive. Boosting demand and lifting growth can also enhance future potential growth. This is because protracted low investment and high unemployment can undermine productivity and labor skills. Structural reforms that raise expected potential growth can spur demand today by boosting confidence and also enhance the growth impact of demand policies by removing structural bottlenecks. While some structural reforms can affect aggregate demand negatively in the short run, reforms can be so sequenced as to support demand and target binding constraints with the largest growth payoff.
Boosting investment is a central element of the agenda to reinvigorate growth, and it is also one that illustrates well the interplay of demand- and supply-side factors. Investment increases demand today and, if implemented well, also expands future supply potential. While not all countries need to expand investment (China, notably, needs to engineer a shift from investment to consumption), investment at the global level currently is estimated to be about 20 percent lower than what it would have been in a normal cyclical recovery. Where economic circumstances warrant and fiscal space exists, countries should implement additional fiscal stimulus programs focused on increasing public investment, especially in infrastructure—in the process also taking advantage of the current low borrowing costs. But this is more than just a matter of spending more. The growth impact will depend importantly on structural measures that affect the composition and quality of spending and supporting policy frameworks. High public indebtedness in most countries reinforces the need to ensure efficiency and sustainability of spending.
Private investment must rise as well. Pump-priming demand through fiscal stimulus can help spur private investment, especially if the additional spending is directed to alleviating infrastructure constraints. But the business environment must also be improved through regulatory reforms to spur competition and innovation in order to lift productivity and enable firms to adjust flexibly to new challenges and opportunities. Also important is further financial sector reform to support orderly deleveraging from high crisis-era indebtedness and improve the intermediation process to channel savings to productive investments.
Another key element of the agenda is to strengthen labor force participation and boost employment. Like investment, this element involves interplay of demand and structural factors. Macroeconomic policies that lift demand must be accompanied by reforms in the labor market and tax and transfer systems that remove disincentives to labor force participation and facilitate labor market adjustment as well as actions to improve education and training. Demographic transition and the dynamics of international competition make these reforms even more important.
The persistent weakness of global growth calls for a stronger and more balanced policy mix that cuts across the binary divide between demand- and supply-side measures that often characterizes the current policy debate on growth. The core of the growth agenda consists of expansion of investment complemented by product and labor market reforms. Within this agenda, specific policy needs and priorities will of course differ across countries depending upon their circumstances.
Todd Stern speaks at The Economist’s Climate Risks Summit.