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ARE THE ADVANCED ECONOMIES IN FOR A LONG PERIOD OF ECONOMIC STAGNATION?
Tatiana Yepifanova
PhD,Rostov State Economic University (RINH) (Russia, Rostov-on-Don)
Yury Grigoriadi Caterham School (UK, London)
Abstract:
The article covers the causes for secular stagnation in world's advanced economies, including Japan, USA and Eurozone. As the research has shown one of the primary causes low and persistent GDP growth is the staggering job sector, clotted by youth unemployment. The reasons for such a situation are the growth in aging population and soaring levels of youth economic inactivity.
Key terms: Secular stagnation - a prolonged period of zero or low economic growth; Globalization - the process of global market integration; Productive capacity- is the maximum possible output of an economy.
Introduction
When a world champion swimmer falls short of his best speeds, it is hard to figure out whether he is temporarily on poor form, or has permanently lost his shape. This is true to some extent if used to mirror the performance of those considered the «more» developed economies. Although the performance of American and European markets has been far from its «top shape», it seems that the «sportsmen» are past their best years and are now on track for retirement, where their places will be taken by the more prosperous and fit «BRIC» economies. But enough with analogies as the underlying question remains: are the advanced economies in for a long period of economic stagnation?
Explaining the term and the current problem
Considering the issue it is important to understand that stagnation, or in more technical terms «secular stagnation» refers to a condition of negligible or no economic growth in a market-based economy. After financial crisis in 2008, global financial institutions suffered massively due to several reasons, one of them being a burst in the U.S. housing bubble. Borrowing was encouraged by the use of expansionary monetary policy, when Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%1. Excessive growth in credits contributed massively, so when the burst happened a large number of banks had to be bailed-out by the government. More fuel was added due to the fact that the economy was booming, the current account deficit grew, which forced the U.S to borrow more money from abroad in order to finance the deficit. The crisis had damaging consequences over the global economy, placing it into a severe recession which would eventually turn into the worst since the early 1980s recession with negative 2009 growth for the U.S., Eurozone, UK and other developed countries2. So by the end of 2010 we are faced with the problem that the world's most advanced economies are on a downturn of the economic cycle, with little hope for a quick recovery.
Main Body (research and judgment)
Globalization has had a a great impact on Europe's path to economic recovery. Close integration of markets is perfectly illustrated by the European Union, where there is a free trade area, without any barriers or external tariffs. Therefore if one economy suffers the effect resonates across the others. This was felt by the whole of the EU during the
1http://en.wikipedia.org/wiki/Financial_crisis_of_2007-08, easy credit conditions
2http://en.wikipedia.org/wiki/Financial_crisis_of_2007-08, effects
on the global economy, global effects
Greece crisis and contributed to increasing levels of government debt. Germany's growth was significantly slowed down due to the fact that it effectively had to bail out some of the «sinking» European economies such as Spain and Greece. That has contributed massively to the EU's internal debt and acted as a constraint to the GDP growth as government spending stayed low.
With the demand side shock, firms were forced to cut the costs as much as possible to prevent them from going broke. In the case when the economy is on its downturn, a rise of unemployment is predictable as businesses start «sacking» workers. This feature of recession feeds itself as with increasing numbers of unemployed labour the growth rate suffers greater damage.
However there is another issue with the «richer» world, which drags the advanced economies in stagnation, which is the aging working population. Across the rich world, older men with good education increasingly work longer. 65% of American working men aged 62-74 have a professional degree3. The picture is pretty much clear - the elder workers with high education squeeze the youthful unskilled population. The pattern in the EU is similar. The phenomenon occurring is the widening gap between the well-educated and the unskilled poor across all the age groups. The wages of those at the top are soaring, whereas on contrast the unskilled are being further dragged into poverty. But why is it that the elderly «hog» the jobs and employment amongst the younger ones is falling? Partly the reasons are that the well-educated older part of the population is putting off retirement while a big part of the less-skilled younger people have dropped out of the workforce. There is a multiplier effect to it as well turning the issue into a vicious cycle. With rising living standards and health care, life expectancy rises as well, therefore the «occupation period» of the valuable working spaces is likely to extend. Moreover the fact that taxation is high in order to guarantee high quality public services, families tend to be small which not only reduces the population, but also contributes to shrinking numbers of workforce. Global population of those aged 65 or more is likely to double over the next 20 years, reaching as high as 1.1 billion4, making it even harder for the younger ones to get employed. Rising standards of education has a massive contribution to it as well. As university graduates will struggle less to find the desired place to work, those who are unskilled are likely to become «economically inactive». Pay is rising sharply for those who are well-educated, however the ones
3 The economist(April 26th-May 2nd 2014) page 11, «A billion shades of grey», line 12
4 The economist(April 26th-May 2nd 2014) page 11, «A billion shades of grey», line 28-29
with lack of qualification are being dragged to poverty. The main reasons due to such misallocation of resources is technological shift. As the machines takeover the places, where manual labour was applied in the past, squeezing the «unskilled» part of the global population who used occupy those places. New jobs are being created requiring new qualifications ranging from management and creativity to IT, and these skills do not necessarily decline with age.
Such problem is likely to hit the growth rates dramatically as the levels of economic inactivity will soar. Those out of job and education will struggle massively to find a job and can become a financial burden to the government. Government transfers will deteriorate with rising demand for benefits, and it will only get harder for those currently on benefits to find themselves employed later on. The gap between the rich and the poor, or for advanced economies it would more appropriate to say the educated and less skilled is further widened by accumulating wealth. As the rich kids inherit their parents wealth, the poor kids inherit their parents debts. Not only it becomes harder for the poor to escape from the poverty cycle, it also discourages them from receiving good education. Most go straight into work after school, without entering the high education. Currently it still may seem as more worth it, because university fees are rising in
such countries as the UK, however in long term those lacking skills are very unlikely to receive larger income. While the earnings of university graduates are growing exponentially, the gradient of the wages/time curve of the unskilled tends to 0.
The damage is felt across the whole economy. The productive potential is falling as less labour is economically active, which causes a drop in aggregate demand. The driving force of the economy is now weakened as the level of consumption falls. The rising number of people on benefits is likely to hit government transfers as well as the tax revenue receive by the government will fall. In order to compensate the loss, the government will be forced to target the rich more, but this is dangerous as this can cause more firms to shift trading to other markets with more favorable tax burden. Stagnation is inevitable without economical changes, however those are tricky to implement. With aging population, lions share of the electorate is going to be pensioners and the elderly. Therefore they determine which manifesto comes into power, by granting the politicians what's called a «popular mandate». In order to maintain high levels of support, the policy contents are likely to be conservative and those in the government are likely to pander to the elderly as oppose to putting disruptive reforms into practice.
The big shift
Old-age dependency, population aged 65 and over per 100 people aged 25-64
1 2000
12010
12035*
Germany Rich world
Developing world
Source: UN Population Division
With aging working population the spending to savings ratio is likely to change its pattern. As people are extending their working in order to finance their retirement in the future they are more likely to save. The financial crisis in 2008, has lead to a large proportion of pensioners to lose their savings which accumulated over the years, so rising anxiety and the willingness to sponsor a happy and safe retirement is likely to encourage the elderly to save more. As the «old-age dependency ratio» is growing faster than before, reaching as high as 69 old people working for every 100 of working age in Japan5, the economy is facing an inevitable threat of stagnation. Low consumer confidence rating is fueling the problem as consumption is further discouraged due to people feeling pessimistic about the state of the economy. This was clearly indicated in the UK in 2011. Although the interest rates were record low of 0.5%, consumer confidence was as low as (-29)6 and the trend doesn't seem to recover. It seems anomalous that low interest rates do not encourage spending,
but people feel safer with the money in the bank account, despite the fact that it is not «working money».
Such a change in the pattern of consumers spending firms are discourage to invest, and government cannot further increase spending as public sector debt is as high as 80% of GDP in the UK7. The aggregate demand further deteriorates causing stagnated, slow growth. All the economic boosts seem to have a short term effect without solving the problem. The Olympic Games were predicted to give that essential «kick» to the UK economy, yet the interest rates are still low and the growth of GDP is 0.8% as of Q1 20148. The argument is that financial crisis had caused a huge slump in the global economy, meaning a long and slow recovery.
On the other hand aging population doesn't necessarily imply that productivity levels will fall. In such advanced economies as Japan and Germany the technology is finding its ways to maintain high levels of output. In the age of ever-smarter machines, manual labour is being done by robots, and the the question of productivity only arises when talking
5 The economist (April 26th-May 2nd), page 22 «Age invaders», the diagram was taken from the same article, page 23
6http://www.marketresearchworld. net/content/ view/1908/77/
7http://www.bbc.co.uk/news/business-25944653 8http://www.bbc.co.uk/news/10613201
about the tertiary sector of the economy, where the major part of the worlds population finds their place of work. However the motivation and determination aspects of personality may not necessarily be higher amongst the young ones, the more important determinant of productivity is certainly education. For these reasons a soaring group of highly educated older folk could offset the effect of shrinking workforce.
The patterns of economic growth have also shown some progress over the last two years. Although the levels are not as high as they were before the financial collapse, the
improvement suggests that the economies are not staggering. The figure shows that GDP growth rate has been improving and is now positive comparing to figures in 2013. Although 0.2% is nowhere near the target growth rate, the improvement signs are already an important step forward. Consumer confidence ratings have gone up significantly from being as low as -17.3% in June 2013 to -7.4% in July 20149, meaning that consumption is likely to face an increasing trend, leading to growth in aggregate demand and hence increase in national real output.
Although there is a lot to be done about soaring figures of youth unemployment and more importantly, economic inactivity which is an important concern in most of the EU countries (France for instance has 33% of men aged 15-74 registered as economically inactive10) total unemployment has gone down. In the UK the most recent figure as of June 2014 is 6.6% (2.16 million) unemployed. This is clearly progressing exponentially comparing to 2008 where there were almost 2.5 million people seeking job11 and hence meaning that more human resources are put into use, meaning that the economy operates closer to it PPF. A solution can also be seen in softening of the immigration policies to allow more younger workers to come from middle east and potentially Eastern Europe, however it doesn't solve the problem caused by education and may contribute to a further widening of the gap between rich, well-educated elderly and poor, unskilled youth.
Conclusion
For now it is hard to say directly whether the advanced economies are going to face stagnation for a long period of time. Clear premises have been shown as «richer» countries recover from the catastrophe that occurred in 2008. The «sportsmen» should seriously change their training program if they wish to return to the worlds economic arena in the near time. The labour market is in need of fresh blood to displace the old folk who are occupying those highly paid job places. This will give the economy an essential boost and broaden its production possibility frontier. Effects of globalization should be smoothened out by better management
in such financial institutions as IMF and the World Bank. In order to see the improvements politicians should act decisively with fiscal changes in order to prevent stagnation from happening in long-run. But for now the situation seems reasonably clear, advanced economies are suffering from secular stagnation and this process has the potential to strangle GDP growth for quite a long time.
Literature:
1. http://en.wikipedia.org/wiki/Financial_crisis_of_200 7-08, easy credit conditions
2. http://en.wikipedia.org/wiki/Financial_crisis_of_200 7-08, effects on the global economy, global effects
3. The economist (April 26th-May 2nd), page 22 «Age invaders», the diagram was taken from the same article, page 23
4. The economist( April 26th-May 2nd 2014) page 11, «A billion shades of grey», line 12
5. The economist( April 26th-May 2nd 2014) page 11, «A billion shades of grey», line 28-29
6. http://www.marketresearchworld.net/content/view/1 908/77/
7. http://www.bbc.co.uk/news/business-25944653
8. http://www.bbc.co.uk/news/10613201
9. http://www.tradingeconomics.com/euro-area/consumer-confidence
10. https://research.stlouisfed.org/fred2/series/LRIN74 MAFRQ156N
11. http://www.bbc.co.uk/news/business-27791749 and
12. http://www.bbc.co.uk/news/10604117
9http://www.tradingeconomics.com/euro-area/consumer-confidence 11http://www.bbc.co.uk/news/business-27791749 and
10https://research. stlouisfed. org/fred2/series/LRIN74MAFRQ156N http://www.bbc.co.uk/news/10604117
