Six years after the global financial crisis, most advanced economies continue to struggle with an anaemic recovery. It is feared that the global economy might never be able to regain the growth rates prior to the financial crisis. One possible cause of this weak recovery is “secular stagnation”. In November 2014, this 1930’s era concept was re-introduced by the former Treasury Secretary of US, Lawrence Summers.

Growth gutter

The IMF defines secular stagnation as a fall in the potential growth rate of the economy due to a slowdown in technological innovation, low growth of population, increase in life expectancy and reduced investment in infrastructure and education. In addition, increasing inequality leads to increased savings by the rich. If per capita income stays at reasonably high levels, savings as a percentage of income tend to exceed investment, especially in education and infrastructure. This leads to a fall in growth rates.

Consumers can also expect this in their own economy and transfer their savings to foreign economies. Paul Krugman says, “In secular stagnation, zero policy interest rates aren’t enough to restore full employment.” Low interest rates undermine monetary policy effectiveness as they give little room for conventional monetary policy to impact investment through a cut in interest rates.

Secular stagnation is an even bigger concern for the European Union, as well as Japan. The World Economic Database shows that the combined growth rate of GDP of advanced economies was 18 per cent between 2000 and 2007; but between 2007 and 2014, the same economies grew at only 6 per cent, over 10 per cent below the projected trend. Both real and nominal GDP growth rates in the US, Britain, Japan, Germany, France and Italy have slowed below 2 per cent and 4 per cent, respectively.

Ageing populations One reason for low investment and resulting stagnation is the demographics of these economies. An ageing population reduces productivity as well as the workforce. The working age population has been declining in Japan, the UK, as well as in the US. In the US, the workforce is expected to increase by only one-third of the 0.9 per cent rate that prevailed in the period 2000-2013. According to OECD, the ratio of the number of workers between 20-64 and those over 65 has decreased from 6.97 in 1950 to 4.59 in 2010 and is expected to fall to 2.53 in 2050. In Japan, the same ratio is expected to fall from 9.98 in 1950 to 1.27 in 2050.

The corresponding figures in the UK, Germany, Italy and France all point to the same decline. Growth is a result of an increasing labour force as well as increasing productivity. With technological innovations having already increased productivity substantially in the last few decades, it is now even more challenging to increase productivity any further.

These factors translate to a fall in long run growth potential. Hence, a deficit in demand due to a savings glut and pessimistic projections of labour supply have made the spectre of secular stagnation an uneasy one across the world. In addition, as long as actual output is below potential output, investment slows down and human capital is eroded, reducing total factor productivity.

Possible solutions Various economists have been debating over an exit route from this secular stagnation. Quantitative easing despite several rounds has failed to recover the economy.

However, monetary policy can help if the central banks of these economies commit to higher inflation target so as to reduce the real interest rates further. Increased public spending is an alternative route, albeit at the risk of high fiscal deficit.

But Europe’s fiscal position and demographics are far worse than the US, making the recovery more tenuous.

Data from the US is positive but EU, Japan and even Australia continue to grapple with an uneasy spectre of secular stagnation.

The writers are professors at ICFAI Business School (IBS), Mumbai

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