MILAN – The world is facing the prospect of an extended period of weak
economic growth. But risk is not fate: The best way to avoid such an
outcome is to figure out how to channel large pools of savings into
productivity-enhancing public-sector investment.
Productivity gains are vital to long-term growth, because they
typically translate into higher incomes, in turn boosting demand. That
process takes time, of course – especially if, say, the initial
recipients of increased income already have a high savings rate. But,
with ample investment in the right areas, productivity growth can be
sustained.
The danger lies in debt-fueled investment that shifts future demand to
the present, without stimulating productivity growth. This approach
inevitably leads to a growth slowdown, possibly even triggering a
financial crisis like the one that recently shook the United States and
Europe.
Such crises cause major negative demand shocks, as excess debt and
falling asset prices damage balance sheets, which then require increased
savings to heal – a combination that is lethal to growth. If the crisis
occurs in a systemically important economy – such as the US or Europe
(emerging economies' two largest external markets) – the result is a
global shortage of aggregate demand.
And, indeed, severe demand constraints are a key feature of today's
global economic environment. Though the US is finally emerging from an
extended period in which potential output exceeded demand, high
unemployment continues to suppress demand in Europe. One of the main
casualties is the tradable sector in China, where domestic demand
remains inadequate to cover the shortfall and prevent a slowdown in GDP
growth.
Another notable trend is that individual economies are recovering from
the recent demand shocks at varying rates, with the more flexible and
dynamic economies of the US and China performing better than their
counterparts in the advanced and emerging worlds. Excessive regulation
of Japan's non-tradable sector has constrained GDP growth for years,
while structural rigidities in Europe's economies impede adaptation to
technological advances and global market forces.
Reforms aimed at increasing an economy's flexibility are always hard –
and even more so at a time of weak growth – because they require
eliminating protections for vested interests in the short term for the
sake of greater long-term prosperity. Given this, finding ways to boost
demand is key to facilitating structural reform in the relevant
economies.
That brings us to the third factor behind the global economy's anemic
performance: underinvestment, particularly by the public sector. In the
US, infrastructure investment remains suboptimal, and investment in the
economy's knowledge and technology base is declining, partly because the
pressure to remain ahead in these areas has waned since the Cold War
ended. Europe, for its part, is constrained by excessive public debt and
weak fiscal positions.
In the emerging world, India and Brazil are just two examples of
economies where inadequate investment has kept growth below potential
(though that may be changing in India). The notable exception is China,
which has maintained high (and occasionally perhaps excessive) levels of
public investment throughout the post-crisis period.
Properly targeted public investment can do much to boost economic
performance, generating aggregate demand quickly, fueling productivity
growth by improving human capital, encouraging technological innovation,
and spurring private-sector investment by increasing returns. Though
public investment cannot fix a large demand shortfall overnight, it can
accelerate the recovery and establish more sustainable growth patterns.
The problem is that unconventional monetary policies in some major
economies have created a low-yield environment, leaving investors
somewhat desperate for high-yield options. Many pension funds are
underwater, because the returns required to meet their longer-term
liabilities seem unattainable. Meanwhile, capital is accumulating on
high-net-worth balance sheets and in sovereign-wealth funds.
Though monetary stimulus is important to facilitate deleveraging,
prevent financial-system dysfunction, and bolster investor confidence,
it cannot place an economy on a sustainable growth path alone – a point
that central bankers themselves have repeatedly emphasized. Structural
reforms, together with increased investment, are also needed.
Given the extent to which insufficient demand is constraining growth,
investment should come first. Faced with tight fiscal (and political)
constraints, policymakers should abandon the flawed notion that
investments with broad – and, to some extent, non-appropriable – public
benefits must be financed entirely with public funds. Instead, they
should establish intermediation channels for long-term financing.
At the same time, this approach means that policymakers must find ways
to ensure that public investments provide returns for private investors.
Fortunately, there are existing models, such as those applied to ports,
roads, and rail systems, as well as the royalties system for
intellectual property.
Such efforts should not be constrained by national borders. Given that
roughly one-third of output in advanced economies is tradable – a share
that will only increase, as technological advances enable more services
to be traded – the benefits of a program to channel savings into public
investment would spill over to other economies.
That is why the G-20 should work to encourage public investment within
member countries, while international financial institutions,
development banks, and national governments should seek to channel
private capital toward public investment, with appropriate returns. With
such an approach, the global economy's “new normal" could shift from
its current mediocre trajectory to one of strong and sustainable growth.
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