Rediscovering Growth. Andrew Sentance
performance by comparison with the pre-2007 growth period. It is also slow growth by comparison with previous economic recoveries in the major Western economies. Average economic growth in the United States in the first five years of this recovery (2010–14) is expected to be 2.2% per annum, compared with 3.8% and 3.3% in the equivalent phases of the 1980s and 1990s recoveries. In the four major European economies, the IMF expects to see annual growth of just 0.9% in the period 2010–14, which is around half the growth rate achieved in the equivalent five years in the 1980s and 1990s (2.0% and 1.6%).
The global financial crisis has clearly played a part in contributing to this experience of slow growth – both in terms of the big shock it delivered to many economies and the impact it has had on access to finance. The pre-2007 world of ‘easy money’ – in which the financial system was providing a substantial tailwind to economic growth – has been replaced by a much more cautious and restricted banking system in many countries. But this change in the financial climate has not been the only factor at work. In Chapter 3 we will discuss how a combination of economic headwinds is contributing to this New Normal of disappointing economic growth in the West. There are, however, a number of myths and misperceptions have grown up about the reasons for disappointing growth in the major Western economies. And it is helpful to dispel some of these at the outset.
Myth 1: Global growth is weak
The first myth is that disappointing growth in the major Western economies reflects a weak global economy more generally. That is not true. Across the world economy as a whole, real economic growth is averaging close to 4% over the course of this recovery8 – not as strong as the peak years in the mid 2000s when the world economy was booming, but very respectable by comparison with historical trends. The slowdown experienced in the West has not been shared by the leading emerging market economies, as Figure 1.2 shows. In the emerging and developing world, economies have generally bounced back to the strong rates of growth they were experiencing before the crisis. Indeed, the IMF is expecting the same rate of growth in the emerging market and developing economies in the five years to 2014 as we saw in the decade to 2007 – nearly 6% per annum.
Figure 1.2. Robust growth in emerging economies. Source: IMF World Economic Outlook.
In the immediate aftermath of the financial crisis, there was also a concern that the world economy would lapse into deflation – a situation where the money value of spending stagnates or declines and where prices fall. Deflation was a feature of the depression of the 1930s, with US consumer prices falling by a quarter between 1930 and 1933. But these fears have not been borne out; instead the value of world economic output continues to expand, measured in terms of its most widely used currency, the US dollar. At the start of this century, the total value of economic activity in the world economy was $32 trillion. By 2008, this figure had nearly doubled to $61 trillion, a remarkably rapid rate of progress, averaging over 8% a year. After a brief dip in 2009, the size of the world economy has now expanded to an estimated $74 trillion in 2013. And by 2018, the IMF estimates that world GDP will be worth $97 trillion – around three times as much as at the turn of the century.
Despite a major global financial upheaval, the money value of output in the world economy has tripled in size in less than two decades. And it is inflation rather than deflation that has been the bigger problem as a result. This has been particularly true in emerging markets and developing economies, where growth has been strongest and consumer prices have risen on average by 6–7% in each of the last three years. One of the key drivers of inflation across the world economy in recent years has been rising energy, food and commodity prices. Since the early 2000s, whenever there has been a sustained pick-up in global growth, we have also seen a surge in the price of oil and many other commodities traded on world markets, including foodstuffs. This has happened repeatedly: in 2003–5, 2006–8 and in 2010–11.
In the major Western economies this has created bursts of the ‘wrong’ sort of inflation. We have been used to seeing inflation as a by-product of strong growth in our own economies. But imported inflation from rising energy and commodity prices squeezes consumers and business profits and hence acts as a dampener to growth in the short term. This squeeze has aggravated the problem of sustaining recovery since the financial crisis. And in countries which have seen a large fall in their exchange rate – like the United Kingdom – a devalued currency has added to the rise in imported inflation and the pressures on consumers to hold back spending.
Myth 2: Fiscal austerity to blame
A second myth that has grown up around disappointing Western growth is that it is primarily due to austerity – a squeeze on public spending and/or higher taxation – as governments seek to reduce their borrowing and debt levels. This view is particularly prevalent in the United Kingdom and in a number of other European countries, where efforts to restrain public spending have attracted a lot of news coverage and public debate.
It is true that government spending has not being contributing to growth in recent years. That is not a great surprise. Public borrowing levels were allowed to rise sharply in 2008–9 as the downturn eroded tax receipts and public spending was boosted in many countries to stabilize the economy. In 2009, public borrowing reached nearly 12% of GDP in the United States, 11% in the United Kingdom and over 6% of the national output of the euro area economies. These are unsustainable levels of borrowing which have pushed up government debt sharply and a period of spending restraint is therefore needed to restore stability.
But the notion that government spending is dragging down growth through austerity, either in the Western economies more generally, in the euro area or the United Kingdom, is misleading. Figure 1.3 shows that for the OECD economies as a group9, for the euro area and for the United Kingdom, real government spending on goods and services has been broadly flat after increasing quite significantly in 2008–9. The country where government spending has been cut back most noticeably in real terms is the United States. And yet the United States has been one of the better-performing Western economies in recent years, which casts further doubt on the view that fiscal austerity is responsible for weak growth.
Figure 1.3. Public expenditure in advanced economies. Source: OECD Economic Outlook.
The main source of the weakness of growth of demand in the Western economies is not from the public sector but from private consumer spending. There are various ways through which lower public spending can affect the willingness of consumers to spend – through its impact on public sector pay and the payment of pensions and benefits – but this does not appear to be the major cause of weak consumer spending. Nor can higher taxes be blamed – across the OECD economies the average tax burden as a share of GDP in 2013–14 is no higher than in 2007–8. There are other more important factors which have been squeezing consumers and making them more reluctant to spend, which are discussed in Chapter 3.
Myth 3: Not enough monetary stimulus
So if governments are not to blame for weak Western growth, what about central bankers? Could monetary policy have done more to restore growth to its previous trend? As we discussed above, monetary policy was used very aggressively in the depths of the financial crisis in 2008–9 to combat the negative trends in the major economies of the Western world. Official interest rates were reduced to near-zero levels across Europe and in North America. Beyond that, central banks have inflated their balance sheets as they have sought to pump money into the economy by purchasing government bonds and other assets. Former Goldman Sachs Chief Economist Gavyn Davies estimates that total central bank assets and liabilities have more than doubled in size in relation to the world economy since the early 2000s – rising from 14% of world GDP then to 32% now.10 The bulk of this expansion took place in response to the financial crisis.
Initially, these policies were successful as they stabilized economic and financial conditions and provided the basis of a recovery starting in the second half of 2009. But subsequent efforts to reinvigorate