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FINANCE and DEVELOPMENT
March 2017

Growth Conundrum Finance & Development March 2017  1

I N T E R N A T I O N A L M O N E T A R Y F U N D

FD
EDITOR-IN-CHIEF: Camilla Lund Andersen
MANAGING EDITOR: Marina Primorac
SENIOR EDITORS
Gita Bhatt Natalie Ramirez-Djumena FINANCE & DEVELOPMENT A QUARTERLY PUBLICATION OF
Jacqueline Deslauriers Rani Vedurumudi THE INTERNATIONAL MONETARY FUND
James L. Rowe, Jr. Chris Wellisz March 2017 • Volume 54 • Number 1
ONLINE EDITOR: Marie Boursiquot
ASSISTANT EDITORS
Babar Ahmed Bruce Edwards FEATURES
Eszter Balázs Maria Jovanović
Niccole Braynen-Kimani Nadya Saber GROWTH CONUNDRUM
Maureen Burke 2 Whither Economic Growth?
PRINT/WEB PRODUCTION SPECIALIST The global optimism at the turn of the century
Lijun Li
has been replaced by fear of long-term stagnation
EDITORIAL ­ASSISTANT: Robert Newman
Nicholas Crafts 2
COPY EDITOR: Lucy Morales
7 Cost of Aging
CREATIVE DIRECTOR: Luisa Menjivar As populations in richer nations get older, GDP growth slows, support costs
SENIOR GRAPHIC ARTIST: Michelle Martin rise, and government budgets feel pressure
ADVISORS TO THE EDITOR Ronald Lee and Andrew Mason
Bernardin Akitoby Laura Kodres
Celine Allard Tommaso Mancini Griffoli 10 Stuck in a Rut
Bas Bakker Gian Maria Milesi-Ferretti To revive global productivity, start by addressing the legacies of the
Steven Barnett Inci Otker-Robe financial crisis
Nicoletta Batini Laura Papi
Helge Berger Catriona Purfield
Gustavo Adler and Romain Duval
Paul Cashin Uma Ramakrishnan 14 Getting It Right
Adrienne Cheasty Abdelhak Senhadji Well-designed fiscal incentives can help spur
Luis Cubeddu Janet Stotsky
Alfredo Cuevas Alison Stuart innovation and ultimately growth
Thomas Helbling Ruud De Mooij
16 Rethinking GDP 14
© 2017 by the International Monetary It may be time to devise a new measure of
Fund. All rights reserved. For permission to
reproduce any F&D content, submit a request
economic welfare with fewer flaws
via online form (www.imf.org/external/ Diane Coyle
terms.htm) or by e-mail to copyright@imf.
20 Can Money Buy Happiness?
org. Permission for commercial purposes
also available from the Copyright Clearance People around the world share their thoughts on
Center (www.copyright.com) for a nominal what sparks this elusive feeling
fee.
24 Point-Counterpoint: Secular Stagnation
Opinions expressed in articles and other Sluggish Future 20
materials are those of the authors; they do J. Bradford DeLong
not necessarily reflect IMF policy. Policy Is the Problem
Subscriber services, Changes of address, John B. Taylor
and Advertising inquiries
IMF Publication Services 26 Straight Talk: The Case for Inclusive Growth
Finance & Development Emerging economies should share the fruits of their growth
PO Box 92780 more equitably
Washington, DC, 20090, USA
Telephone: (202) 623-7430
Tao Zhang
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E-mail: publications@imf.org ALSO IN THIS ISSUE
Finance & Development 30 A Middle Ground
is published quarterly by the International The renminbi is rising, but will not rule
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FROM THE EDITOR
40 Forests for Growth
Forests are a key asset for climate What to Do about Growth

D
stability; Brazil has shown protecting
EEP unease about rising inequality and stagnating
them is compatible with development
living standards in advanced economies was at the
Frances Seymour and Jonah Busch 40 heart of the 2016 political upheaval. Globalization
43 Risky Mix and trade have been blamed, but entrenched slow
If financial institutions combine banking and growth—what economists call secular stagnation—may be
nonbanking business there is potential for danger the real culprit. Parents who took for granted that their chil-
Ralph Chami, Connel Fullenkamp, Thomas dren would enjoy a brighter future had their dreams dashed
Cosimano, and Céline Rochon by the global financial crisis of 2008. Nine years later, rising
46 Unburnable Wealth of Nations populism and a return to nationalist, inward-looking poli-
Successful action to address climate change would cies threaten to unravel the postwar economic order.
diminish the value of fossil fuel resources in many As Nicholas Crafts of the University of Warwick argues
in our overview story, declining productivity growth—the
of the world’s poorest countries
main reason for slow growth and falling incomes—was evi-
James Cust, David Manley, and Giorgia Cecchinato
dent long before the crisis struck. This issue of F&D looks
at why and asks whether the world’s advanced economies
DEPARTMENTS should resign themselves to secular stagnation or hope that
28 Picture This the right policies can revive productivity and lasting eco-
nomic growth.
Girl Power 28 Diving into the causes of slow productivity growth, IMF
Policies that help integrate women into the economists Gustavo Adler and Romain Duval find roots
workforce benefit everyone in the global financial crisis—tight credit undermined
Maria Jovanović not only firms’ productivity but also the economy’s ability
50 Currency Notes to redirect capital. Other factors were also in play, espe-
cially aging populations. Ronald Lee of the University of
Fifty Marks the Spot 50
California, Berkeley, and Andrew Mason of the University
Trinidad and Tobago’s new of Hawaii, Manoa, argue convincingly that slower popula-
$50 bill is dressed for a celebration tion growth will almost certainly mean slower national
Marie Boursiquot income and GDP growth. But they also show that the effect
52 People in Economics on individuals—in per capita income and consumption—
will depend on economic policies.
Parallel Paths
We wonder what to do. Can policy choices calm fears
Atish Rex Ghosh profiles Kristin
about redistribution and fairness without shutting down
Forbes, who straddles academia
trade, the main engine of postwar economic growth?
and policymaking What drives higher productivity and innovation? How can
55 Book Reviews 52 advanced economies adapt to an aging workforce?
The Man Who Knew: The Life and Times of Alan First we must measure the right thing. Diane Coyle of
Greenspan, Sebastian Mallaby the University of Manchester discusses the pros and cons of
The Vanishing Middle Class: Prejudice and Power GDP to measure economic welfare.
in a Dual Economy, Peter Temin Second, we should not forget that two-thirds of the world’s
population—namely, those in developing and emerging market
A Culture of Growth: The Origins of the Modern
economies—face a different reality. Younger populations and
Economy, Joel Mokyr
still-vibrant productivity in many of these countries are driving
higher economic growth at home and in the global economy.
Illustration: cover: Michael Glenwood; pp. 28–29, David Hunt, ThinkStock, Freepik;
Third, we shouldn’t go overboard. Global trade has been
pp. 30, 32, iStock via Getty Images.
a leading force behind productivity growth, and barriers
Photography: pp. 2–3, Christof Stache/Getty Images; p. 5, Michael H/Getty against it would hurt all economies, large and small. Instead
Images; p. 7, Tuul & Bruno Morandi/Getty Images; p. 10, Orjan F. Ellingvag/
of reaching for easy answers, economists and policymakers
Corbis via Getty Images; p. 14, Toru Yamanaka/Getty Images; p. 16, Christopher
must probe their own economies’ challenges. As Berkeley
Jue/Getty Images; p. 24, courtesy of University of California, Berkeley; p. 25,
courtesy of Stanford University; p. 26, IMF photo; p. 34, Money Sharma/AFP/
economist Bradford DeLong argues, “Only if we do some-
Getty Images; p. 37, Mike Kemp/In Pictures Ltd./Corbis via Getty Images; thing about it, is it likely that in nine years we will no longer
p. 40, Ricardo Siqueira/Brazil Photos/LightRocket via Getty Images, ThinkStock; be talking about secular stagnation.”
p. 42, ThinkStock; p. 43, Ryan McVay/Getty Images; p. 46, Andrey Rudakov/
Bloomberg via Getty Images; pp. 50–51, Central Bank of Trinidad and Tobago; Camilla Lund Andersen
Carole Ann Ferris; p. 52, IMF photo; pp. 55–57, IMF photo. Editor-in-Chief
Read o n lin e a t w w w.im f.o r g /fa n d d
V isit F& D’s Fa c e b o o k p a g e :
www.facebook.c o m /F in a n c e a n d D eve lo p m e n t Finance & Development March 2017  1

Germany. 2   Finance & Development March 2017 .Whither ECONOMIC GROWTH? The global optimism at the turn of the century has been replaced by fear of long-term stagnation A man stands on scaffolding by construction works near Munich.

That could mean a continuation of to diminish by half. Compared capital flows away from advanced economies toward with 1995 to 2007. ing economies. period of low real interest rates and redirection of cial crisis that began in 2008 (see table). of a future of secular stagnation. so possible that today’s pessimism is excessive. Compared with the economy was ascendant and growth expectations golden age of the 1950s and 1960s. in which very Slower growth in Europe and the United States has slow growth will be the new normal—especially in mixed implications for growth prospects in develop- advanced economies. But today there is a widespread fear even more pronounced. of-the-century optimism was not justified. The slowdown may also United States and the European Union over the reduce the availability of new technology across the medium term represent a marked slowdown from world. the slowdown is were buoyant. While it is clear that the turn. a serious rapid catch-up growth and a faster rise in their share weakening of growth in labor productivity (output of world GDP. it is also it means less demand for these countries’ exports. GROWTH Nicholas Crafts I T seems like only yesterday that the so-called new per hour worked) is expected. future US and European growth emerging markets with more promising investment of real (after-inflation) GDP per person is expected opportunities. it may imply a lengthy growth rates in the decades prior to the global finan. models of development based on export-led growth Current mainstream growth projections for the may need to be rethought. Finance & Development March 2017  3 . Most obviously. especially for Europe. On the other hand. In each case. on the negative side. or worse.

Second. Even as Hansen was wringing his the combined effect of the earlier advances. as some estimates ing. not unknown for economists to make inac. and US Congressional Budget Office 2016.6 4. empirical world where artificial intelligence is progressing rapidly and economic analyses show that before the global economic robots will be able to replace humans in many tasks—includ- crisis there was a marked decrease in the trend of produc. lamented that “you can see the computer age everywhere but US growth could exceed expectations in the productivity statistics.9 percent a year underpinned labor pro- Real GDP Real GDP per Real GDP Real GDP per per person hour worked per person hour worked ductivity growth of 2. Nearly half a century later. Havik and others 2014. Alvin Hansen. Robert M. in the future the opposite will likely be the case. In the recent past. (annual growth rate. he said ter technology was widespread. Productivity growth is crucial to increasing the reach of technological advances—another surge of labor economic output per capita and the overall standard of liv. there is clear agree.2 2. Although there are reasons to think that some of the claim. In fact.0 4. Netherlands. If. recent global crisis typically exceeded that of labor productiv- Note: The EU15 are the countries that were members of the European Union prior ity.9 2.5 2. This is largely because the output that is missing—the of new technology to 20th century reliance on technology 4   Finance & Development March 2017 . Finland. in a mance.” This type of empirical analysis. United Kingdom. information and communica- future of sustained high unemployment.5 preclude rapid increases in productivity when the national 1995–2007 2. (see “Residual Brilliance” in the March 2011 issue of F&D). 2014–23 1. usually presages declining productivity). is inherently back- Today’s pessimism.0 1. It is.5 percent a year between 1929 and 1950–73 2. Portugal.4 growth of real GDP per person in the 40 years before the Sources: Conference Board 2016.0 1. Germany. Solow achieved in the 1930s. This out- to 2004: Austria. is a spectacular example. There are at least three reasons to think so. percent) to identify. including major changes technological progress was too weak to generate economic in office work and retailing as well as the mechanization of growth at a rate that would encourage investment and avert a factories. there is a glimmer of hope. and a significant slowing in the rate of improvement of labor quality that arises from Inaccurate predictions increases in educational attainment. of course. Dimming horizon gap between today’s GDP and predictions of what it should be based on earlier estimates of trend growth—is at least 20 Near-term projections of growth in both real GDP per person and times greater than most estimates of the consumer welfare productivity (real GDP per hour worked) are not promising for either gains that conventional national income accounting fails the United States or Europe. Innovation is the foundation of rapid growth in labor pro- curate predictions about future growth or to be slow to ductivity. but the key characteristic of the stagnation.9 1941—shows that severe banking crises do not necessarily 1973–95 1. about 40 percent of work is amenable to computer- gains from digital technology are not captured well by GDP ization within 20 to 25 years (Frey and Osborne 2013). Still. ward looking.0 0. Spain. Whereas 2016–26 1. Belgium. France. Greece.5 innovation system is strong. pects. Sweden.8 The future of income growth in the United States looks even less promising than that of labor productivity. For example. In his 1938 presiden. this and other national income accounts. productivity growth may be possible. however. Ireland. the founding father of the idea of secular engine had a major impact. the rise of China could boost world is not a statistical artifact but a real phenomenon—more research and development intensity considerably. well-known appreciate the scope for improved performance of productiv. Denmark. First. in 1987. including a revival of Hansen’s secu. the halcyon tion technology made a stellar contribution to productivity period of US economic growth during the postwar economic growth in a relatively short time span—but it did not match boom was on the horizon. come is predicted on the basis of an aging population (which Luxembourg. another leading US economist. a key hands the economy was experiencing very rapid growth in message from empirical analyses of US growth performance total factor productivity—the portion of economic growth is that the impact of technological progress on productivity not explained by increases in capital and labor inputs and growth has not disappeared but is now much weaker than at that reflects such underlying societal factors as technology its zenith in the mid-20th century.7 1. the growth and efficiency. Indeed. Italy.3 1. could underpin a return to labor productivity growth above ment among experts that slower growth in the United States 2 percent a year.2 2. inventions such as electricity and the internal combustion ity. The precedent of the Great Depression years—when total factor produc- United States EU15 tivity growth of 1. limited potential for more people in the workforce. on the in total factor productivity for the next 10 years projected eve of the revolution in information and communication by the US Congressional Budget Office is about half the rate technology. From the 1920s through the 1960s. US economy was that productivity growth based on bet- tial address to the American Economic Association. It is possible that a forward-looking approach lar stagnation thesis (see “Sluggish Future” in this issue could give a more optimistic view of future US growth pros- of F&D) is based on the recent history of growth perfor. For both the United States and Europe. Periods after 2016 are projections. Britain than a temporary symptom of the recent global economic switched from its 19th century role as the leading exporter crisis. ing in low-wage service sector jobs that once seemed out of tivity growth.

political agreements and corporatist structures that under- Luxembourg. which ended in the early 1970s. Finance & Development March 2017  5 . from the mid-1990s to the crisis. The first. productivity businesses. The upshot is a large weight on long-term real returns rather than tomor- that in 2007 the income level of the original 15 members of row’s share price. France. market rules and barriers to new entry in markets. with the arrival of disruptive new information and communication technology—whose productivity gains depended on businesses’ reorganization—employment pro- tection and product market regulation were bigger handi- caps. and Europe quickly narrowed the gap with the United States both in income and productivity. That was the result of a decline in work hours and employment despite strong growth in labor productivity and an ever smaller gap with the United Rapid growth during the European golden age of the 1950s States in real GDP per hour worked. from a surviving long tail of low- Aerial view of city overpass at dusk. United States. the move- phase. which had not prevented (but may have slowed) them from catching up. which ment—paves the way for discovery of useful new technology. for Western Europe the narrative is about of assembly-line manufacturing technology may fall short catch-up growth rather than the rate of cutting-edge techno. Moreover. fered from too little competition. The postwar Denmark. In service- oriented economies. placing than catching up. Italy. assimilate the technology developed by leaders (such as ity within the next few decades. European ity growth did not keep up with the United States and. and bility can be thought of as the incentive structures. Germany. However. European medium-term growth prospects depend both In the years before the 2008 crisis. During Innovation is the foundation of the second phase. and catch-up in terms of rapid growth in labor productivity. Put simply. from the early 1970s to the mid-1990s. American diagnosis of the reasons for this turn of events Economic historians see social capability as a key determi. recent global crisis. These forces were weaker in Europe than in the United States. It was not that Europe became more heavily regulated. even more critical were the forces of creative destruction. in the third and 1960s benefited from postwar reconstruction. been significant technological progress in ity varies with the technological epoch—institutional and the research and development sector. saw rapid catch-up growth. Much of the remaining productivity gap. especially the United regulation and taxation. European growth slowed markedly. To sus- communication technology revolution—by reducing the cost tain social capability as development progresses generally of accessing knowledge and greatly enhancing the scope for entails reforms of institutions and policies. Third. gained wide currency. Each of these had disappeared. Finland. it said that Europe suf- nant of success or failure in catch-up growth. Social capa. Portugal. by the late 20th century. From the middle of the 20th century to the advances in market services. United pinned the reconstruction of the European economy implied Kingdom) was slightly lower relative to that of the United not only much larger social transfers—which eventually States than it had been in 1973. Ireland. social capabil- There has. this experience comprised three distinct phases. may prove politically challenging. California. Greece. too much taxation. However. but that the existing regulation was more costly. European productiv. Netherlands. rather economic integration. such as too much regulation—which impaired social capability. real GDP per person ground to a halt. the information and the United States) and to eliminate inefficiency. especially in southern Europe. ment of labor from agriculture to manufacturing. been greatly weakened. policy settings that worked perfectly well for the transfer In contrast. which is the cornerstone of scientific advance. This was hardly a new turn of events—many European countries had arguably been in this position for some time. Los Angeles. when Europe was no on how fast productivity grows in the United States and longer catching up but falling behind the United States. A similar transition of roles between China and the innovation decisions that allow businesses to effectively United States does not seem beyond the realm of possibil. Europe steadily fell behind. such as capital- data analysis. an whether catch-up growth can resume after a long hiatus. when it comes to diffusing information and technology logical progress. in fact. Belgium. that is. and patient capitalism. generated substantially higher direct taxes that distorted economic behavior—but also bequeathed a legacy of high Social capability is key regulation for most EU countries. stemmed from less efficient allocation of resources—in particular. or at least the European Union (the so-called EU15—Austria. Sweden. which replace less efficient firms and old technology with those that are new and more efficient. that influence the investment and States.transfer from the rest of the world. Spain.

Listening can Found at IMF. as with (using a forward-looking approach that embodied a catch-up information and communication technology.org/podcasts tell us a great or on your favorite podcast app. Europe may well growth model rather than extrapolating recent trends). implementation of the European Union’s declared intention to Havik. www. and Valerie Vandermeulen. it envi. This is clearly much more bullish than Nicholas Crafts is Professor of Economics and Economic the extrapolation of recent trends by the European Commission. but it is not necessarily permanent. and that catch-up growth is still possible. trade costs associated with different regulations and other bar. European Union is a good example. US Congressional Budget Office. Osborne. History at the University of Warwick. “The Future exercises. Carl Benedikt. but this (OECD) made long-term potential growth projections in 2014 seems unlikely under current circumstances. “An Update to the Budget and ket economy throughout Europe. Anna Thum-Thysen. deal about the world 6   Finance & Development March 2017 . son growth of 1.United Kingdom. August. Werner Röger. between 2014 and 2030.” European the already difficult politics of such reforms have been further Economy Economic Papers 535. significant supply-side (structural) reform References: would be required. zon and fall further behind the United States. 2016. DC. reforming taxation. European Commission. Brussels. May. 2016 to 2026. Strengthening competition. OECD and the European Commission have undertaken such Frey. complicated by rising populism and ebbing support for the mar. 2013. 2016. Europe could grow faster than the United States. and of Employment: How Susceptible Are Jobs to Computerisation?” reducing regulation could play a big part—together with full Unpublished. respectively.Mixed prognosis In summary. Indeed. even though Technological progress is central to future productivity growth it has slowed. gov/publication/51908. The Conference Board Total Economy that could be expected to deliver the projected result. “The Production Function Methodology riers to entry for EU suppliers. Christophe Planas. as always. When but is. Listen to IMF PODCASTS featuring the brightest minds in economics and development. Alessandro Rossi. Both the Database. Oxford Martin School. struggle to exploit the potential of new technology on the hori- sioned potential EU15 labor productivity and real GDP per per. Fabrice Orlandi. the productivity slowdown in the United States The prognosis for growth in the EU15 is mixed. Kieran McMorrow.5 percent a year. create a single European market in services by eliminating the Rafal Raciborski. is that productivity is still rising in the United States. The good news is real and predates the crisis. But the very bad news is that for Calculating Potential Growth Rates and Output Gaps. The British vote to exit the Economic Outlook. With significant supply-side the Organisation for Economic Co-operation and Development reform. and Michael A.cbo. the bad news is that to achieve the outcome pro- jected by the OECD. It is not difficult to construct a list of reforms Conference Board. However. unpredictable.” Washington. Karel. 2014.6 percent and 1. Oxford.

nation if firms are discouraged from investing That will depend on how much. we look more tion and labor force growth—despite immi. Many empirical studies have found age. working-age people pay more more than 20 percent between 2015 and 2055. but on per capita. That should some degree by the old is covered by prime- lead to a corresponding decline in the growth age adults—those roughly 25 to 59—who Finance & Development March 2017  7 . and (productivity) and reduce interest rates as population growth also leads to rising output higher wages lower the return on capital. GROWTH Cost of Aging Card players in Naples. Ronald Lee and Andrew Mason A N aging population and slower rate of GDP and aggregate consumption. health and retirement programs for old people. Per capita output matters GDP growth Yet an aging population may raise the But individual well-being depends not amount of capital per worker. and the same is true on average for grew 1. lation ages. slows. the 20. that GDP growth slows roughly one to one which measure how people at various ages with declines in labor force and population produce. Many labor force growth affect economies advanced economies already have a declining in many ways—the growth of GDP working-age population—in Europe it will fall As populations slows. Consumption by children and to 0. closely at how economic activity varies by gration.org. To answer that question.24 percent a year. under the burden of the higher total cost of get older. and save resources growth—a disquieting prospect for both the (NTAccounts. but is projected at only the elderly. government Alternatively. drawing on national transfer accounts.29 percent for the next 40 years. of the baby boom led to a decline in popula. United Nations 2013). In the United States. during the 40 years from Children consume more than they pro- 1975 to 2015. in richer nations to support the elderly. United States and Europe. growth. will translate into higher per capita income. and wages per worker. Lee and Mason 2011. population aging and slowing tion is whether this higher output per worker budgets feel labor force growth could lead to secular stag. and public budgets strain with an attendant decline in GDP growth. consume. which would on aggregate. support boost wages and output per hour worked Standard growth models predict that slower costs rise. Italy.to 64-year-old population duce. increased productivity offsets the Economic growth is slowing in advanced rise in the number of dependents (old and economies at least in part because the end young) per worker. as the popu- pressure abundant loanable funds. The underlying ques.

(support ratio. and in-kind public transfers such as health care and long- term care. Another part comes income includes earnings. relative ally retire later and rely more on their own assets in old age. so either consumption must be reduced Earning and eating or labor supply increased—for example. in others. the proportion of workers declines.40 percent in (average per capita value. such as Austria and Spain. unless the labor supply 1. ages 25 to 59. Greater consumption Public sector transfers for pensions. 9 percent in the United States. and by the elderly may be partially offset by a smaller propor. This means that by 2050. corrected 1/27/2017 The lower the support ratio. 2015 = 100) Europe. These public transfers are paid for by taxes. labor income of the self-employed. funded by tax payments from the elderly. even after subtracting the portion to recover from current low levels. and elderly) will decline between now and 2050. Lee. and 13 percent in other high- 0. Sweden. proportion of high-consuming elderly rises. and Asia resembles the depicted in Chart 1.6 earning. a whole because the number of workers declines relative to Fiscal support ratios are a way to look at the problem. In some coun. This phenomenon is quantified by are constructed like support ratios. But in much of the rest of Asia (including Japan and Korea). the higher the proportion of consumption the Source: Mason.0 increases. where people gener- tries. the relative increase is much smaller.4 to accommodate new demographic realities. Between 2015 and 2050 the support ratio will drop while the young and elderly do the opposite. while the work—it is a recipe for heavy costs as the population ages. In the (which includes everyone—young. Lee.8 income countries. the less cost falls on prime-age Note: Other high income = the 24 countries classified as high income by the World Bank. long-term care are a particular problem as populations age. prime age. rely in part on their assets—including farms and businesses. mostly those paid by the prime-age adult population.2 Chart 2). Some consump- Chart 2 tion may come through net support (support received minus Burden sharing support given) from younger family members. and elderly). through later retire- Prime-age adults. older consumers Lee. and others. The elderly in The number of workers supporting consumers (young. the proportion of chil. the fiscal support ratio will drop 11 percent 8   Finance & Development March 2017 . like those shown in Chart 1.26 percent a year in the United States. prime age. Projections indicate that typically ing pressure on prime-age workers. forthcoming. Consumption is based on household from the government in the form of cash such as pensions expenditures imputed to individuals plus in-kind public transfers received by people at each age.2 Consumption Paying for elderly consumption 0 0 10 20 30 40 50 60 70 80 90 100 The elderly pay for consumption in a variety of ways. 1 = average labor income of ages 30–49) other high-income nations. east Asia get more support from their families than they give. 0. and others. and 0. United States. Note: The data cover the 24 countries classified as high income by the World Bank. the fewer workers there are to Chart 1 finance consumers. these programs will be unsustainable unless taxes are raised An aging population puts budgetary pressure on society as or benefits reduced or both. and the United States. benefits. Lee. health care. Besides Age what they may earn from continuing to work. corrected 2/10/2017 Source: Mason.82 percent in China (see 1. They the number of consumers. older people on average give more 120 to their younger family members than they receive. 1980 90 2000 10 20 30 40 50 In general. and savings and investments. absorb a large por- dren and old people in the population may increase. But if fertility rates begin because these payments. China US Other high income 110 100 An aging population puts 90 80 budgetary pressure on society 70 60 as a whole. boost. 0. index. heavy reliance on public sector transfers to pay for elder con- sumption. Labor housing. everyone). excluding the United States. The age patterns of consumption and 0. consumption must drop by 25 percent in China. When older people contribute little to their own produce more than they consume (see Chart 1). tion of public budgets. consumption by old people is much higher than the average Latin America is between the two. Labor income 0. except they relate taxpay- the support ratio of the total number of workers to consumers ers to beneficiaries rather than workers to consumers. United States. such as Japan. will have to be adjusted 0. ment. earn more than they consume. consumption—either through asset income or continuing to lation ages. forthcoming. The support ratio is the number of workers divided by the total adults as higher taxes (see Chart 3). and the Americas. As a popu. and an estimate of the value of labor supplied by unpaid family workers. elderly pay for themselves. The reverse is true in the United States. tion of children in the population. Europe stands out for its number of consumers (that is.

the United Kingdom. United Nations. Andrew. Jamaica. In this case. and for Japan it is 26 percent. Longer lives and lower fertil. France. GDP and between 2010 and 2050 from population aging. Spain. Population Division Technical Report. Should firms –20 0 20 40 60 80 100 120 become pessimistic. tax rev. The extent of the problem politically difficult task of restructuring their public trans. with high Source: National Transfer Accounts: www. eds. A third possibility is that those Measuring and Analysing the Generational Economy. Asia A long-term slowdown Firms may choose to cut investment in the domestic econ- Europe omy substantially. China. Korea. Taiwan lar stagnation (see “Sluggish Future” and “Whither Economic Province of China. “Macroeconomics. But it may also bring more capital per countries. Labor income includes earnings. edited by John Piggott the 1 percent a year decline in productivity during 2015–55 and Alan Woodland. VoxEU. Some governments are attempting the economy defies simple answers. Whether population aging is good or bad for the welfare component. just to offset these people do not support themselves by relying on assets the increased costs from the aging population. “Support Ratios ity raise saving rates. India. New York. Asset-based flows are and Europe’s failure to recover from the global financial crisis defined as asset income minus interest expense minus saving.­ labor force slows. Uruguay. labor income of the self-employed. the Philippines. Mexico. and office equipment involved in the pro. but thatStates ply in the United to balance tax revenues and expenditures in the public the effect on individuals—as measured by per capita income budget (federal. Latin America = Brazil. domestic workers will not benefit The sources of support for elderly consumption vary by region. and others.ntaccounts. and local combined) in 2050. where populations are younger and rates of return Old-age wallets may be higher. more assets than younger adults. Mason. Some economists inter- El Salvador. Amsterdam: Elsevier. compared with 1975–2015 implies a substantial increase in ———. if they think output and consumption growth will slow in response to a Latin America declining population and labor force. state. Public pret Japan’s virtually flat economic growth in recent decades and private transfers are net (transfers received minus transfers provided). interest rates. 59–118. not just the social (Lee 2016). adults may choose to save less. These fig. Ronald. unemployment for many years—a condition some call secu- Note: Asia = Australia. In the United States and most other coun. Growth?” both in this issue of F&D). Generational Economy: A Global Perspective. Lao P. and consumption—may be quite different. United tries.D. Cambodia. Secular Stagnation: benefits. ultimately reduc. 2016. then the per capita amount of capital (such as machines.” United Nations But in some scenarios capital per worker may not increase. If population aging forces governments to borrow more to pay Teulings.org. although returns (percent of consumption) on the foreign investments would still raise national income. and perhaps lower total factor productivity (the portion of economic growth not United States explained by increases in capital and labor inputs and that reflects such underlying factors as technology). roads. For European or their own labor. funds for private capital investment may be crowded Facts. Coen. the economy could remain stagnant. Population Division. Berkeley. References: duction of goods and services) would rise. London: Centre for Economic out. the corresponding number is between 14 percent worker and rising productivity and wages. Italy. Population Aging and the capital per worker. Lee. corrected 2/9/2017 tal markets. and Andrew Mason. 2014. Japan. Or if capital per worker does begin to rise and push down Policy Research.org eBook. benefits. boosting productiv. This means national income growth will most certainly slow down. Lee. Chile. even if central banks drive interest rates Labor income Public transfers Private transfers Asset-based flows below zero. Finance & Development March 2017  9 . New York. Costa Rica. Ronald Lee is a Professor of the Graduate School of the Univer- sity of California. Slovenia. and Richard Baldwin. As populations age and grow more slowly. or some combination of the two. Manoa. Ecuador. Causes and Cures. Department of with money to invest will seek higher returns in foreign capi.. government debt does not crowd out investment in capital ures refer to the total government budget. the elderly are net savers (Lee and Mason 2011) and hold Kingdom: Edward Elgar. Cheltenham. in these terms (Teulings and Baldwin 2014). National Transfer Accounts Manual: ing the increase in capital. Finland. In the United States. Aging and Growth. Economic and Social Affairs. and an estimate of the value of labor supplied by unpaid family workers.R. and Andrew Mason is a Profes- Productivity gains sor of Economics at the University of Hawaii. Thailand. Handbook of the Economics of Population Aging. reinforcing private saving. Sweden. Hungary. will depend on the severity of population aging and how well fer programs to address these issues—such as by raising the retirement age and linking the level of benefits more closely public policy adjusts to new demographic realities. Europe = Austria. and a If the overall saving rate remains the same while growth of the Senior Fellow at the East-West Center.” In ity and wages and reducing interest rates. Ronald Lee. Germany. and Demographic Dividends: Estimates for the World. particularly in developing regions and emerging Chart 3 economies. 2011. Colombia. through rising wages and higher productivity. particularly if and 28 percent. A graying popula- enues will have to be 11 percent higher or expenditures 11 tion will mean more old-age dependency. 2013. ■ to the availability of tax revenues. Forthcoming. to the extent that percent lower. even as interest rates fall.

private and public debt. But. productivity is inherently diffi- global The prospect of such inventions as cult to measure. to cure the affliction. This phenomenon is Lasting scars evident in advanced economies and seems Productivity growth comes from technologi- to extend to many developing economies as cal innovation and diffusion. over the past decade—and even if it has. to be happening faster than ever. California. it start by monplace suggests a new wave of technologi. and especially since the 2008–09 global financial crisis. we can see it everywhere protection systems. but there is no good reason to productivity. driverless cars. United States. sluggish productivity growth legacies of the more goods and services with less capital will seriously threaten progress in raising financial crisis and fewer hours of work—that is. past decade. robot lawyers. the viability of social ate Robert Solow. . These advances should raise our down. and there is no Workers wait to be called for jobs at Local 13 Longshore Workers Dispatch Hall. Stuck in a Rut Gustavo Adler and Romain Duval T To revive ECHNOLOGICAL change seems well (see Chart 1). It would The vexing truth is that output per worker be unwise to sit around and wait for artificial and total factor productivity—which mea. But. intelligence and other cutting-edge technolo- sures the overall productivity of both labor gies to spawn a hypothetical productivity and capital and reflects such elements as revival. to paraphrase Nobel laure. to be more global living standards. and suspect that measurement error has increased 3D-printed human organs becoming com. would hardly account for the bulk of the slow- addressing the cal progress. as recent studies show (Svyerson 2016). ability to respond to future shocks. the sustainability of productive. and economic policy’s but in the productivity statistics. we must technology—have slowed sharply over the first diagnose its root causes. 10   Finance & Development March 2017 Los Angeles. standard of living by allowing us to produce If sustained. Of course.

TFP is the portion of economic growth not explained by increased inputs of capital and labor. These factors appear to have fed a vicious circle between weak investment. Why did the credit crunch wreak such enduring harm on magnitude. In fact. the economic and policy uncertainty Note: Group averages are weighted using gross domestic product (purchasing power parity). percent) Advanced Economies Emerging Market Economies Low-Income Economies The dynamics following the global 3 financial crisis were no different. entered the crisis with sizable maturing loans and those with and Mojon 2016). tions. financial conditions tightened the most. total factor productivity. along with tight credit condi- Adler. The combination of two factors vis- slowed. firms with pre- Finance & Development March 2017  11 . Note: TFP = total factor productivity (deviation from pre-recession trend) in advanced Balance sheet vulnerabilities were compounded by hard- economies. and potential growth. those with high debt or substantial expiring loans— 2 before the crisis experienced a more abrupt productivity drop 0 than their counterparts with stronger balance sheets (Chart 3). total fac- Chart 2 tor productivity. If these firms had been doing badly –2 before the crisis. Adler. the rise of specific-knowledge-based capi. In those economies. and IMF staff calculations. may well remain a drag on productivity. gic businesses and insufficient labor and product market the postcrisis divergence in productivity between firms that reforms (Andrews. sets the global financial crisis apart shortage of explanations for why either or both may have from past recessions. and Gal 2015. and later the euro area crisis. or slowing global trade integration (IMF 2016). such as apply to developing economies. from the crisis shock. drop in productivity (see Chart  2). World Economic Outlook. Firms with more vulnerable balance sheets enjoyed productivity dynamics similar to those with lower vul- –8 –1 0 1 2 3 4 5 nerability until 2008. demographic factors such as aging popula. financing working capital may have forced distressed firms prits. But the abruptness. Cerutti. especially since investment but also a permanent the global financial crisis. with lingering adverse effects on productivity. Fernald. IMF. mismatched and tion suggests that the interplay between preexisting firm- deficient skills. The crisis itself is a first-order factor. or Unlike typical economic slowdowns. cul. and IMF staff calculations.0. and Sources: Penn World Tables 9.95corrected 20002/10/2017 1990 05 10 15 1990 95 2000 05 10 15 1990 95 2000 05 10 15 tions. not from intrinsically poor performance. for up to a third of the total slowdown in productivity after Many of these factors have played a significant role and the crisis in advanced economy firms. 2008–09 All 2 global How could a major—but seem- 1 financial ingly temporary—financial shock crisis have such large and persistent effects 0 Excluding China on productivity? –1 Much can be attributed to the –2 interplay of weak corporate balance –3 sheets. In advanced economies. which suggests that the persistent slug- Years gish performance of more vulnerable firms after 2008 resulted Sources: Blanchard. on average. their downsizing or outright market exit –4 would have led to higher aggregate productivity—allowing the so-called cleansing effect of recessions to play out. layoffs. the sharp drying up of credit that followed the Lehman Brothers failure. percent) that is. ibly affected productivity—particularly in countries where tion technology boom (Fernald 2015. Penn World Tables 9. weak aggregate demand. and although some of our findings The output decline seen during deep recessions. Cette. ening financial conditions. level vulnerability and tighter credit may account. We focused primarily Lasting effects on advanced economies. or even the main. intangible investment cuts. But this –6 was not the case. and persistence of the productivity slowdown in productivity of existing firms? Our evidence suggests that the aftermath of the global financial crisis suggest that these the sudden liquidity squeeze and the associated difficulty in slow-moving forces are not the only. and Summers 2015. low refinancing needs was most striking. A simple calcula- tal and winner-take-all market dynamics. Criscuolo.0. lethar. firms with weaker balance sheets— (TFP response to deep recessions. factors behind their produc- the global financial crisis. TFP total (global financial crisis) TFP total (past episodes) This was not good news. Such Chart 1 output losses reflect not only con- Easing off tinuing declines in employment and Productivity growth has slowed dramatically around the world in recent years. reflects a long-lasting drop in tivity slowdown are less clear and warrant more research. corrected 2/10/2017 GROWTH persistent declines in output. that characterize the postcrisis envi- ronment. deep recessions— bankruptcy. (five-year average productivity growth rate. Gordon 2016). often associated with financial crises—involve large and Immediately following the Lehman failure. Some blame a fading information and communica. KLEMS. into asset fire sales.

and Timmer. tive features of the postcrisis era. lower-return Not long after the information and communication technol- projects (Aghion and others 2012). as a year. technological change such as Internet use was embodied in new and increasingly Divergent paths powerful computers. Hong. construction) that relied more on 80 80 2005 07 09 11 13 2005 07 09 11 13 external financing. Leverage is measured as total debt to total assets. greater 84 84 uncertainty weakened productivity disproportionately in industries (for example. Hong. 0. forthcoming. 2005 = 100) Elevated policy uncertainty since the crisis also appears 100 TFP by firm leverage 100 TFP by firm rollover risk to have played a significant role in driving down investment and productivity in important economies.07 percent of total sales. percent in the United States. in Europe.1 percent in Japan. More broadly. and Timmer. Worker weak (so-called zombie) firms to delay recognizing losses skills tend to increase until a certain age and then start to from bad loans and the need to raise capital. but other adverse longer-term forces tight access to credit induces firms to shift their investment were already at play. lower- 88 88 return projects. as is typical in a well-functioning total factor productivity growth in advanced economies market economy. corrected 2/10/2017 Chart 3 1990s and early 2000s. Rapidly increasing international trade flows in productivity gains by slowing the adoption of new tech. affected lagging economies. (total factor productivity index.2 percentage point a year on average relative Persistent weak demand and investment are also distinc. tighter credit conditions during the crisis may have played a role by impeding the growth of financially constrained firms vis-à- Persistent weak demand and vis their less constrained counterparts. Insofar as some firms in the former group offered strong return prospects while investment are also distinctive some in the latter group offered weak prospects. Rollover risk is measured as debt maturing within a year in 2007. for example. especially those dependent on external 92 92 financing. lower-risk. to the 1990s. the return of capital across firms and sectors) increased fol- lowing the crisis. Although the causes are not yet fully understood. any failure features of the postcrisis era. following the crisis. structure of the workforce and aggregate productivity sug- ened the usual process of resource reallocation away from the gests that rapid aging during the 2000s may have lowered latter toward the former. on average. the late 1990s and early 2000s supported productivity growth nologies. since the late 2000s. especially productivity growth within firms but also the economy’s in the most technologically advanced countries. According to new IMF findings. Higher uncertainty overall may have aggravated the post- Note: High/low leverage and high/low rollover risk correspond to the 75th and 25th percentiles crisis productivity slowdown by as much as 0. Estimates suggest that falling invest- Firms that were highly indebted or had substantial expiring loans ment may have lowered total factor productivity growth in before the crisis saw a bigger drop in productivity than those with advanced economies by nearly 0. This also ability to shift capital to areas where it is most productive. productivity growth in sectors Tight credit conditions seem to have undermined not only most reliant on this technology slowed significantly. especially in advanced The global trade slowdown is another long-term drag on economies. Adler. To the extent decline—with attendant effects on innovation and pro- that such routine renewals benefited highly profitable firms ductivity. which are often embodied in capital. Arguably. Analysis of the relationship between the age as well as those that were not profitable. capital misallocation (measured by the dispersion in nologies had been an important driver of productivity. Weaker investment in information and Low High communication technology were a contributing factor. it may have weak.2 percent a of the cross-country cross-firm distribution of leverage and rollover risk in a large sample of firms in advanced economies. to reallocate capital between them would show up at the aggregate level as an increase in resource misallocation and weaker productivity. more than 0. In the late by strengthening domestic firms’ incentives and ability to 12   Finance & Development March 2017 . It is also possible that some banks routinely renewed Population aging in advanced economies also appears loans—without requiring that the principal be paid off—to to have gradually become a drag on productivity. forthcoming). and 0. lower-risk. spending toward shorter-term. Higher uncer- 96 96 tainty leads firms. Source: Duval.2 percentage point a year stronger balance sheets. this phenomenon also helped erode productivity. where adoption of leading tech- Indeed. not only to cut investment but also to concen- trate what it does invest on shorter-term. existing balance sheet weakness invested substantially less Structural forces in intangible assets than their less vulnerable counterparts The effects of the crisis have held back productivity growth (Duval. ogy revolution of the late 1990s.

and after the Great Recession. Parker and Michael growth.” Unpublished. This reflects primarily weak economic activity. As global trade integra. trade has barely kept pace with The debate on the future of productivity has yet to be global GDP. as aging populations. productivity will benefit as well—especially in Europe. and continue to reap the gains from open Cyclicality of R&D Investment: Evidence from France. across firms. 2016.” Healing productivity To address these long-term issues. may be around the corner—or not. Olivier. Such measures would help Learning from exposure to foreign markets. Aggregate Paper.” Journal of the trade and migration. ensuring that these benefits are shared European Economic Association 10 (5): 1001–24. marily in continental Europe.” IMF Working investment in physical and intangible capital. Cambridge. balance sheets to ease their access to credit and stimulate “Financial Frictions and The Great Productivity Slowdown. support current investment and technological innovation. Washington. mies’ reallocation of resources toward activities with interna. Washington. NJ: Princeton particular regarding fiscal. “Global Trade: What’s behind the Slowdown?” World potential growth—for instance. 2015. Policies aimed at addressing crisis legacies and longer. and Yannick Timmer. opment tax incentives. Technology Diffusion and Public Policy: Micro Evidence from ing productivity growth—and its key role in boosting living OECD Countries. of course. This Gustavo Adler is Deputy Division Chief and Romain Duval an slowdown may have contributed about 0. A new leap in innovation. April. edited by Jonathan A. growth Another global headwind is a decline in the level of edu- cational attainment that made an important contribution to may be stuck in a rut for years to come. and Benoît Mojon. settled. Dan. Volume 29. Productivity Slowdown. demand and investment returns. which contributed to technologies. up banking supervision will also improve capital allocation 1–51. widely within countries as well. pri. reviv.” NBER Working Paper 21726. such would mean a reversal of earlier productivity gains. But because much of the Andrews. Standard of Living since the Civil War. 2015.” OECD Productivity Working Paper 2.S. Organisation for standards—requires action targeted to crisis legacies. “The Pre-Great technologies and help reverse the downward spiral of weak Recession Slowdown in Productivity. MA: National Bureau of Economic Research. Washington.3 percentage point Advisor in the IMF’s Research Department. also helped raise productivity. This will support investment and its shift toward higher risk International Monetary Fund (IMF). a comprehen- as 10 percent of the average overall productivity increase in sive approach is the best way to break the vicious circle of low advanced economies between 1995 and 2007. Eugenio Cerutti. Princeton. however. investment in the short term—including through balance We estimate. in U. as well as econo. Paris. and Lawrence Summers. Economic Co-operation and Development. Gal. •  Boost demand where it remains weak. Lifting future ———. 2015. Policies geared toward boosting domestic demand and tional comparative advantage. Philippe. MA. Firms. or migra. John Fernald. Gilbert. and use more or better inputs. 2015. particularly “Inflation and Activity—Two Explorations and their Monetary Policy investment—through carefully selected public investment Implications. 2016. University Press. 2016. All in all. Chapter 2. “Productivity and Potential Output before. 2012. Otherwise. Romain. What’s the Holdup?” World Economic Outlook. Facilitating corporate restructuring and stepping Woodford. Robert. for example. Svyerson. “Private Investment: and higher returns. Chad. and Peter N. “Frontier slowdown reflects scars of the global financial crisis. This article is based on the IMF Staff Discussion Note “Gone with the Headwinds: Global Productivity. DC. strengthen innovation Aghion. through research and devel.S. “Credit Constraints and the and education. International Monetary Fund. and trade policies. DC. regulatory. term issues can be mutually supportive. new outright trade restrictions crisis legacies up front and the longer-term challenges. and others. Economic Outlook. But without slower productivity (IMF 2015). some major innovation. Gee Hee Hong. Forthcoming. 3–20. where balance sheet repair has been slower than in the during. Finance & Development March 2017  13 . The Rise and Fall of American Growth: The •  Give clear signals about future economic policy.produce efficiently. Fernald. that increased trade solely from sheet repair—would pave the way for structural reforms with China’s global trade integration may account for as much high long-term productivity payoffs. the prospects for a return to a healthy tion matures it could also mean lower productivity gains in pace of productivity growth look dim. to support capital accumulation and the adoption of new Cette. policymakers should References: strive to advance structural reforms. Blanchard. output and productivity growth. Chiara Criscuolo. Since 2012. John G. innovate. ■ aggregate labor productivity growth in past decades. Cambridge.” European Economic Review (88): investment and productivity. to weaker annual labor productivity growth since the turn of the century. •  Help firms restructure debt and strengthen bank Duval. 2016. “Challenges to Mismeasurement Explanations tion and trade policies—would raise expectations of future for the U. National Bureau of Economic projects and removal of obstacles to private investment— Research. DC. October. Gordon. Chapter 4.” In NBER Macroeconomics United States and is likely a persistent drag on productivity Annual 2014. driven by major break- but also to a lesser extent waning trade liberalization efforts throughs in artificial intelligence or other general purpose and maturing global supply chains. unless we tackle the the future—and. infrastructure spending. at least gradually.

which lower the cost of innovation innovation Just as inventions such as electricity and the and encourage firms to invest more. These invest. percent. in part because However. labor cent over the long term. Some observers. have worked well. relatively generous tax credits effectively Inspiration. for example. they do not reduce the 14   Finance & Development March 2017 . research by one firm income from innovation (such as from pat- usually ends up being beneficial to others. ments tend to benefit the broader economy Take. and effective bankruptcy But it is not just the size of fiscal incentives laws. Countries vary widely in this they are well designed. which often inspires follow-up cantly reduce the corporate tax burden on innovations. esti- thing is clear: policy matters. driven by innovation. As a result. studies suggest. Such expansion could lift GDP in tion—through the protection of intellectual these economies by as much as 5 to 8 per- property rights. for instance. helps advance innovation at private compa. In Australia and Korea. so too could three. Most of these fiscal incentives role in fostering innovation by businesses. regard. artificial intelligence pave the way for growth During the past decade. market regulation. but they have not worked. Many will rely on produc. tion. Tax and spending policies do much to that matters: good design and implementation stimulate innovation and growth—provided are also critical. driverless cars. Others may imitate the technology in introduced recently. in research and development. competition policies. so they will not spend enough how countries can increase their po. This underinvestment can be addressed by can help spur ing years. Empirical and ultimately internal combustion engine in the late 19th studies suggest that fiscal incentives must century laid the foundation for high growth reduce a firm’s research and development growth in the mid-20th century. on research and development. not all fiscal incentive policies they lack adequate incentives. Germany funding higher education and basic research offers targeted subsidies to encourage collabo- at universities and public laboratories. one incentives to meet this target level. and the spillover benefits that others gain. Getting It Right Ruud De Mooij T Well-designed HERE is considerable debate over anything away. Governments play an important role in they approach the theoretical ideal. But fiscal policies can also play a direct of researchers. and support is generally believe a major growth surge is in the offing. box regimes many European countries have priate. Yet differ- of the Massachusetts Institute of Technology. Although Private companies are not interested in giving they reward success. If Others. when they Private firms typically do not invest enough were implemented effectively. subsidies. are less optimistic. fiscal incentives such as tax credits and direct tivity growth. the so-called patent in addition to what the firm itself can appro. for private research and development has such as Erik Brynjolfsson and Andrew McAfee increased in most countries. These programs signifi- new products. such as Northwestern University’s advanced economies were to increase their Robert Gordon. incentives reduce the cost of extra research and develop- Research and development help drive innova. costs by approximately 50 percent to factor in dimensional printing. well below the 50 percent desirable level. Other countries grant tax relief for the wages nies. support in the form of tax credits or other Whatever your view of the future. ences remain large. ment investment by nearly 50 percent—that is. are equally effective at nurturing innovation. ents). which ration between universities and private firms. fiscal support during the coming decades. perspiration. fiscal incentives tential economic growth in the com. Governments mates suggest that research and develop- generally pursue a wide variety of policies to ment would increase by approximately 40 make a welcoming environment for innova.

GROWTH
cost of experimentation, which often leads to failure. And
knowledge spillovers thrive on trial and error. In some coun- Arrested development
tries, patent box regimes appear to have had no measurable Costa Rica’s tax incentive for small businesses has led many
firms to remain small to benefit from a lower tax rate.
impact on research and development. Elsewhere, such as
(share of firms with different taxable incomes)
in the Netherlands, they have. For every euro spent by the
0.007
Dutch government on the patent box, research and devel-
Observation distribution
opment expanded by 56 cents, one study reports. However, 0.006
Counterfactual
another study found that the Dutch tax credit plan yielded an
0.005
impact of €1.77 for every euro spent. In other words, innova-
tion could be spurred considerably by shifting funds from the 0.004
ill-designed patent box toward the well-designed tax credit.
0.003
Sincerest form of flattery 0.002
Imitation of technology from abroad is another critical com-
0.001
ponent of innovation, especially in emerging market and 50 60 70 80 90 100 110 120 130 140 150
developing economies. These technology transfers increas- Taxable income/kink (percent)
ingly originate in multinational corporations that dissemi- Source: Brockmeyer A., and M. Hernandez. 2016. “Taxation, Information, and Withholding: Theory
and Evidence from Costa Rica.” Policy Research Working Paper 7600, World Bank, Washington, DC.
nate their advances across the world through foreign direct Note: The kink refers to the income level at the exemption threshold for self-employed taxpayers for
investment. Foreign investment inflows can bring important the years 2006–13. A value of 100 on the horizontal axis means taxable income is equal to the
threshold. The tax rate above the threshold is 10 percent.
productivity gains to an economy if local firms learn about
the new technology or copy new management and organi- distortion by offering special tax incentives for small com-
zational practices. To boost productivity, many governments panies—for example, by granting them a reduced corporate
therefore try to attract foreign investment, including through income tax rate. Despite good intentions, however, such
tax and spending policies. incentives are not cost-effective. In fact, they tend to hamper
Some of these policies, however, are highly ineffective and productivity growth by discouraging firms from expanding
inefficient. For example, many countries offer generous tax and losing the small business tax incentive. This small busi-
incentives to multinational investors, such as tax holidays ness trap is evident in data for Costa Rica that show bunch-
or tax exemptions in special economic zones. But investors ing of small firms as they try to stay just below the income
report when surveyed that such incentives have relatively lit- threshold for preferential treatment (see chart).
tle effect on their choice of investment location—a view sup-
ported by empirical evidence.
What really matters are good institutions and a predict- Not all fiscal incentive policies
able legal system. Moreover, domestic firms benefit from for-
eign investment only if there is a solid human capital base are equally effective at nurturing
in the country—in other words, people able to absorb the
imported knowledge. There is a significant positive associa- innovation.
tion between productivity gains from foreign investment and
human capital indices, which measure countries’ ability to To foster entrepreneurship, governments should target fiscal
nurture, develop, and deploy talent for economic growth. support to new firms instead of small ones. Countries such as
In light of this, governments would do better to redirect Chile and France, for instance, have developed effective policy
revenue currently spent on ill-designed tax incentives to initiatives to support innovative start-ups. Such incentives are
education. China understood this well when it phased out by definition temporary. Support is granted when the start-up
several tax incentives for foreign direct investment in 2008 does not yet generate much income. Many new firms incur
as part of broader corporate income tax reform and instead losses early on and do not benefit from simple relief of income
plowed money into education and research to create a strong taxation. Generous loss-offset rules are also critical for entre-
human capital base capable of absorbing foreign knowledge. preneurs whose endeavors have a significant risk of failure.
While no one really knows what will happen to productiv-
Banishing “success” taxes ity growth over the long term, one thing is certain: appropriate
Many radical innovations arise from new entrepreneurial fiscal incentives for research and development and entrepre-
ventures, which have no vested interest in existing technolo- neurship matter for the pace of innovation. Ultimately, such
gies. The pace of innovation therefore depends critically on well-designed and well-implemented incentives at the micro
an efficient process of entrepreneurial entry, growth, and
exit—a process that in many countries is hampered by red
level are critical to sustained growth at the macro level. ■
tape, financial constraints, and tax barriers. Ruud De Mooij is Chief of the Tax Policy Division of the IMF’s
Evidence indeed suggests that high corporate income taxes Fiscal Affairs Department.
are a drag on entrepreneurship and thus deter productivity
growth. Governments in some countries try to offset this tax This article is based on the April 2016 issue of the IMF’s Fiscal Monitor.

Finance & Development March 2017  15

Rethinking GDP
It may be time to devise a
new measure of economic
welfare with fewer flaws

16   Finance & Development March 2017

GROWTH

Diane Coyle

W
HY does economic growth matter? The an- term measure. Economic policies aimed at delivering growth
swer for economists is that it measures an im- have demonstrated the validity of the famous comment of their
portant component of social progress—name- intellectual architect, John Maynard Keynes: “In the long run
ly, economic welfare, or how much benefit we are all dead.”
members of society get from the way resources are used and Seventy years on, the long run is upon us. A broad measure
allocated. A look at GDP per capita over the long haul tells of the sustainability of economic growth, and thus long-term
the story of innovation and escape from the Malthusian trap economic welfare, would take account of economic assets as
of improvement in living standards that is inevitably limited well as the flows counted in GDP: the need to maintain infra-
by population growth. structure or record its depreciation as bridges crumble and
GDP growth is instrumentally important as well. It is roads develop potholes. A true national balance sheet would
closely correlated with the availability of jobs and income, account for future financial liabilities, such as state pensions. It
which are in themselves vital to people’s standard of living would also include increases in human capital as more people
and underpin their ability to achieve the kind of life they attain greater education and skill. Economic welfare must be
value (Sen 1999). calculated net of such changes in the value of national assets.
However, GDP is not a natural object, although it is now
everyday shorthand for economic performance. It cannot be Household work
measured in any precise way, unlike phenomena in the physi- A long-standing criticism of reliance on GDP as the mea-
cal world. Economists and statisticians understand, when sure of economic success is that it excludes much unpaid
they stop to think about it, that it is an imperfect measure work by households. There must be an accepted definition of
of economic welfare, with well-known drawbacks. Indeed, what is part of the economy and measurable and what is not.
early pioneers of national accounting, such as Simon Kuznets Economists call this a “production boundary.” What is within
and Colin Clark, would have preferred to measure economic that boundary and what is not inevitably involve matters of
welfare. But GDP prevailed because the demands of wartime judgment. One early debate was whether government spend-
called for a measure of total activity. So from the very start, ing should be included—on the grounds that it is collective
the concept of GDP has long had its critics. But coming up consumption—or excluded—on the grounds that the gov-
with a better gauge of welfare is easier said than done. ernment is paying for things like roads and security that are
inputs into the economy (just like a business expense) rather
Short-term measure than consumption or investment goods.
GDP measures the monetary value of final goods and ser- Another key debate concerned how to define goods and
vices—that is, those that are bought by the final user—pro- services produced—and often also consumed—by house-
duced and consumed in a country in a given period of time. holds. Home-produced goods such as food were included,
The limit of GDP as a measure of economic welfare is that because in many countries these can just as easily be bought
it records, largely, monetary transactions at their market and sold in the market, but home-provided services such as
prices. This measure does not include, for example, environ- cleaning and child care were not. Not surprisingly, feminist
mental externalities such as pollution or damage to species, scholars have always decried the fact that work done mainly
since nobody pays a price for them. Nor does it incorpo- by women is literally not valued. Many economists agreed in
rate changes in the value of assets, such as the depletion of principle, but the line was drawn partly for reasons of practi-
resources or loss of biodiversity: GDP does not net these off cality: surveying household services was a daunting task, and
the flow of transactions during the period it covers. these services were seldom purchased in the marketplace.
The environmental price of economic growth is becoming This of course has changed dramatically in the econo-
clearer—and higher. The smog over Beijing or New Delhi, the mies of the Organisation for Economic Co-operation and
impact of pollution on public health and productivity in any Development (OECD) since the 1940s and 50s, when the pro-
major city, and the costs of more frequent flooding for which duction boundary decisions were made. As more women work
countries are still ill-prepared are all illustrations of the gap for pay, the market for services such as cleaning and child care
between GDP growth and economic welfare. This is why econo- has grown, and households can and often do switch between
mists and statisticians have been working to introduce estimates performing and buying these services. There is no logical rea-
of natural capital and its rate of loss (World Bank 2016). When son not to treat household work like any other work.
they do, it will be clear that sustainable GDP growth (that enables The evolution of the digital economy has reignited this old
future generations to consume at least as much as people today) debate, as it is starting to change the way many people work.
is lower than GDP growth recorded over many years. Getting National accountants have treated government and business as
these new measurements into the mainstream policy debate and the productive part of the economy and households as non-
reflected in political choices, however, is another matter. productive, but the previously relatively clear border between
Indeed, GDP ignores capital assets of all kinds, including home and work is eroding. More and more people are self-
infrastructure and human capital; it is an inherently short- employed or freelance through digital platforms. Their hours

Finance & Development March 2017  17

may be flexible. and glass. and government plus more information about prices is needed. But approach adds up the market value of all spending on final there is a sizable drawback. and wider range of goods and services affected by digital transfor- green energy. economists construct a statistic called an index. businesses. and firms—mainly wages. and collecting price exports minus imports. then deducts This box draws in part on “Measure Up: A Better Way to the value of the intermediate products to get net output. Marco Marini. The Calculate GDP” (IMF Staff Discussion Note 17/02). There are millions of producers. The production approach adds up the data is costly. An automo. the volume of shoes produced rose 2 percent). collecting the data is immensely compli. Researchers who have tried to extend hedonic adjustment to a broader range of prices in the information and communica- Ever-evolving technology tion technology sector in the United States have concluded The blurring of boundaries between home and work is not that it makes little difference to the picture of slow productiv- the only way in which technology is making GDP calculation ity growth. the nominal increase in the shoe component of GDP is an and services. understate productivity and growth in real terms? and it clearly has great economic value despite a price of zero. and work can overlap with other activities. for example. deriving In many countries. First. plastic. new good? In other words. sequencing has been falling rapidly. the price of such innovations as solar energy and genome In many cases they are using household assets. That index reflects more final output (volume) and how much reflects higher is applied to prices to take out the inflation component (or prices (inflation). which Price effects is measured in current dollars (or other national currencies). yet few coun. this research has not been extended to the far such as telecommunications. deflate) in current prices. rents. revolution. and interest income. say. biotechnology. and there are some conceptual questions that need to growth and productivity performance of so many advanced be resolved. the products by consumers. The steel. that price part of GDP would turn that 10 percent nominal increase are used to make it are intermediate products (or inputs). they rightly point out—making the lackluster mation. lent to a digital download or buying compact discs. compression technology allows wireless net. is. gross output. Eric Metreau. say. is the consumer buying a specific works to carry more data faster than ever at high quality. The actual output of shoes was constant. by Thomas income approach adds up everything earned by people and Alexander. illusion. Moreover. the official GDP is based on the production GDP is not. the more accurate the real GDP calculation. For example. value of everything that is produced. into a 2 percent real increase (in statistical lingo. the so-called nominal GDP is affected by available to consumers and how much is due to changes in changes in prices and does not necessarily reflect whether prices adds another layer of complexity. Claudia Dziobek. Many in the technology sector argue that conven. if the nominal value of shoes an economy. nesses. The pace of innovation has not slowed in areas However. then a deflator applied to the shoe bile is a final good. GDP is a measure of the final goods and services produced in To return to the shoe example. and format or simply the ability to listen to music? If the former. tion and communications technology manufacturing (Byrne. is 5 percent higher than a year ago increased—which is what interests most people and busi- and GDP registers a 5 percent increase in the value of shoe out. and prices. those that take into account quality improvements. materials. due to inflation. the three approaches never give the same value. tistics are not properly adjusting for quality improvements Many people contribute free digital work such as writing open. which takes account of changes in the price of a good or a To determine how much of any. 18   Finance & Development March 2017 . rose 10 percent over a year. prehensive and accurate. or by how much the volume of those goods and services has If the price of shoes. If the price they are used to produce another good or service. those that are consumed by people or businesses. Official figures in practice incorporate very little qual- These developments underline the need for a much better ity adjustment to calculate “hedonic” price indices—that statistical understanding of household activity. Michael Stanger. from comput. in part because there is little US-based informa- difficult. Because the prices of goods and services are collected in represents a real change in the amount of goods and services current dollars. and Reinsdorf 2016). the nominal GDP for that year Intermediate goods and services are netted out in GDP because would reflect a 10 percent increase in shoe output. or is it a For instance. is a streamed music service equiva- economies even more of a puzzle. economists use a technique called deflation. approach because source data from producers are more com- cated. The expenditure the deflator. Three measures Deflators present their own difficulties. Measuring up All three measures theoretically come up with the same GDP is the monetary value of the total output of goods and value for GDP. for paid work. The more precise There are three ways to measure GDP. Could it be that the sta- ers and smartphones to their homes and cars. source data. tional GDP statistics understate the importance of the digital Fernald. Although the definition seems straightforward. figuring out how much a change in GDP. year-to-year change in GDP service between a base year and the current year. services. tries collect any suitable information on household assets. But because of difficulties in collecting the services in an economy during a specific period. of shoes rose 8 percent. profits. To see the effects of inflation on the prices of goods put. products. arising from technology and therefore overstate inflation and source software that can substitute for marketed equivalents. The more precise the deflator.

Diane Coyle is Professor of Economics. University Press. It is easier to express dissatisfaction with current measures than to reach consensus on what should replace GDP. the market price. Development as Freedom.” and other nonmarket aspects of economic welfare. However. so the erosion of GDP’s status as a reasonable mea- tributional questions. and author of GDP: A Brief but Affectionate History. Working paper version available at https://papers. The digital revolution and become especially obvious in its debate about the links between technology and productivity growth—and technology and future jobs—add a subtle twist. sluggish all their purchases. and GDP today. “Modernising Economic Statistics: Why It Matters. Problem?” BPEA Conference Draft. Economists National Institute Economic Review 234 (November): F4–F8. national accounts (Jorgenson.ssrn. Although to pay to attain the same level of “utility” or satisfaction from inequality has begun to diminish in some countries. and equating GDP growth with an improvement in economic welfare assumes that there is no sure of economic welfare is a serious matter indeed. given the Inequality matters widespread belief that—as calculated by GDP—recent eco- GDP’s shortcomings have become especially obvious recently nomic progress has not measured up. Dale. These measures. John G. have started to debate (once again) specific adjustments. “Does the United States Have a Productivity Problem or a Measurement nobody is ignoring distributional questions anymore. University of Manches- When income distribution did not change much—until the ter. At the same time. forthcoming). mid-1980s in most OECD countries—ignoring the issue did not matter much. but not all. 1999. Oxford: Oxford tributional information from household surveys with the University Press. fare measures. have made for a lackluster recovery and simmering discontent with economic policy that follows business as usual. leisure. “Within and Beyond the GDP: Progress in gap in living standards between the United States and other Economic Measurement. 2016. Diane. The question is on economists’ the possibility of a particularly wide wedge between welfare research agenda for the first time since the 1940s and 50s. Hepburn. failure to account for inequality. economists argue that it is impossible to capture mended the publication of a “dashboard” of economic wel- all the economic welfare benefits of innovations in GDP. arguing that its multiple dimensions could not which measures transactions at market prices. and inequality. debt overhang. Report by approach in a way that at least takes inequality into account. given digital technology’s effects on busi. and Peter J. thanks in part to Thomas Piketty’s References: bestselling Capital in the Twenty-First Century and in part Byrne. Joseph E. culations show that this approach closes much of the apparent Jorgenson. Reinsdorf. Fernald. The landmark Stiglitz-Sen-Fitoussi Commission in 2009 recom- Indeed.” Brief. Amartya Sen. growth.cfm?abstract_id=2850061 and Peter Klenow have proposed a single measure incorporat. plays down This might happen. Amartya. For example. “Beyond GDP? Welfare ing consumption. The 2008 global financial index. and high unemployment in some cases is not straightforward. there will sensibly be reduced to one number.” American Economic Review 106 (9): 2426–57. Hamilton and C. Progress. set up a new research center on economic statistics.” In Jorgenson of Harvard University proposes combining dis. It is possible to adjust GDP to take account of distribution Coyle. The debate about how best to measure economic welfare is World Bank. price indices calculate what people have crisis and its aftermath are casting a long shadow.” Digital goods are no different from cal debate. the best-known measure in the important new medicine will eventually always far exceed framework System of National Accounts. ■ reason for anything other than the status quo distribution. 2016. but putting this calculation into practice growth. Those who use national consensus process. across Countries and Time. and Jean-Paul Fitoussi. while correct. Paris. This argument. Brookings Institution. Washington. Charles I. “The Political Economy of National Statistics. It is a vitally important debate. 2015. The aggregation of about economic policy is largely conducted in terms of GDP individual incomes or expenditures into GDP ignores dis. Charles Jones com/sol3/papers. National Wealth. mortality. 2016. Public conversation in its failure to account for inequality. David M. it is hard to ignore the evidence of the environmen- GDP’s shortcomings have tal cost of past economic growth. the Office for National Statistics has ness models and consumer behavior. In principle. edited by K. and Marshall B. 2009. Dale ———. GDP is set by a slow and rather low-profile inter- previous waves of innovation in this regard. Others argue that a single always be some utility above and beyond that price. so it is hard to imagine any clean GDP growth as a measure of economic performance must break with the current standard unless economic researchers keep in mind that it has never been a complete measure of can come up with an approach as compelling in theory and economic welfare.” Journal of Economic Literature. OECD countries when this is assessed on the basis of GDP Sen. Jones. Finance & Development March 2017  19 .. launched in February 2017.. extending the standard national accounts Stiglitz. their cal.. Forthcoming. Klenow. Oxford: Oxford per capita (Jones and Klenow 2016). the consumer benefits of an as feasible in practice as GDP. Forthcoming. to the populist movements springing up in many countries. DC. In the United Kingdom. the Commission on the Measurement of Economic Performance and Social address some of the challenges to gauging GDP. labeled indicator is essential to have traction in the media and politi- “consumer surplus.ideally there would need to be a quality-adjusted music price intensifying for several reasons. DC. “Natural Capital Accounting. Washington.

India “ Can money buy happiness? It certainly doesn’t make one sad. I’d buy a bigger car. a bigger house. So can money buy happiness? Just for feeling While rich people are generally hap. richer countries they’d do if they suddenly got a big chunk aren’t always happier than poorer ones. though they worked ” harder. If I had money. level.000—though in some coun- what sparks economist Richard Easterlin discovered tries this figure might be lower or higher. higher income fails a country’s success in terms of its to increase happiness beyond a certain the world GDP. According to Nobel share their curately measure well-being. But GDP doesn’t always ac. that threshold for the United essarily guarantee a happy population. a better education for my child. and a better holiday for my family. Easterlin found. F&D asked a cross section of people pier than poor people in a given coun. Kahneman. of money. Russia Can Money Buy HAPPINESS? E People around CONOMISTS generally measure And for individuals. fun. in five countries that question and what try. I’m investing more than my par- ents did right now. If it comes my way. I think the economy is much better these days. ANNA TERESHINA Assistant Product Manager Moscow. States is $75. And laureates Angus Deaton and Daniel thoughts on even high per capita income doesn’t nec. JASPREET SETHI Independent Financial Consultant New Delhi. 20   Finance & Development March 2017 . this elusive in the 1970s. I’ll be happy. some believe. I believe.

is any item that is generally accepted for payment for goods and services. they say. If you need a home Doctor. you need money. If you want to buy yourself something to eat. isn’t it? I walk miles every day around London and it’s all free. Most of the very good car. you need money. I’d get myself a home. I’d pay off my children’s mortgages. Finance & Development March 2017  21 . ” lems. Colombia for yourself. If I had some extra money. Abuja. So if you don’t have money to get these things. London. Bogotá. If I had money to spare. Right now. “ Yes. a time you have some resources. ” ” facing the sea. It doesn’t solve your prob- it comes my way. I have to pay double problems of this country and the world are solved with what I used to pay for goods and services. and I’m really happy doing that. and here’s why. ADAM HASSAN Self-employed. it helps. Money. Nigeria “ I think money can buy happiness. It’s all inside you. That means if you have JAIME OSPINA to pay school fees. And it’s really money. United Kingdom make one sad. I don’t need anything. GROWTH “Can money buy happiness? It certainly doesn’t PAT WALL Retiree. and a wife. There’s a feeling in this country that if you have problems and at the same If I were blessed with money. ” I’ll be happy. If “ Money cannot buy happiness. there won’t be happiness. money can buy happiness. I would buy a house affecting my daily life. At my age. you need money.

and think about investing. Real happiness that you feel deep in your heart is only found through other people. like the air we breathe. Of course I wish my pension were higher. relatives and close ones are healthy—for me. and the prices in Money is not happiness. ” things. St. The best things in life are free. and family. Or I’d buy a better house and then fill it with all the material things that have now become necessities. Graduate Trainee. savor it. NATALIA BALYBERDINA Retired Nurse. Moscow. had bigger salaries. or Abkhazia. If I had some extra money. I used to buy decent salami If I came into a big sum of money. Russia “ I think that money is evil. I would save it a lot—now I buy it when I get my pension payment. I’m not sure I would just buy and then wait until the next month’s payment. India “ Money can’t buy happiness. Nigeria When I have extra money I try to take my grandchil- dren to see places like Moscow. the shops were less outrageous. As long as there’s happiness in the family. utility prices were lower. friends. ” MOHAMMAD ADNAN Automobile Mechanic. New Delhi. that’s happiness. Kazan. Happiness bought with money is only temporary—like when you go out to dinner or attend a wedding. I’d buy a better education for my two kids and perhaps expand my business. ” 22   Finance & Development March 2017 . my kids “ I don’t think money can buy happiness. Abuja. everyone gets BLESSING ADISA along. Petersburg. Money can’t buy happiness.

We If I had some extra money to play with. Kshitij Nagar. you won’t be able to share it. and talk If I had money. Bogotá. Bogotá. ” go riding at 6:00 every morning before starting my day. United Kingdom Moscow. London. Colombia “ You can have lots of money. at the end of the day. a happiness that has nothing to do with material things. but if you don’t have happi- ness in your heart. ”■ Reporting/photos by Feature Story News: Abuja. If I suddenly found myself with lots of money. But what is happiness? You know. people happy to me. ARSENY YATSECHKO RICHARD WICKS Graduate Student in Graphic Design Market Vendor. I’d like to have a Russians know that we can survive any crisis—we’ve lived small holding where I’d keep horses at my back door and through hard times before. If you have enough money. I’m not so worried about the economy. Family can change. because that’s the way to become happy. Natalie Powell. I’d probably spend it on a trip. but money won’t change. as long as you’ve got your health and can get can change. Fernando Ramos. single mothers. I’d go to to one another. New Delhi. brush your teeth. up. Moscow. London. They never seemed “ Money can buy anything. Paris or Berlin. Kunie Babs. I would help the displaced in our country. you’re the richest person in the world. get dressed in the morning. Finance & Development March 2017  23 . and children who have been subject to violence and war. I would invest it and try to help people. ” MIGUEL JOSUE MOLANO Librarian. you can make yourself happy. Andrei Kharchenko. I’d help people try to achieve a different type of happiness. Russia “ I’ve seen people with untold wealth.

the North Atlantic economies means markets cannot properly reward those who invest in new have lost a decade of what we used to think of as normal eco- technologies.  Higher income inequality. ments—from bridges to basic research—become extraor- 3. 1. fiscal policies that provide for Eight reinforcing factors have driven and continue to drive this long-term reduction in safe interest rates: expansionary investment. which puts too point.5 percent in stagnation. there is little room for cutting rates central banks are reduced tion in 1938. themselves and leave a hard demonstrated by US Treasury securities. Harvard Professor Kenneth Rogoff thinks this is nominal terms. uncertain. He says that there is no sign we will 5. ing the value of assets in the future to be higher and encourage mist Alvin Hansen put it consumption spending by making people feel richer. which boosts saving too much because the rich can’t think of other things to do with The natural response to this secular stagnation is for their money.  Technological and demographic stagnation that low. end soon or is healthy for some contrarian reason. employment by cutting interest rates in recessions. with long-term rates following them down. central banks and real interest rates on all can no longer easily and effectively act to maintain full kinds of safe investments. Financial markets do not expect this problem We should adopt appropriate to go away for at least a generation. we see “sick re. coupled with Critics of Summers’s secular stagnation thesis miss the rapid declines in the prices of those goods. ary investment the private sector is reluctant to undertake. 6. and so we should that even a zero safe nominal rate of interest is too high to bal. Harvard’s Lawrence Summers cial sector finds itself overleveraged and failing to mobilize argues that interest rates are so low that the inability of cen- savings. a passing phase—that nobody will talk about secular stagna- tion in nine years. Bradford DeLong is Professor coveries… die in their infan. Each seems to focus on one of the eight factors driving much downward pressure on the potential profitability of the decline in interest rates and then say that factor either will the investment-goods sector. and much weaker tools to try to J. entrants. 7. The short-term and seemingly immovable annual interest rate has fallen from 4 percent to 1. Bradford DeLong Y OU are reading 8. which make investment unprofitable for long. banks typically—and powerfully—operate by buying and sell- ties. steady de. dinarily attractive in benefit-cost terms. to using novel.2 percent core of unemployment…” In other words.and rent-seeking-driven obsta- this because of the cles to competition. Perhaps. even when the technologies have enormous social nomic growth. When interest rates are low and ers the return on investment and pushes desired investment expected to remain low. adopt appropriate fiscal policies that provide for expansion- ance desired investment and planned saving at full employment. guide the economy.  Limited demand for investment goods. and market cannibalization possible for incumbents.  A collapse of risk-bearing capacity as a broken finan. costs and provide investors the safe saving vehicles (gov- 4. which means emerge from this state for a generation. a chronic condition. thus driving a large wedge between the returns on tral banks to conduct effective monetary policy has become risky investments and the returns on safe government debt. ■ 24   Finance & Development March 2017 . ernment bonds) they value. The decline has created ing bonds for cash to encourage investment spending by lead- a world in which. POINT COUNTERPOINT Sluggish Future J. cline in nominal The result is that with rates so close to zero.  Increasing technology. Central such as US Treasury securi. governments to adopt much more expansionary tax and 2. But when when he saw a similar situa. as econo.  Very low actual and expected inflation. and government uid assets is driven not by assessments of market risk and debt levels should rise to take advantage of low borrowing return.  Market failure in the information economy—which Since the turn of the century. spending (fiscal) policies. with secular stagnation the major contributor. But the balance of probabilities is the other way. a world of secular in real (inflation-adjusted) terms and from 8 to 0. but by political factors. all kinds of government invest- spending down too far. liq. Berkeley. of Economics at the University cy and depressions… feed on The magnitude of this decline in safe rates since 1990 is of California. we will no longer be talking about secular stagnation. returns—which lowers the private rate of return on investment Only if we do something about it is it likely that in nine years and pushes desired investment spending down too far.  Nonmarket actors whose strong demand for safe.

I and others have seen a more plausible reason for the and bring new ideas into practice. Why the recent slowdown? Growth accounting points ing equilibrium interest rates and economic growth low. But secular stagnation as an explanation for this 2005—and to a decline in the application of new ideas. Summers posited have swung back and forth together in a marked policy- and Robert Raymond that for the past decade and performance cycle. To reverse this trend and reap the benefits of a large boost long-term interest rates have increased with expectations to growth. raised the chances for tax. constrained by a “substantial sider the most recent swing in productivity growth: from increase in the propensity to 2011 to 2015 productivity grew only 0. 2011–15 compared with 1. And the fact that central banks have chosen low policy rates since the crisis secular about this. and the current decline. 50 years. regulatory. and per- Indeed. the recent shift in govern. the ongoing debate suggests a growth is depressingly low now—actually negative for the need for more empirical work. tural reform—including regulatory. and its ability to produce. as well as tions simultaneously. to the empirical database. etary—to provide incentives to increase capital investment sis. Productivity the secular stagnation view. the United States needs another dose of struc- of normalization of monetary policy. which along with employment While the view that policy is the problem stands up to growth is the driver of economic growth. pared with 3.4 percent a year com- save and a substantial reduc. The recent US election has past four quarters. a broad base.2 percent a year clip from 2011 to 2015 years. the real rate of return required to keep the economy’s output equal to poten- negative—but there is nothing tial output—was low prior to the crisis. regulatory reform. before the financial cri- sis were associated with a boom characterized by rising inflation and declining unemployment—not by the slack Productivity growth is economic conditions and high unemployment of secular stagnation. also help increase labor force participation and thus raise ment economic policy. tion in the propensity to spend and invest. such as the US Federal Reserve. Finance & Development March 2017  25 . (output per hour worked). structural policy and economic performance John B. con- Stanford University. further boosting economic growth. to insufficient investment—amazingly. especially when the financial crisis is taken into compared with a 1. so there is hope for yet another convincing swing in the policy-performance cycle to add ■ past: the slump of the 1970s.8 percent during 1996–2005. These shifts are closely related to changes in economic tion has been the policy—mainly supply-side or structural policies: in other subject of much de. words. capital per worker Few dispute that the economy has grown slowly in recent declined at a 0. Indeed. those that raise the economy’s productive potential bate ever since 2013. But there is nothing secular about this. the rebound of the 1980s and 1990s. which was only 0. Professor of Economics at a half. and budget proposed the hypothesis “that reform proved successful at boosting productivity growth the economy as currently in the United States. Such reforms would poor economic growth—namely. there have been huge swings in productivity in the haps even budget reform. tax when Lawrence Summers reform. and mon- For a number of years going back to the financial cri.6 percent during Low policy interest rates set by monetary authorities. monetary. casts doubt on the notion that the equilibrium real inter- est rate just happened to be low.2 percent a year increase from 1996 to account. Taylor S ECULAR stagna. The evidence runs contrary to the view that the depressingly low now—actually equilibrium real interest rate—that is. During the 1980s and 1990s.” which were keep. tax. total factor productivity.” with erratic fiscal and monetary policy. In contrast. in recent months.0 percent from 1996 to 2005. such as low marginal tax rates with and stable financial condi. the stagnation of the structured is not capable of 1970s and recent years is associated with a departure from achieving satisfactory growth tax reform principles. or phenomenon raises inconsistencies and doubts. and with increased regulations. the economy had been To see the great potential for a change in policy now. Consider the growth in productivity employment. Taylor is the Mary ference. During the past Speaking at a recent con. monetary reform. GROWTH Policy Is the Problem John B. budget.

ensure that growth’s benefits are shared equi. we cannot be com- only because it is the morally right thing to placent. support for structural reforms—which would the saying goes. and greater income disparity and higher poverty. income do.­ remains inclusive in these economies so that for over half of global growth.) financial services. access to financial services and health care and lag behind in access to key social services has improved.40 from . like health care and finance. advice can support country authorities in cal and social instability. ficient—the most common indicator of table sharing of the benefits of increased pros. decent-paying jobs. and other countries rebounding international trade. STRAIGHT TALK Toward Inclusive Growth Emerging markets should share the fruits of their growth more equitably Tao Zhang G ROWTH rates in emerging mar. to 1. But sustaining this progress can be chal- We need to make growth inclusive not lenging. in human and physical capital. Raising productivity (out- impede the sustained growth that emerging put per hour worked) will help create the 26   Finance & Development March 2017 . But with this rapid expansion comes More progress needed the danger that the gap between the rich and Over the past few years. In many emerging markets.45. and outside the IMF has shown that high lev. standards of living have im- proved. markets need to achieve high-income status. to favorable global timistic about the future in emerging markets conditions. I see five priority areas where IMF policy tably. with increasing uncertain- durability of growth and that policymakers ties. As emerging markets strive to attain the should not be afraid to adopt measures that same level of development as advanced econ- ensure shared prosperity. More important. ket countries have significantly Addressing these issues today is all the more outpaced those of more developed important in light of the prospect of less economies in recent years. Failure to do so risks increasing politi. Research inside still live in absolute poverty. in part. stifling investment addressing these challenges. these countries has averaged about 4 per- Managing Director at omy status. emerging markets experience risen. And income this optimism is justified. accounting the IMF. perity. Nigeria. such as low interest rates and such as India. favorable global economic conditions. To begin with. employment has economies. inequality—falling to about . emerging markets the poor in those countries will widen. capital and raising productivity—these chal- So it will be important for policymakers to lenges will tend to worsen. education levels have gone up. these countries are facing a new global eco- els of inequality tend to reduce the pace and nomic landscape. and improved everyone has the same income. Growth in Tao Zhang is Deputy that are progressing toward advanced econ. equal employment (The Gini coefficient ranges from zero. but also because it is critical for achieving inequality remains high and too many people sustainable strong growth. when access to and provision of health care and a single individual receives all the income. Pew have made progress in fostering inclusive Research polls show that most people are op. when and education opportunities. Pov. and eroding Productivity: A rising tide lifts all boats. In comparison to advanced Poverty has also fallen. I mean a more equi. But we must ensure that growth cent a year since the early 2000s. inequality has declined. growth—thanks. including ones that omies—a process that entails accumulating redistribute wealth. erty has fallen. with the Gini coef- By inclusive growth.

a situation in which some workers needed—think of programs like Brazil’s Bolsa Familia. In some cases. This will not only enable the of promoting economic stability. tems that improve the balance between equity and efficiency. and improve business environments. financial inclusion ple. In Bolivia. •  On safety nets and redistribution policies. This helped us learn. This means not only understanding kets and trade. we countries as Brazil. over the workers lose their jobs. These reforms are high on policymakers’ agendas in such •  On inequality. from the collapse in commodity prices. Such measures are cial services around the world. efit the rich. undermining efficiency. GROWTH widespread increase in income and wealth needed to reduce growth and fully integrating structural reform analysis into inequality and poverty. we are trying to tackle what economists call labor of education. then. For example. including skills Fund Facility—which helps countries facing serious balance upgrading. Still. is a key source of data on access to finan- Broader Reach” in this issue of F&D). India. sustainable strong growth these countries need to achieve •  On productivity. short-term economic and social costs of those reforms. making tax systems more progressive (including In addition. and promoting mobile banking (see “A launched in 2009. and Morocco are employed. Achieving this goal won’t be easy. and well-targeted social safety of payments problems—more than 1½ million recipients were nets. tion. China. encourage foreign direct investment. Stepped-up engagement Putting it all together. result from an expansion of credit. among low-income households. that deposit accounts at commercial banks in India have efforts should be accompanied by strengthened supervision grown by half a billion over the past five years. which have well-paying protected jobs and others have poorly pay- provides cash transfers to low-income families to encourage ing jobs with little protection and few benefits. putting in place financial •  On financial inclusion. in this issue of F&D). by easing access tices and encouraging female employment in retail settings to ATMs. especially that target female customers. better redistribution policies can pro. For example. and eliminate tax pro. and stipends were raised by such policies include replacing general price subsidies with more than 50 percent. More generally. as less competitive firms shut down and nomic and financial crises more acutely. we continue Safety nets and redistribution policies: With rapid to protect social spending when designing IMF-supported growth and improved productivity. nities. Examples of lished cash transfer program. getting a job is more difficult for women. programs because the poor typically feel the effects of eco- ners and losers. Arabia in frank discussions on female labor force participa- visions that discriminate against second earners in a family. ter of women in Egypt. In countries such as ability and help break the vicious cycle of poverty and lack Colombia. limited resources toward achieving better economic and social outcomes. which would allow countries to put their combating tax evasion. This could be achieved. thanks to the and regulation to avoid the financial instability that might government’s efforts to make financial inclusion a priority. or Mexico’s Opportunidades. finance which reforms enhance growth but also being aware of the infrastructure projects. it will also help put the global econ- understanding the sources of productivity and long-run omy on a stronger footing. our dialogue with member countries (see “Stuck in a Rut. literacy programs. Reasons include rigid labor regulations and large disparities in educational attainment. and South Africa. for governments •  On promoting equal access to employment opportu- to reduce barriers to hiring while still protecting workers. added to the Benazir Income Support Program. In many countries. we are devoting more resources to higher living standards. increased spending will be market “duality”—that is. and promote gender balance through more widespread remote work prac- growth. there are several examples. only about a quar. and financial safety net. I would say the time is ripe for We have recently stepped up our work in many of these emerging markets to make inclusive growth a centerpiece of areas—in large part because it is critical to the IMF’s mission their development strategies. have been working with the government to figure out how Education and health care: Improving the quality of best to counter the rise in inequality that will likely result education and health care will enhance workers’ employ. In particular. promoting access to banking services. we have engaged the authorities in Japan and Saudi remove restrictions on labor mobility. attendance at primary schools.” Countries will have to promote competition in product mar. It is critical. We also help countries adopt tax sys- cash transfers to the poor. we are working hard to strengthen the global in some cases expanding the personal income tax base). which provides subsidies to enhance schools’ performance and better align curricula with the job market. Access to employment opportunities: Ensuring that Better redistribution policies women and men have equal opportunities would help boost can promote equity without growth and reduce inequality. Jordan. a well-estab- mote equity without undermining efficiency. for exam- used extensively in India and Peru. for example. reduce poverty. our Financial Access Survey. our analysis of labor market disparities in Financial inclusion: Greater access to financial services Saudi Arabia highlighted possible measures to address the will help improve livelihoods. ■ Finance & Development March 2017  27 . reducing tax loopholes that ben. Below are a few examples. training programs. inevitably there are win. It will be important for governments course of Pakistan’s economic program under the Extended to adopt measures to ease that transition.

For example. Despite much progress in recent decades. at least one legal hurdle pre- economy suffers. East & North Africa it's 21% 40% 63% In sub-Saharan Africa. and educa- all people—not just women. Especially in low-income countries and emerging markets. including wage gaps. In addition to reforming uity across gender lines persists in the workforce. ineq. Female labor institutions. health and education disparities. however. nity. vents women from finding work. unequal access to opportu. THERE ARE LARGE REGIONAL DISPARITIES IN FEMALE LABOR FORCE PARTICIPATION Globally. If half of the world’s expand their labor force by including women. countries facing tion would help women join the workforce. that number is The UN Gender Inequality Index (GII) measures inequality in both opportunities ALMOST 90% and outcomes. friendly policies like parental leave and affordable child care.1 on the LEAST ONE GENDER-BASED GII leads to a 1% increase in economic LEGAL RESTRICTION growth. governments can implement family- many factors. and is closely linked with overall income inequality. PICTURE THIS GIRL POWER Policies that help integrate women into the workforce benefit everyone E QUALITY between men and women is important for shrinking workforces because of an aging population can both moral and economic reasons. 28   Finance & Development March 2017 . regulations. women make up 40% of In the Middle the labor force. and laws that promote discrimina- force participation continues to be lower than that of men due to tion against women. health. and legal obstacles. Equal access to jobs and economic opportunities benefits additional investments in infrastructure. the whole global In most countries. population cannot reach its full potential. OF COUNTRIES Reducing HAVE AT inequality by 0.

Finance & Development March 2017  29 . and health Prepared by Maria Jovanović. Increasing that 3–8% number to 3 out of 10 PROFITS would result in a 3–8% increase in a company's return on assets. THE GENDER WAGE GAP IS ROUGHLY 16% IN OECD COUNTRIES. education. Text and charts are based on the IMF's ongoing gender research. available at imf.00 WOMEN=$0.org/gender and drawing on other institutions’ knowledge and data.84 How much would a country's GDP increase if women's labor force participation were increased to match men's? REDUCING THE GENDER GAP IN LABOR FORCE PARTICIPATION USA 5% BY 25% BY THE YEAR 2025 WOULD POTENTIALLY CREATE 100 9% MILLION JAPAN 12% UAE 27% INDIA JOBS FOR WOMEN 0 10 % 20 % 30 % FISCAL POLICIES THAT SUPPORT INCREASED FEMALE LABOR FORCE PARTICIPATION: Greater equality between maternity Social benefits linked to Access to affordable and paternity leave policies labor force participation child and elder care Taxes on individual rather than family income Investing in infrastructure. MEN=$1.In Europe. 2 out of 10 senior corporate + = positions are held by women.

has proved accounting for 13 percent of global trade in goods. sec- this erosion of confidence. to a large extent. Transforming the domestic economy may in fact right (SDR). accounting for 15 percent of world GDP. partly reflecting loss of confidence in the econ. In 2016.­ elite global reserve currency. and prominence as financial capital surges out of China. Japanese yen. China’s overblown. China is also an important player in international trade. perhaps even rivaling the dollar. on how lar. The renminbi has lost value relative to the dollar.­ Since then.­ ond only to the United States. euro. and British pound sterling) that con. The renminbi was to join the In the long run. A Middle Ground The renminbi is rising. the special drawing currency. The renminbi’s inclusion in the SDR (based on market exchange rates). which took effect in October 2016. whose annual GDP is $19 tril- The earlier hype predicting the renminbi’s inevitable rise lion. the global financial system depends. has not stanched was $11 trillion. what the renminbi’s ascendance means for select basket of currencies (previously comprising the US dol.­ tion of its currency. It decided to anoint the Chinese renminbi an Reality likely lies somewhere between these two extremes. its annual GDP basket. The renminbi appeared to be on its way to taking have been a hidden agenda behind China’s aggressive promo- the world by storm and reshaping global finance. much has changed. and China is dealing with a spate of cap. Size counts but not for all ital outflows. but will not rule Eswar Prasad I N November 2015. China’s economy is now the second largest in the world omy and the currency. the IMF made an announcement that scenarios now predicting a plunge in the renminbi’s value was symbolically momentous in the annals of internation. to dominance. But the same is likely to be true for doomsday impact on the world economy is even greater when measured 30   Finance & Development March 2017 . China’s economy itself changes in the process of elevating its stitute the IMF’s artificial currency unit. al finance.

its greater use in denominating and settling cross. According to IMF estimates. in that currency without major restrictions on cross-border ments in foreign markets. but higher de- economic liberalization. Given China’s sheer size they did not want stronger demand. Korea. the government poses. China’s sheer eco- widely used currencies such as the dollar and the euro.­ ernment also set up the Cross-Border International Payment Remarkably. At the same time. Over the past year. the renminbi accounted for cally and economically diverse group of countries.­ border trade and financial transactions—that is. The renminbi’s Reserve currency adoption in global markets is constrained. The country holds about 30 percent instability. the renminbi is only now beginning to emerge swings in proper perspective.­ renminbi’s progress in this dimension was impressive ini- tially. to different finance over a relatively short period. to damage their export sectors. financial has set up a number of systems to allow foreigners to invest market participants’ views do more to determine a cur- in China’s stock and bond markets.­ In any event. This status is often seen as a mixed blessing—a reserve currency may reflect a conservative approach to giving market forces economy can borrow more cheaply from foreign investors by freer rein as well as prudence dictated by the risks of rapid issuing debt denominated in its own currency. Even though the IMF has. traditional mold. These arrangements give them access Finance & Development March 2017  31 . Germany and Japan at- moting the renminbi while trying only gradually to free up tempted to resist their currencies’ gaining this status because capital flows and the exchange rate. The trajectory of the degrees. And clearly the path In recent years.along other dimensions. does not quite match that of tal flows has come to a grinding halt. Malaysia. the other limitations. value. a sharp boom and bust cycle in the world have signed bilateral local currency swap arrangements stock market. Despite the constraints on as a factor in the global economy. reserve currency even though China does not meet some of tic and foreign companies using renminbi rather than more the prerequisites once seen as essential. the govern. this topic may seem premature given that In the mid-2000s. here. After all. As in many other eco- borders. well-established roles in global finance. and British pound—all have. since Another aspect of a currency’s role in international finance the Chinese government seems unwilling to condone a is its status as a reserve currency. preciation. The others—the dollar.­ its economy. and the liberalization of capi- of its currency. Many central banks around the world are gradually acquir- tional medium of exchange. acquire and easily trade financial instruments denominated tions. the renminbi has already become a de facto System to facilitate commercial transactions between domes. The of global GDP growth since the financial crisis. the government started removing China has neither a flexible exchange rate nor an open capi- restrictions on capital inflows and outflows. including sanctioning 15 offshore trading centers for nomic matters. it is important to keep both the upswings and down- economies. Chile. Indeed.­ global foreign exchange reserves are now held in renminbi- But then the currency’s progress stalled. Furthermore.­ the currency’s value will not be controlled by a government China has promoted the availability of renminbi outside its with scant regard for market forces. the renminbi. but these developments are still at a nascent stage and Unique playbook should not be blown out of proportion. tal account—once considered prerequisites for a reserve trolled and gradual manner. The gov. about 2 percent of among the top six payment currencies in the world.­ mand can sometimes make it harder to manage the currency’s China has  therefore adopted a unique playbook for pro. and concern about rising debt and financial with China’s central bank. yen. This account that allows for free cross-border capital flows.­ ber of steps to elevate the renminbi to this group of elite cur- rencies by increasing its international use. as China grappled denominated financial assets. there rency’s status. but in a con. foreign investors must be able to are now many channels for Chinese households. for all practical pur- after the global financial crisis. For instance. Austria. China appears to have broken the transactions between renminbi and other currencies. and which—although a low share—already placed the renminbi South Africa.­ nomic size and the strength of its trade and financial linkages These measures led to rising internationalization of the with economies around the world seem to have overridden renminbi. This process continued even currency. about ing at least a modest amount of renminbi assets for their foreign a third of China’s international trade was denominated and exchange reserve portfolios. corpora. although still modest. in the 1980s and 1990s. and institutions to place some portion of their invest. and ensuing currency ap- and its rising shares of global GDP and trade. the international stature point to signs of a sharp retreat. as an interna. By the latter half of 2014. Some 35 central banks around the with a growth slowdown. Australia. will be bumpy and involve many detours. the renminbi has begun euro (used by two of the six largest economies—Germany playing a larger. And they must be reasonably confident that keep a tight grip on each of these channels. But the government continues to financial flows.­ quantitative indicators of its use in international finance all Despite China’s economic might. however. too. role in international and France). one held by foreign central fully market-determined exchange rate and an open capital banks as protection against balance of payments crises. Nigeria.­ ment’s steps quickly gained traction. The list comprises a geographi- settled in renminbi. including about 2 percent of cross-border payments around the world. Among the currencies of the world’s six largest Still. Japan. the Chinese government has taken a num. the renminbi’s progress as an of global foreign exchange reserves and accounts for a third international medium of exchange has gone into reverse. anointed the renminbi a reserve currency. capital flowing in and out of China.

which would allow smaller banks power. financial liberalization and limited mar- rate will allow for more independent monetary policy that ket-oriented economic reforms. The large state-owned banks resisted more competi. Similarly. Many of the international finance. including eign wealth funds.­ China may be gaining economic clout. In short. Such reforms into stiff opposition from powerful interest groups that stand are apparently not in the cards.­ liberalization measures that would otherwise have floundered. it employment growth. typically seek to invest in highly liquid central banks and sovereign wealth funds. a collapse of the to compete with them for household and corporate deposits financial system could alter this trajectory and derail the ren- by offering better rates. the notion that the ren- to lose from any changes to the existing system. such as central banks and sover. its progress along this dimension is likely public institutions (especially a credible central bank). legal.­ for China’s own economic development and for promoting the international role of its currency. Such a ered for inclusion in the SDR basket. however.­ mined exchange rate. These to be limited by its lack of well-developed financial markets.to renminbi liquidity that they can tap to defend their currencies A country seeking this status for its currency must have a or maintain stable imports even if foreign capital inflows dry up. and the independence of key institutions ter job of allocating China’s copious domestic savings to more from government interference. the rule of law. reduce its and not just to diversify their assets or seek higher yields. Thus. a government has. a more flexible exchange meandering manner. strengthening its financial markets is important both maintaining the credibility and value of the currency.­ will not attain safe haven status without far-reaching reforms However. and deadline set by the IMF for the renminbi to be consid- tion in international finance: the “safe haven” currency. at least in principle. In fact. it is possible to make a broader case that China has prominence will change tried to use elevation of the status of its currency mainly as a cudgel against opposition to domestic reforms. regardless of what happens Chinese leaders are pursuing. elements have traditionally been seen as vital for earning the Foreign official investors. remove some restric- one that investors turn to for safety in times of global turmoil tions on capital flows. it is to liberalize bank deposit interest rates.­ The Trojan horse strategy has indirectly helped to advance at least a limited set of financial sector reforms and capital Gulf between reserve and safe haven account liberalization. reform-minded officials pose China’s economic and financial stability to a number of have in effect used a Trojan horse strategy to push economic risks if these policy changes are mishandled. both private and official. no doubt in a slow and often with the currency. been accompanied by ever gain the trust of  foreign investors is an open question. some of the policies related to enhancing resisted certain economic reforms that could pose short-term the renminbi’s international stature—including capital ac- risks. a new concept has gained trac. reforms to the real side of the economy. preferring stability and control to the inherent volatil. treated fairly according to well-established legal procedures. sion. Some government officials have also minbi’s rise. even if such Foreign investors typically want to know they will be securities have a relatively low rate of return. For instance. an open and democratic government. China’s govern. rolled back freedom of expres- broader and better-regulated financial system can do a bet. China’s of having to maintain a particular exchange rate.­ The renminbi’s rise to Trojan horse Indeed.­ intervention in foreign exchange markets. reforms necessary to enhance the currency’s international role will ultimately benefit China. When it comes to Such trust is crucial for a currency to be seen as a safe haven. By casting these reforms as essential to mined more freely by market forces—could themselves ex- promoting the status of the currency. global reserve currency is far-fetched. count opening and allowing the exchange rate to be deter- ity of market forces. minbi will one day rival the US dollar for dominance as the Chinese exporters for a long time opposed a market-deter. and institutional reforms. but whether it will These changes have not. They but are still seen as having limited trading volume and weak also tend to value independence of institutions such as the regulatory frameworks. trust of foreign investors. fearing that it would lead to currency appreciation and make their exports less competitive in foreign Risks ahead markets. and robust a reserve currency. The renminbi’s path to global prominence depends to a sig- tively determined interest rates on deposits (rather than rates nificant extent on China’s growing economic and financial fixed by the government). For instance. if anything. worse.­ central bank from government interference—important for Thus.­ sound institutional framework—including an independent Although the renminbi has managed to attain the status of judiciary. while the renminbi productive investments that generate more stable output and has the potential to become a significant reserve currency. For instance. state-owned enterprises and much-needed improvements to 32   Finance & Development March 2017 . many of these reforms have traditionally run to China’s institutional and political structure. to meet the conditions Since the global financial crisis. and. But they have unequivocally can target domestic policy objectives without the constraint repudiated political. A major growth slowdown or. during 2015 China had currency is more than just a plain vanilla reserve currency. ment and corporate debt securities markets are quite large rather than subject to the whims of the government.­ and relatively safe fixed-income debt securities.

many of which are unprofitable and inefficient tively. eventually account for as much as 10 percent of global for- verse incentives for bankers to lend to government enter. ©2017. (For comparison. respec- companies.­ rather than yielding the benefits of well-functioning markets. 288pp. University and senior fellow at the Brookings Institution. If China plays its cards right. and even China itself. Such ward pressure on the currency and.­ Policies that support well-functioning markets and economic management — or “soft infrastructure” — play a key role in China’s economic transformation. and they have powerful patrons. This cial sector and other market-oriented reforms. as the central bank has changes are currently not in the cards. resulted in a loss of about $1 trillion in foreign change international finance. Brookings Institution $38. the renminbi’s rise to international prominence will the US dollar. how- Concern about the economy’s growth prospects and high ever. Loans to state-owned the euro now account for 64 percent and 21 percent. which has generated more volatility economic and financial system reforms. The limited financial market reforms past few years.­ For the renminbi to become a safe haven currency. with suitable finan.) but still undertake large investments. This book explores the country’s changing economy and suggests ways to further strengthen policy frameworks. ■ don’t expect it to rule. the renminbi is on its way to becoming a significant international currency. While the currency has made remarkable progress in a rel- anteed by the government. the state of China’s economy and tance in international finance could well serve as a catalyst the status of the renminbi are closely linked.­ atively short period. of global foreign exchange reserves.corporate governance and the urgent need to remove per. which would ulti- capital outflows over the past couple of years. Over the next few years. This put down. are still implicitly guar. the US dollar and prises.org/fd317 I N T E R N A T I O N A L M O N E T A R Y F U N D Finance & Development March 2017  33 . And its full potential may remain unrealized and capital account opening have not been supported by unless the Chinese government undertakes a broad range of reforms in other areas. “…essential reading to understand China’s challenges…” —David Dollar. Paperback.imf. but Despite some fits and starts in the process.­ although this will take many years and will hardly be a lin. ways. the renminbi article is based on his new book. English. there is still a long way to go. Gaining Currency: The Rise could one day be an important reserve currency and could of the Renminbi. and public institutions. eign exchange reserves. ISBN 978-1-51353-994-2. in many exchange reserves (relative to the peak level of nearly $4 tril. Eswar Prasad is a professor in the Dyson School at Cornell ear process.­ tried to continue managing the currency’s value relative to Still.­ End game The renminbi will continue to rise in global finance. Stock #MCISIEA Order now at bookstore. mately alter its political. it is far from assured that it will continue China is thus facing complications from haphazard and along the same impressive trajectory it has followed for the unbalanced reforms. Clearly. the renminbi’s rising impor- lion in June 2014). China would have to initiate even more far-reaching volatility in domestic stock markets helped fuel a surge in reforms of its institutional framework. legal. for domestic reforms and perhaps even promote a more sta- ble international financial system. Senior Fellow.

In other words. excluded individuals with entrepreneurial whole society whether for personal or business purposes. might help productivity and economic can benefit cause they almost always involve cash. Furthermore. has become a extended illness or a natural disaster. The benefits of financial services of access to financial services prevents them could lift many people out of poverty. have to cial inclusion. Martin Čihák. the durable goods. people who have lim- scale entrepreneurs—mainly in ited or no access to financial services people and developing and emerging mar. broader access to financial services can be costly and sometimes dangerous. be. a house. even explicit quantitative targets for finan- cial system and did not. their savings would increase if they Several aspects could deposit any funds they can accumulate The notion of financial inclusion has sev- in an interest-earning bank account rather eral dimensions. Their financial transactions. talent. could be better off if they did. and even securities firms offer. borrowing funds reduce inequality. but key is access to finan- than having to hide the money in their homes cial services such as banking and insurance and if they learned how to assess and buy the at an affordable cost—particularly for the products and services that banks. for example. these services. Similarly. a refrigerator. ministries. omies and emerging markets. So might more firms ket economies—find that lack society. In almost 60 might be improved if they had access to and countries. India. Promoting financial inclusion. or other consumer if it makes credit available to previously services. or purchasing preneurship and investment. and encourage entre- to financial to expand their businesses. the process of broadening access to and use their financial condition is vulnerable to an of financial services is called. rely on extended family for emergency funds. as limited ability to save or to buy insurance. have access from saving for a rainy day. 34   Finance & Development March 2017 . A Broader Reach Man outside an ATM in New Delhi. and Ratna Sahay M When more ANY households and small. mantra of many central banks and finance The lives of a vast number of people. there are national strategies and used a secure and affordable formal finan. particularly in developing econ- including many poor in advanced economies. insurance poorest—and effective and responsible use of companies. With growth. Adolfo Barajas.

the number of bank accounts per 1. based on data col. 21 percent of firms (estimated bank stability. business Number of borrowers per 1. and the economy: nomic growth. financial inclusion can hurt high-income countries to 86 percent in low-income countries. because they lack an Finance & Development March 2017  35 . •  Increased access to financial services by firms and indi- Saharan Africa. sectors that rely heavily on external The Global Findex estimates that in 2014. In those with weaker tries and 42 percent in low-income countries. lected annually since 2004 by central banks from providers New data sources now make it possible to demonstrate that of financial services in 189 countries: The survey shows a financial inclusion affects the overall economy—the so-called great expansion in financial inclusion over the past decade. 2/10/2017 Only three-quarters of account holders use their account to •  But risks to financial stability. and despite only two its annual long-term GDP growth by 3 to 5 percentage surveys so far. 36 percent of firms worldwide said lack Safe inclusion of access to finance was a substantial impediment to their In countries with strong supervision. and 37 35 percent did in sub-Saharan Africa. benefits for growth wane as inclusion and financial depth cial institution. At very high levels. points by boosting people’s access to ATMs or firms’ access tiate by age. growth by encouraging such behavior as irresponsible lend- The survey also shows opportunities for increasing the use ing by financial institutions that make loans without duly of financial services by those who bank with an institution. Barajas. 2 billion adults. macro level. productivity. For example. such 5 as checking and savings accounts. constructed with the median level of financial depth—the total amount from a worldwide survey of individuals’ access to and use of funds mobilized by financial institutions—can increase of financial services: It started in 2011. or to make try’s economic growth by several years. hand in hand with financial stability. attention. Among developing economies financial services in more than 100 countries. mainly •  The World Bank Enterprise Survey. had no account with a formal finan. 30 25 High quality of banking supervision Effects of inclusion 20 It has been clear for a while that financial inclusion is good for 15 Average quality of individuals and firms—what economists call the micro level: 10 banking supervision •  Poor people benefit from basic payment services. The higher the Z-score also helps firms. considering risks. to make at least three withdrawals a month. There are considerable differences across countries those with bad credit ratings who had largely been excluded) and regions. there were 1. job creation. its more than 100 indicators—which differen.000 consumption. The chart covers 64 emerging market and developing economies from 1980 to 2014. about 7 percent fewer women than men inclusion and stability: the buffers (capital) banks should hold are financially included. Financial inclusion was not on most macroecon- Worldwide. gender.000 adults in high-income countries. compared with 3 percent in high-income coun.081 accounts morphed into the global financial meltdown of 2008. –10 0 100 200 300 400 500 600 700 800 900 1. or collateral. Among devel. The level varies from less than 10 percent in increase.000 adults investment. and eco- services and its effect on people. But one form of lending that has gained much •  The IMF’s Financial Access Survey. increase when access or receive electronic payments. Researchers and policymakers rely mainly on indicators established reputation. firms. in 2014. Z-score) in east Asia and the Pacific said they felt constrained. Field experiments show that providing individuals –5 supervision with access to savings accounts increases savings. supervision. Their access from three global sources to gauge the spread of financial to credit is associated with innovation. that is. using data on access to and use of 88 in low-income countries. income. face difficulties in obtaining bank credit.000 adults increased from in subprime mortgages (made mostly to poorer people and 11 to 16. A country •  The World Bank’s triennial Global Findex. compared with Sahay and others (2015). In countries despite an increase in access to and usage of formal financial with weaker supervision. tries with greater financial inclusion.000 adults evidence on macroeconomic effects of financial inclusion: ranged from 978 in Europe and central Asia to 158 in sub. greater inclusion can prompt financial instability. However. per 1. oping economies and emerging markets. Moreover. when the problems that increased from 180 to 654 between 2004 and 2014. which has irregu. which can set back a coun- save. because of a failure to take proper account of a rapid increase larly collected data on firms’ usage of financial services since 2002: In 2014. which often the more stable the institutions and implicitly the financial system. so-called micro-credit. The survey also shows that to credit is expanded without proper supervision. especially small and new ones. to credit. financial inclusion goes expansion. Source: Authors’ calculations. provided some and emerging markets. the marginal were unbanked. and investment in preventive health care. • Improved access to credit and other types of funding Note: The Z-score measures the stability of financial institutions by comparing buffers (capital and earnings) to the risk of a negative shock to earnings. there is a stark trade-off between services by women.000 adults omists’ radar until the early 2000s. bank branches per 100. track record. viduals substantially benefits economic growth. women’s empowerment. while the originated in large part in the United States due to growth number of bank branches per 100. sources to finance investment grow more rapidly in coun- or almost 40 percent of the worldwide adult population. has had mixed success. as well as from insurance 0 Low quality of banking services. and income level—provide rich detail. to guard against adverse shocks are allowed to erode.

vide the only contact between the customer and a financial ulation has access to financial services. Slovenia has the highest level of risk to financial and economic stability from housing booms credit information. “Financial Inclusion: Can It Meet ple. Ratna. For example. money and to raise pension awareness among the elderly. and María Soledad Martínez Pería. introducing limits on the frac. although there has been limited research on insurance. the private sector. when red tape makes opening accounts too costly. tion of their income borrowers may pay in order to reduce the Among these four countries. in developing economies and emerging markets. “How Bank with loans is different—about 65 percent in Slovenia. mobile payment platforms. efforts to improve loan repayment can also conflict and Martínez Pería also found that the quality and availabil- with inclusion. is only part of the story. This suggests that other factors are also at play. Sahay. poli- In Pakistan. in which mobile phones pro- inclusion. and others. bank A more financially literate branches. and smartphones—does not hurt financial stabil. 2015. savings. •  Increasing access to noncredit financial services such as payment and savings accounts—for example via ATMs. whether they can foster saving. but the percentage Adolfo Barajas is a Senior Economist in the IMF’s Institute of firms with loans illustrates the overall positive relationship for Capacity Development. DC. able collateral. and Uganda the goal of increasing financial literacy should be to increase get financial services through mobile phones. Tanzania. economically viable for banks and other institutions—rather For example. World Bank. Only 2 percent of the world’s adults use mobile on educating potential customers to make sound financial banking. but use is expanding rapidly in sub-Saharan Africa. DC. populace should enhance overall ity. where much of the pop. uals and businesses is a key element of successful financial One avenue is mobile banking. in Mongolia. such as vehicles—often the only types of assets owned by many potential borrowers in developing econo- Raising financial literacy mies—helps expand firms’ access to finance. petition in the banking sector boosts access to credit—which International Monetary Fund. For example. differences between Slovenia and Nepal or Ukraine. Washington. In the Netherlands. About 20 percent of adults in Kenya. and the United try’s entire adult population. likely to achieve macroeconomic goals. Hong Kong SAR. Inessa. a program supported by the central bank and cymakers can take steps to make account opening simpler. both in the IMF’s Monetary depth. debt general increase in bank credit or by setting up goals for rapid management. however. 50 percent Competition Affects Firms’ Access to Finance. with a credit bureau that covers the coun- and busts—as Australia.” Policy Research Working in Mongolia.) The link to financial Ratna Sahay is Deputy Director. Washington. and Capital Markets Department. Yet the share of firms Love. ity of financial information on potential borrowers are factors. Paper 6163. Multiple Macroeconomic Goals?” IMF Staff Discussion Note 15/17. lar financial depth can have very different levels of inclusion. But in countries with could help explain why Slovenia has higher credit access than strong supervision. financial products. bor- example. The spread of technology can also enhance inclusion. Because overall financial stability can be undermined by a cial concepts such as budgeting. gram that involves the government. and branchless banking. policymakers are exploring how to increase inclusion using A more financially literate populace should enhance over. (Of course. For exam. in part by Other research shows that establishing registries of mov- enhancing diversity in the depositor base. a comprehensive nationwide financial literacy pro. •  Increasing the share of women who have accounts helps raise growth without impairing financial stability. and Ukraine private References: sector credit is about 60 percent of GDP. In advanced economies. ■ unlimited access to credit is not desirable. 35 percent in Nepal. for mostly for transactions. Love Moreover. there is a positive relationship between a proxy for than schemes that direct lending to certain sectors—are more financial depth—the volume of credit—and a measure of finan- cial inclusion. financial inclusion increases with financial depth. policymakers should consider other policies School-based projects in India and Brazil use family and aimed at helping the poor. the focus should be institution. Countries with simi. Policies that make financial inclusion Generally. Peruvian awareness of and the ability to use available services. Slovenia. But competition cannot explain the large by an increase in banks’ loss absorption buffers (see chart). con. rowing. greater access to credit is accompanied that of Slovenia). and insurance is unclear. and educational institutions has undertaken addressing the underlying market and government failures projects to teach primary school children how to deal with that keep people out of the financial system. Kingdom have done—will also limit access to credit. Love and Martínez Pería (2012) found that greater com. 36   Finance & Development March 2017 . economic and financial stability. and 18 percent in Ukraine. the private sector informs the public about basic finan. investments. Recent research shows that the financial literacy of individ. For example. fers to people in need. Nor does increased access to insurance services. As a broad principle.in loans that are not being paid on time. credit growth. Mobile accounts are still used all economic and financial stability. Martin Čihák is an Advisor and between inclusion and financial depth. decisions. 2012. financial inclusion goes hand in hand Mongolia (whose level of bank competition is less than half with financial stability. such as direct and targeted trans- social networks to spread the literacy effort beyond students. inclusion efforts are best aimed at sumer groups. Nepal. the percentage of firms with loans.

Typically. much a person trusts unspecified people when conventional economic and political rather than friends or family. people—and part because they don’t trust the fairness of sured by so-called generalized trust—how can stifle the game or the person playing it. United Kingdom. Trust is a com. can be trusted or that you can’t be too careful nomic inequality is one reason people may be when dealing with others?” less likely to perceive economic and political During the past 40 years. is gauged by a question such as “Generally growth tors as untrustworthy. Gould and Alexander Hijzen “T RUST me”—it’s a common Our research examines whether the down. response to increased income inequality. generalized activity as fair.­ trust in the United States has declined Finance & Development March 2017  37 . Rising eco. trust is mea.­ the United modity that’s in short sup- Social glue States and ply lately. speaking. In survey data. Inequality in phrase that often arouses ward trend in trust and social capital is a suspicion. in the United States and around the world. this economic activities are perceived as unfair or their ac. Similarly. Most people are reluctant to take (Putnam 1995). Take the example of the three-card tal that “enables participants to act together trust among monte or shell game played on streets around more effectively to pursue shared objectives” the world. In Equality We Trust A hustler’s shell game being played on the streets of London. people want extra re. Eric D. would you say that most people assurance before they participate. with potentially serious implica. Trust is a key component of the social capi. Europe erodes tions.

­ If economic disparity stems from family background. When people see a rising income gap among 20 1970 80 90 2000 10 people like themselves in terms of age. making taxation more that discontent is brewing in many European countries. the decline in generalized and Uslaner 2005). govern- economies is limited and does not reveal consistent patterns. Trust in government shows a that differences in trust between regions or countries are similar downward trend. Systematic evidence Fair play on the causal relationship between inequality and trust at At the same time. unequal outcomes indicate the degree of the variation across states and over time (1980–2010). However. dis- parity is highly persistent and social mobility limited. These trends may threaten the caused by differences in inequality. inequality substantially lowers sonal connections. trust declines.­ inequality and trust is driven by a third factor. One explanation is that inequality that stems from demographics. responding that most people can be trusted.” However. The World Values Survey shows that trust is even more pronounced. education.­ The results show clear evidence that in the United States wide-ranging inequality substantially lowers people’s trust Fading trust The share of US people trusting others has fallen steadily since the in each other. Adjusted is the share of the working-age population. Zak and ulation has become more educated. controlling for changes in US affected. the increase in inequality explains 44 percent of the observed (percent of working-age population responding that most people can be trusted) decline in trust. the share of those who Indeed. Changes in example. For about 50 percent to 33 percent (see chart). a large income gap will erode a general income. per. data from the General Social Survey for the United the composition of the US population. If the relationship is causal. The analysis uses data from the American National sense of trust when people’s values clash—in other words. Our analysis for the United States exploits this argument. Since the early 1970s.­ that for Europe utilizes the variation across European coun- tries and over time (2002–12). undermine people’s trust in each other.markedly. and type of work. moreover. Election Survey for the United States and the European Social “familiarity breeds trust” (Coleman 1990). mainly because the pop. According to Survey for Europe. such mea- sures may not do much to restore trust. and economic activity weakens trust and 30 social capital. progressive. but inequality between education groups does not. the findings also reveal that differ- Adjusted ent sources of inequality account for significant differences 50 in inequality’s impact on trust and social capital. Note: Actual is the actual share of the working-age population responding that most people can made different educational and career choices trust is not be trusted.­ lishing causality is crucial because of the widely different Evidence on trends in social capital in other advanced policy implications. 2/10/2017 status is associated with shared val- ues that foster trust. result- ing in high inequality of opportunity (Putnam 2015). Our research examines whether the downward trend in tus. and more educated Knack 2001). differences in human capital decisions and investments is 38   Finance & Development March 2017 . or strengthening public income support for the Whether this translates into less trust and lower social capital poor—could be the solution. The results for the United States indicate that 1970s. When this is the case. or mere luck rather than individual merit. 1972–2012. Alesina and La Ferrera 2002. But if the correlation between is open to question but often assumed to be true. it may seem particularly unfair and. When controlling for high (for example. estab- for mainstream political parties. ment measures that seek to reduce economic inequality— But recent anecdotal evidence and electoral results suggest such as raising the minimum wage. many studies have noted a strong correlation respond that most people can be trusted has declined from between generalized trust and economic inequality.­ Actual Inequality within socioeconomic groups as defined by 40 education. therefore. Findings were qualitatively similar for “trust 60 in government. Rising economic inequality is typically regarded as an important reason for the decline in trust and may render economic outcomes less fair or drive a wedge between socioeco. Rothstein changes in US demographics. In the United States wide-ranging nomic groups. trust is higher in more equal societies (for example. age. These correlations do not necessarily mean people tend to trust more.­ Economic outcomes also determine socioeconomic sta. tend to States show that trust is lower in states where inequality is mask the true extent of the decline. while social stratification in society. economic inequality has increased in the this point is rather limited. trust in others and in government. Both trust and inequal- effectiveness of public policy and reduce popular support ity may be the result of some third factor. But if the gap involves people who Source: General Social Survey. If corrected socioeconomic trust and social capital is a response to the increasing gaps in Gould.­ United States and in many advanced economies.

DC. Similarly. Eric D. Given rising inequality in many advanced economies and However.­ References: This literature highlights two key ways trust influences Alesina A. and withdrawal from mainstream politics States.” OECD Social. Our Kids: The American Dream in Crisis. However. Kalpana Kochhar.” Political Science and policy. Coleman. distrust prevents poli. Cambridge. P. Inequality: A Global Perspective. complements other recent empirical work show- or collective bargaining.­ economic incentives and shape the economic behavior of ———. Federico. 111 (470): 291–321.­ it comes to monitoring employees and determining appro. all quality of public institutions.” IMF Staff Discussion Note cially when it comes to constitutional reforms and inter. R. its member states. and Social Trust. other advanced economies may have shattered hope in eco- gesting that inequality’s damage to trust extends beyond nomic processes. priate rewards. Andrew Berg. J.. This study. So policies that seek to restore gest that this growing disparity could be affecting growth and trust by reducing market wage dispersion before taking into development in an important.­ than just a good income.­ action in the private sphere by replacing transaction costs. However. Inequality both at the top and at the bottom of the may be the fallout. 2015. In addi. “All for All: Equality. and Growth.­ national treaties. societal dynamics. Berg. our results sug- demand for redistribution. James S. intolerant. 2014. and S. 2015. Era. Distrust also reduces the credibility of public Disappearance of Social Capital in America. via specific drivers such Zak. “Trust and Growth. International Monetary Fund.­ differences at the bottom of the earnings distribution. and firm productivity. Frantisek sphere by reducing collective-action problems related to Ricka. wary companies may Moreover. No. Public Economics 85: 207–34. which often require healthy popular Putnam. M. 1995. it smooths the way for economic inter. Tuning Out: The Strange support. and Alexander Hijzen is a Senior Econo- policies in the form of more progressive taxation policies or mist at the Organisation for Economic Co-operation and stronger social protection. tural economics shows that trust is a key ingredient for good economic performance. Inequality. Paper 163. “Tuning In. inequality does not appear to foster a greater the role of trust in economic performance. a lack unexplained factors drive incomes apart. “Growing Apart. institutional settings.­ investing in the stock market.. Uslaner. Nujin Suphaphiphat. First. and political practices the United States to advanced economies with different that deliver fair outcomes. La Ferrara.­ MA: Harvard University Press. trust can promote cooperation in the public Dabla-Norris.­ cies from being effectively implemented.. In this case. D. “Causes and Consequences of Income the provision of public goods and by enhancing the over. 2001. and divided—espe.­ be able to solve pressing socioeconomic challenges in a Ostry. Simon & Schuster.­ Development. In other words. Tsangarides.­ Finance & Development March 2017  39 . and E. the impact of inequality on trust in Europe is more general.­ The rise in economic inequality in the United States and in We found similar results for European countries.” Economic Journal as international trade. 2002.” It does not necessarily reflect the views of the OECD or nomic implications. for example—appear more prom. innovation. “Trends in Income Inequality and Its Impact such as legal and insurance fees. financial development.­ ■ distribution are found to eat away at trust and social capital. providing evidence of a particular channel for some of the ill a quality job with dignity and a decent salary means more effects of inequality on growth. 1990. Organisation for Economic Co-operation and Development. Gould is a Professor of Economics at Hebrew Uni- But in contrast to the United States. 2005.­ Second. Lower economic participation. way. and Tsangarides 2014) by income tax or increased social spending.­ motes economic growth generally. For example.­ Rothstein. DC. ing that inequality reduces growth (Dabla-Norris and others ising than redistribution in the form of more progressive 2015. A substantial body of literature in cul. The decline in trust and social capital is troubling not only 16/176. Ostry. B. on Economic Growth. “Who Trusts Others?” Journal of the economy. and E. Foundations of Social Theory. New York: citizens and business.” IMF Staff Discussion Note 15/13. “Redistribution. it may also have eco. Cingano 2014. Employment and Migration Working mal ways of forming and maintaining agreements. the impact of inequality on trust and social shy away from outsourcing or offshoring and thereby miss capital in the United States is driven largely by rising wage out on potentially profitable opportunities. albeit indirect. Washington. which undermines its ability to effectively change Politics 28 (4): 664–65. Losing Trust? The Impact of Inequality on because of its effects on social cohesion. Washington. and Charalambos G. 2014. There is also growing empirical evidence that trust pro. society that is distrustful. with less expensive. account taxes and benefits—regarding the minimum wage therefore. Corruption. in contrast to the United social polarization. Jonathan D..easier to understand and seems fair. people lose faith of trust in the financial system may prevent people from in other people and in government. Cingano. greater trust can mean fewer problems and costs when Paris. infor. if luck or entrepreneurship. Knack. 14/02. sug.” World Politics 58: 41–72. Social Capital. and Evridiki Tsounta. inequality in Europe versity and a Research Fellow at the Centre for Economic does seem to increase the demand for more redistributive Policy Research. tion.­ Who cares? This article is based on the authors’ 2016 IMF Working Paper. Governments may not International Monetary Fund.

fuels generates the emissions that cause cli- nation. The sential services that underpin both global cli. And because forests recapture carbon as table and inclusive growth. Brazil GROWTH has shown protecting them is compatible with development Atlantic Forest. an area of forest is cleared or burned. especially to poor could deliver reductions of up to 30 percent households and countries. drag on development. branches. in forests a natural carbon-capture-and-storage tech- can help overcome incentives for nology. and forest protection is an under- them more practically—as a source of timber valued solution to the problem. single major natural disaster such as a hur. deforestation’s role is less well diversity. and removals. Paying developing they grow back. But evidence to support a third view is carbon stored in tree trunks.Forests for Forests are a key asset for climate stability. In other words. While everyone knows that burning fossil der and beauty in the popular imagi. essential to the long-term goal of the 2015 Paris Agreement on mitigating cli- From problem to solution mate change for balance between emissions Climate change is increasingly rec. Protecting tropical forests need not be a trailing only China and the United States. Halting tropical deforestation—which cur- off with growth and poverty reduction. tional cooperation. they can also mitigate emis- economies to keep carbon. affordable. forests can produce net negative deforestation as usual. nor a zero-sum trade. Brazil. total contribution of emissions from defor- mate stability and development goals. emissions. Development planners view known. Every time revenue or a land bank for agricultural expan. the sion. The Agreement endorses 40   Finance & Development March 2017 . The potential of forests to contribute ricane—expected to be more frequent and to mitigation was one reason the Paris severe on a warming planet—can knock a Agreement singled out forest conservation country off its economic growth trajectory as an important opportunity for interna- for decades (Hsiang and Jina 2014). Exposure to a of current emissions (see Chart 1). regrets” measures in tune with more equi. rich in cultural and biological mate change. “no global annual emissions. leaves is released to the atmosphere. Stopping tropical deforesta- ognized as a key threat to global economic tion and allowing damaged forests to recover growth and development. a major sions from other sources. estation exceeds that of the European Union. and growing rapidly—tropical forests provide es. Brazil rently denudes an area the size of Austria has demonstrated that many of the steps to every year—would make a significant dent in protect forests are feasible. Frances Seymour and Jonah Busch T ROPICAL forests are places of won. as source of global warming.

2/10/2017 tunities for corruption. and forest-based eco- Halting and reversing tropical deforestation could reduce total system services are effectively assigned a value of zero in emissions by up to 30 percent. to tame deforestation. these communities (Angelsen and others 2014). and a wide variety of plant Chart 2 materials for medicine and ornamentation. Seymour corrected. How did Brazil do it? Responding to domestic constitu- encies and negative international attention generated by Invisible contributions forest destruction and lawlessness in the Amazon. These included the establishment of ter governance. millions of tons) But forests’ economic contributions go far beyond goods 30 10 Cattle (right scale) to include ecosystem services that are enjoyed locally and on a broader scale. which leads to more transparent and accountable forest uses are essential to economic growth and the reduction management. Brazil’s successful forest protection can improve forest governance. achievement undermines the frequent assertion by tim- Results-based financing requires governments to monitor ber and agribusiness interests and their government allies and report progress according to agreed performance indica. from disasters are mostly invisible to economic decision Chart 1 makers. Potential mitigation Total potential from sustaining forest mitigation from tropical Yet economic valuation shows that the losses from for- Potential regrowth forests est destruction can be substantial. health. Over a decade gone benefits of forest exploitation. and main. clean water. but measur- ing the value of forests for storing carbon is feasible and a framework for reducing emissions from deforestation and increasingly accurate. and not just through climate protection and bet. and panied by increasing production of soy and beef. starting in 2004. and safety Finance & Development March 2017  41 . nuts. Forested 15 watersheds provide freshwater for reservoirs that power Soy (right scale. which violence in many countries—paying forest-rich countries for are key drivers of forest clearing (see Chart 2). Typical national statistical surveys and accounts Damage control fail to capture forest-based income. of rural poverty. and Baccini and others 2012. (Amazon deforestation. results-based payments reduce oppor. economic analyses. Surveys con. The massive fires in mitigation from reducing gross emissions Indonesia in 2015. marshalled the political will to implement a suite of policies sive growth. conflict. are a good example. mushrooms. wild fruits. that forest resource exploitation and conversion to other tors. Green balance ducted in 24 countries revealed that on average such for. Communities in and around forests collect wood for fuel and charcoal. Brazil reduced the rate of deforestation in And unlike logging and conversion of forests to export. At the scale of farms and villages. Further. 10 of millions of tons) tain municipal water supplies. clean energy. Recent research suggests 2 that forests play a key role generating the rainfall neces. Such flawed accounting leads to a bias (percent of total global net emissions) in favor of clearing forests for other uses. support irrigation systems. The World Bank 24–30% estimates losses from those fires at $16 billion. which burned an area the size of the US 8–11% = state of New Jersey. thousand square kilometers a year) (production. Putting a price tag on forest services has proven methodologically challenging. and bushmeat for food. and poverty. 25 8 ests provide habitat for the birds. 1995 97 99 2001 03 05 07 09 11 13 15 16 Yet forests’ many and varied contributions to achieving the UN Sustainable Development Goals related to hunger Sources: FAO 2015 and INPE 2016. agricultural sector growth from forest loss. forest degradation (REDD+): rich countries provide perfor- mance-based financing to developing economies in exchange Feasible and affordable for lower forest-based emissions. bats. for. tens 4 hydroelectric dams. Such revenue streams can Brazil has demonstrated that it is possible to decouple at least partially compensate forest-rich countries for the for. Brazil reduced deforestation and increased agricultural est products constituted 21 percent of household income in production at the same time. double the 16–19% + potential revenue from planting the burned land with oil palm. Brazil Efforts to reduce deforestation go hand in hand with inclu. insects. The decline was accom- oriented crops—associated with corruption. and insects that 20 pollinate crops. 5 sary to sustain agricultural productivity across continents Deforestation (left scale) 0 0 (Lawrence and Vandecar 2015). help stabilize landslide-prone hillsides. (World Bank 2015). 6 and protect coastal communities from storms. whose cultivation has driven much deforestation Sources: Pan and others 2011. the Amazon by some 80 percent.

“The Causal Effect of benefits include maintaining rainfall that waters southern Environmental Catastrophe on Long-Run Economic Growth: Evidence agricultural breadbaskets. The Green Climate Fund is and allowed the authorities to catch unauthorized deforesters developing a REDD+ funding mechanism. “The Indeed.” Nature 2016). In Brazil. toward achieving the goals of the Paris Agreement. Economics. 2011. and K. “Effects of Tropical Deforestation on Climate and Agriculture. REDD+ will remain a great idea that’s hardly cover. and pulp win-win for climate and development. and others. and making land-use planning and management more transparent and accountable are all con. 42   Finance & Development March 2017 . attenuating drought. and the politics of the Paris Pan.700 Cyclones. Satellite-based technology for monitoring deforestation There are a number of possible sources of REDD+ financ- was a powerful new tool for effective policy implementation ing beyond limited aid budgets. under pressure from activists.” Indonesia growth. mated at about $2 billion. ■ and paper. Felipe A. 2012. Yude. strength.” http:// economics of forest-based mitigation and valuation of for.­ ening the rule of law. state. producer of hydropower. Fogliano de Souza Cunha. soy. and municipal governments have been esti. partly In addition. allowing less expensive and more rapid progress Food and Agriculture Organization of the United Nations (FAO). In the Amazon. and reduc.. it was wealthy soy farm. reducing deforestation is one of the most cost. D. fao. and well-being. The missing piece National Institute for Space Research (INPE). Indeed. “Production quantities by country. www. and A. Rather than aid.” Nature Climate Change 5 (1): 27–36. and others. “Environmental Income and Rural are affordable: Brazil’s out-of-pocket implementation costs Livelihoods: A Global-Comparative Analysis.” NBER Working Paper 20352. and others. imposed a moratorium on sourcing from recently deforested Brazil’s deforestation rate has begun to creep back up. are considering international forest offsets as part of their emission-reduction programs. And they Angelsen. 2014. 2016.. With appropriate financial instruments. source of funding for both domestic and international pay- tion—not the indigenous and other local communities who ments. Poorly defined and enforced property rights ­ rances Seymour and Jonah Busch are Senior Fellows at F mean that forest frontiers are often the focus of conflict the Center for Global Development and the authors of Why among competitors for forest resources. 2014. from reduced deforestation. Jina. REDD+ payments should be viewed as depended most on forest goods and services for income purchases of a service that the world needs urgently.php ests’ development benefits. 2015. the soy industry because of austerity-driven cuts in law enforcement budgets. Vandecar. A.. 2016. these Hsiang. 2015. And in the past two years. “Estimated Carbon Dioxide Emissions bon dioxide emissions (Fogliano de Souza Cunha and others from Tropical Deforestation Improved by Carbon-Density Maps. while the leading driver of tropical forest loss is the been tried. enhanced law Brazil has received more than $1 billion in REDD+ funds. guaranteed public or private payments for performance in reducing forest-based emissions could transform the future flow of carbon sequestra- The Brazil example also exposed myths about the causes tion services into a bankable asset. Data from satellites stoked public awareness of the California and the International Civil Aviation Organization problem and strengthened political will. And that would be a missed opportunity for a commercial-scale conversion of forests to produce globally traded commodities such as palm oil. Baccini. this bargain does not even include the value of the domes. from 6. Implementation Costs of Forest Conservation Policies in Brazil. The US state of in the act. Arild.” Science 333 (6045): 988–93. S.inpe. enforcement against illegal logging and forest clearing. or less than $4 a ton of avoided car. And Statistics Division. S. “A Large and Persistent Carbon Sink in Agreement are all aligned to support international coop. but that is only a fraction of the value of emissions avoided and restricted credit to high-deforestation municipalities.obt. now subsidize fossil fuels would be a particularly appropriate ers and cattle ranchers who benefited most from deforesta.protected areas and indigenous territories. and others. “Reforming amid Uncertainty.org/browse/O/*/E tic benefits of noncarbon forest services.. change. http://faostat3. The missing piece is performance-based financing. Tropical Forests and Climate Change. S12–28. Economic Quarterly (December). MA. Forests? Why Now? The Science. “Projeto Prodes: The science linking deforestation to climate change. National Bureau of ing sediment behind dams in the world’s second largest Economic Research.” effective ways to mitigate the emissions that cause climate Ecological Economics 130: 209–20.br/prodes/index. far less than the social cost of such emissions or the Climate Change 2 (3): 182–85. Lawrence. Repurposing the funds that of deforestation. M. But these initiatives are still nascent and have not yet translated into tangible incentives Efforts to reduce deforestation go for decision makers in forest-rich countries. eration to protect forests in ways compatible with inclusive World Bank. Cambridge. hand in hand with inclusive growth. across the tropics the presence of Without a significant increase in the availability of results- indigenous peoples is associated with maintaining forest based finance. beef. References: sistent with more equitable and inclusive growth. the Monitoramento da Floresta Amazônica Brazileria Por Satelite. land. and Politics of Recognizing the rights of indigenous peoples.” World Development 64: by federal.’’ updated 2015. the World’s Forests. cost of reducing emissions in other sectors.

in which the the rest of their operations. involved in combining banking with other financial services called Volcker Rule. or are holding companies These actions.­ Differing risks We found an important distinction between the risks involved in traditional banking and the risks of other financial activities that helps explain why nontraditional activities may be dangerous for banks based on two categories of financial risk: slow moving and fast moving. Credit. Connel Fullenkamp. regulators in both the United Kingdom in addition to lending money. After the global tional activities such as proprietary trading. many reg. Offering many differ. In Europe. in the United States. Often. Thomas Cosimano.­ something bad could happen than on experience. possibly months or even years. For example. are based more on a fear that that own separate bank and nonbank providers. banks can work with their custom- ers to prevent default by temporarily reducing Finance & Development March 2017  43 . and act as brokers in 2010. manage mutual funds. borrowers go through periods of declin- ing sales or other income that indicate they will have trouble repaying their loans. risk is the lead- ing example of a slow-moving financial risk. This its and making loans) from the risks associated with other decision should be based on careful consideration of the risks financial services. was enacted as part of the Dodd-Frank Act securities. or default.­ Slow-moving financial risks take time to build up and cause losses over long peri- ods. ing decisions by banks and many nonbank lenders appear to ulators believe that new risks are added that could endanger have been the main cause of the crisis. Risky Mix If financial institutions combine banking and nonbanking business there is potential for danger Ralph Chami. these risks often give advance warning that a future loss may occur. Because they accumulate relatively slowly. tial damage caused by banks’ other financial activities. it financial crisis of 2008. This longish process gives a bank time to take steps to miti- gate or even prevent damage from default. rather than nontradi- both the institution and the financial system. the so. however. and the European Union have proposed various types of ent kinds of financial services increases the profits of these ring-fencing—separating banks’ traditional functions from institutions—whether they are universal banks. For example. which prohibits banks from engaging in in a single company. regulators in a number of countries may be necessary to protect traditional banking from poten- proposed rules to insulate traditional banking (taking depos. Poor lend- But when all these activities are under one roof. and Céline Rochon T HE biggest banks in the world are not just banks— proprietary trading (using their own money rather than trad- they’re financial supermarkets that can underwrite ing for a client).­ functions are all part of the bank. Nonetheless.

Because they are unpredictable. In addition. but agers of the investment division can take advantage of the the investment division is constantly adjusting its portfolio banking division’s slower pace. tage.or postponing payments. think about a universal bank (or bank hold. The banking But there are also downsides. ever. banks that mix slow-moving credit risks and fast- tively determine the overall riskiness of the bank. and it ing company) that takes deposits and makes loans. both banks that do not mix these risks.72 8. fast-moving risks pose special challenges for financial managers who try to profit the bank’s overall capital cushion—which helps protect both from taking on exposures to these risks. Note: The five largest US bank holding companies (in descending order in terms munication networks. potentially severe. 24-hour markets. but also is costly to do so. This means that changes the same institution may be dangerous—the two types of risk in interest rates.­ moving market risk of investing and trading.­ risks virtually instantaneously. slow-moving and fast-moving risks must be man. the invest- event than anticipated—a firm’s capital can immediately be ment division’s profits are probably realized more frequently reduced by a large amount.92 42. If the investment division by buying and selling government securities (see table). it will earn larger profits as long as these exposures do not go bad.24 54. the firms that take on these risks rate risk. even if the bank- ment managers can adjust a bank’s exposure to fast-moving ing division is doing a good job managing credit risk.­ moving market risks could experience distress more often than There are two sides to this combination. this effectively gives them a first-mover advan- But the risk of the investment division can change dramati. securities. Bank of America. in which market prices within min. risks could bankrupt the entire institution. because invest. rate risk because banks tend to borrow for short periods of This is why the mixing of these very different types of risk in time and lend for longer periods. The ratio is also expressed in terms of crashes in recent years. division. Not only decisions. a Safety first bank has time to work with the customer to restructure the Key financial ratios for the five biggest bank holding companies in loan to minimize the loss. the banking and the investment divisions against losses. which should smooth out a loss event as (or after) it occurs is generally not possible in the firm’s accumulation of capital. They generally do not give reliable (percentage of total assets or risk-weighted assets) warning signals. part of ment division managers take on only prudent risks. both stock Goldman Sachs. the invest- Banking and trading ment division has recourse to an additional buffer to absorb The banking division’s risk changes slowly because only a its losses—the capital that has been set aside for the banking small amount of the total credit risk exposure changes daily. therefore have a strong incentive to take on higher risks ceivably crash at any time—but the continual trading by the inside a universal bank than they would if the investment investment division can rapidly alter the exposure of the division were an independent company. and within minutes or even seconds. estimate a fast-moving risk—and it causes a much larger loss Moreover. The man- division makes relatively few new loans on any given day. have limited ways of hedging against interest rate risk. market prices can change dramatically of total assets) are JPMorgan Chase.­ the case of fast-moving risks. In fact. and electronic com. The ratio is expressed in terms of risk-weighted assets. The chief the investment division’s profits can be retained to increase executive officers of these banks could mitigate the problem 44   Finance & Development March 2017 .­ the United States have improved since the global financial crisis Fast-moving risks evolve quickly and inflict damage over that started in 2008. Because the investment division is taking on fast- and credit risk is a slow-moving financial risk to begin with. Therefore. risk-weighted assets.74 the leading example of a fast-moving risk. subjecting the lending arm to the risk from investment cally from day to day and even minute to minute. computerized trading.­ bank income. how- operates a division that invests in government securities. they are in a position to effec. may be able to help by generating trading profits from The banking division takes on the slow-moving credit risk changes in interest rates that offset the banking division’s of lending. Citigroup. losses from these changes. If managers under. very short periods of time. while the investment division takes on the fast. On one hand. Loans. In these days of Source: Authors’ calculations. The business of banking faces significant interest may need to be structured and regulated very differently.98 44. Wells Fargo. so it is very difficult to predict when fast- Date Tier 1 Capital Leverage Loans Securities Deposits moving risks will become loss-causing events. But if they do.44 24. hedge against interest aged differently. but also reduce the value of bank capital. And even if a borrower defaults. It’s up to the top managers of the banking division and the overall institution can benefit: a universal bank to act in the best interests of the overall institu- • The investment division’s expected profits will help tion by ensuring that both the banking division and the invest- diversify the entire institution’s earnings. especially increases. moving risks. Market risk— March 2016 10. can not only decrease are not necessarily compatible. Banks For example.­ total assets.80 22. Tier 1 capital is mainly common stock and retained earnings. Leverage is Tier 1 capital plus and bond markets around the world have experienced flash longer-term bonds such as subordinate debt. And these higher investment division to market risks. The managers of the investment division will is market risk a fast-moving risk—the market could con. given the fast-moving nature of trading.08 the potential loss from changes in market prices of assets—is March 2008 6. In addition.­ takes on excessive risks. tution. and deposits are expressed as a percentage of utes fell by large multiples of their typical daily price changes. including the banking division. And mitigating the damage from than the banking division’s profits.­ •  The investment division can also help the entire insti- Thus.93 70.28 11. The investment division of the bank. For example.

and agencies. however. but the process also resembles interference the Speed of Financial Risks. Jun Ma. and a 2017 IMF Working Paper. Therefore. the Basel group of financial regulators moves in this direc- tors and is typically called the regulatory cycle—in which a tion. include provisions in traders’ and managers’ compensation management. The This regulatory dilemma is not a new one. As the incentive in the investment division to to separate slow-moving risks from fast-moving ones. Connel Fullenkamp. but the new regu. it could also likelihood of taking on excessive fast-moving risks. soundness of the banking division anyway. And none of this extra Thomas Cosimano. monitoring.” by Ralph Chami. which. It may seem at first glance that the best policy would be ment division. the next day. Our research into distress. Continuous monitoring and supervision would not only be This article is based on a forthcoming paper. it is based on capital. “Financial Regulation and extremely costly. This could constrain market lators around the world follow some type of uniform system liquidity.­ is retired Professor of Finance at the University of Notre Dame. bank supervisors may could reduce the incentive to take certain types of risks that need to review the banks’ choices of division and lower-level are spread over longer periods. and Review Department. earnings. for that matter—can many regulators are already prompting banks to improve the monitor and enforce restrictions they place on the invest- ment divisions of universal banks. ones they don’t pos- Prudent managers sess at the time of the sales agreement) would allow banks to But there is also an important role for regulators. This means that an invest- “softer” side of their risk management practices. and to implement. measuring. ciently prudent. holding management assume.­ But increasing the frequency of supervision is not the answer. the international lation offers some unforeseen opportunities for mischief. buy (and hold) securities only. Separating risks Policy. for example. however. is a fact of life for regulators. however. receive a rating that to predict than slow-moving ones. investment the proponents of policies like ring-fencing argue. The Financial Stability Board. because fast-moving risks are much harder managing risks. by requiring supervisors to review banks’ compensation crisis spawns new laws. latest version of international capital standards endorsed by Lagging behind industry changes is a fact of life for regula. losing the investment arm’s ability to sell assets short (that is. packages. Because Capacity Development. This focus on the quality of management in the bank supervision process gives regulators influence over the choice of the management team at the bank. Finance & Development March 2017  45 . must deal Alternatively. and bankrupt the bank. the lower the ing benefits from managing fast-moving risks. A current strategy is to emphasizes governance. including risk and leverage tolerance. it is Lagging behind industry changes possible that bank supervisors could require CEOs of universal banks to choose investment division managers who are suffi. But contracts. among other things kets and damage overall financial stability. and market sensitivity. rules.­ top management. in its set of principles The new feature in today’s markets is the speed and expo. which in turn could reduce confidence in the mar- for rating financial institutions. bank supervisors could strictly limit the risk suggests that such regulation should focus on strengthen- exposures the investment division of a universal bank can ing oversight of bank governance. This is also likely to be very difficult for regulators accountable for identifying. is likely to be difficult and controversial. and Céline Rochon. it is unclear whether bank good conduct” among bank employees. US banks. and Céline Rochon.­ ■ ment division that is well behaved one day could rearrange Ralph Chami is an Assistant Director in the IMF’s Institute for its positions. asset quality.­ hurt financial stability. Bank regu. which suggests that supervisors—or any financial regulator. and standards for good compensation practices noted bank sure to fast-moving risks. expense and interference is needed to improve the safety and “What’s Different about Bank Holding Companies?” by Ralph Chami. to limit the possibility that the investment with the temptation to exploit fast-moving risks in a way that division’s activities will plunge the entire financial institution is dangerous to the institution and to society.­ Thomas Cosimano. the more policy. in the day-to-day operations of a bank. For example. such as investment portfolios or supervisors’ increasing emphasis on “building a culture of trading positions. In addition. and Céline Rochon is a Senior Economist in the IMF’s Strategy. but it is unclear whether they managers to ensure that they reflect the values of the banks’ will reduce the overall incentive to take on risk. as take on exposure to more fast-moving risk increases. fast-moving Practice of Economics at Duke University.­ emphasizes not only the technical ability but also the character of bank managers.­ monitor of the global financial system. Connel Fullenkamp is Professor of the supervisory reviews take place only periodically. liquidity. in which a large part of performance-based pay even closer collaboration between regulators and bank man- is deferred and is forfeited if trading positions lead to losses agement may be necessary if banks are allowed to mix fast- during subsequent years.­ Regulatory alternatives to ring-fencing. however. Therefore. Such a division managers become less risk averse. would not only deprive banks of the hedg- prudent the manager of the investment division. Finding an objective supervisory standard to judge the prudence of investment managers.somewhat by choosing the right type of manager for the invest. Such so-called clawback provisions and slow-moving risks. Thomas Cosimano risks could cause financial distress between reviews. For example.

global actions to address climate change. First. poorer countries that are rich in fossil fuels will likely face a precipitous fall Carbon risk in the value of their coal. the is that the world cannot consume all of its oil. and coal likely result will be a huge reduction in the value of their reserves without catastrophic climate consequences. droughts. If the world What seems clear to virtually all scientists who study the issue makes a permanent move away from using fossil fuels. But if there are successful of a decline in demand for their natural resources (see map). gas. poor tries create pressure to invest in industries. and Giorgia Cecchinato T O achieve climate change goals. the world must cut ability to diversify their economies and sources of govern- consumption of fossil fuels dramatically. To limit national and natural wealth. and oil deposits. national compa- countries are likely to be disproportionately harmed by nies. Last.Unburnable Wealth of Nations Successful action to address climate change would diminish the value of fossil fuel resources in many of the world’s poorest countries James Cust. But climate ment revenues—and it would take them longer to do so than change success may put developing countries rich in countries less dependent on fossil fuel deposits. and projects based on fossil fuels—in essence doubling the floods. Second. economic and political forces in many of these coun- If there is no progress in combating climate change. David Manley. 46   Finance & Development March 2017 . and other weather-related problems down on the risk and exacerbating the ultimate consequences spawned by a warming planet. gas. they have more conservative of the goals agreed to by governments at a higher proportion of their national wealth at risk than do the 2015 climate change talks in Paris—more than two-thirds wealthier countries and on average more years of reserves of current known reserves. let alone those yet to be discov- than major oil and gas companies. fossil fuels in an almost no-win situation. the increase in global temperature to 2 degrees Celsius—the These nations face three special challenges. Kazakhstan. they have limited ered (see Table 1). Workers perform maintenance on oil pumping unit in Akkystau. must remain in the ground (IEA 2012).

the sharply reduced Fossil-fuel-rich developing countries face a drop in demand for demand for oil.3 24 5. Whether they can diversify Other developing Asia 2.6 9 0. geographically and con- gies. future government revenues from fossil fuel extraction will be reduced as will other benefits to the domestic economy. education. sil-fuel-related assets into other nonrelated assets and whether Note: Percentages represent the estimated reserves that must remain unburned before 2050 as the economy can develop other strong productive sectors. These are developing countries in which the on existing investments and makes further development of value of fossil fuel production is 10 percent or more of GDP or the value of fossil fuel reserves is reserves less profitable. which cannot be sold fossil fuels. so-called proven reserves. compa- Reserves—that is.4 34 30 90 oil and gas would drain critical revenues that governments Canada 40 75 0. if they wanted. to ownership of reserves. China. cally shrink.8 12 2. Finance & Development March 2017  47 . Europe 5.5 53 207 77 structure. and with it their value to exporting countries.and gas-producing countries America between 2006 and 2010 (Venables 2016). If those reserves stay in the ground. Table 1 such as job creation. nies hold the development rights to relatively few reserves— mated to be extracted profitably at current prices—may and those have relatively high production rates.3 6 74 89 •  Fossil-fuel-rich developing countries may be less able to Middle East 264 38 47 61 3. While many of them have enjoyed the benefits of fossil fuel extraction. Companies could.” For these countries. Note: Fossil-fuel-rich developing countries are in red. fuel wealth. their oil.6—which means the national wealth Billions Percent Trillions Percent Percent held in these reserves is valued at more than three-and-a- of of total of cubic of total Giga. Because fuel reserves are such a sig- Left in the ground nificant portion of their national wealth.and middle-income countries rich in fossil fuels. and India. other developing Asia = all Asian countries except advanced economies (Japan. At some point. of total Country/Region barrels reserves feet reserves tonnes reserves half times their total economic output. the reserve-to-production ratios for all oil and gas limit the market supply of fossil fuel resources. the assets of fossil fuel companies (Leaton 2013).7 46 2 51 85 95 economies or fossil fuel companies. Those that dis- covered their fossil fuels more recently may find themselves arriving “too late to the party. therefore. is for companies. respectively (EY Collier and Venables propose a sequenced closing of the 2013). it is likely that the market for stitutionally. but coun- tries are more vulnerable than private companies. carbon market risk highlights three vulnerabilities: •  Fossil-fuel-rich developing countries are generally highly exposed to a shrinking market for oil. Further.8 years and 13. gas. the Middle East. outright but only licensed to companies for development.1 22 17 60 or reduce their wealth exposure to carbon market risk depends United States 4. run down their global coal industry (2014). countries are tied. unless there are existing reserves in less than 15 years. natural gas. A fall in fossil fuel prices for producers significantly reduces the excess profits available from fossil fuel extraction Sources: BP Statistical Review 2015.4 99 diversify their assets away from this exposure than developed OECD Pacific 2. OECD = Organisation for Economic Co-operation and Development. Unlike many fossil-fuel-rich developing countries. they have typically failed to diversify their economies.4 82 could spend on investments in health.3 21 0. and coal will be permanent. and coal reserves if the world succeeds in reducing Such a “carbon market risk” is potentially catastrophic for use of carbon-emitting products. Furthermore.9 years. 25 percent or more of a country’s national wealth. which are esti. For example. a portion of total reserves in the country or region. Lower demand for Africa 28 26 4. These countries have a median ratio of fossil fuel Oil Natural Gas Coal reserves to GDP of 3. major—and unlikely—breakthroughs in technology to cap- Wealth at risk ture the carbon emitted by fossil fuels. and authors’ calculations. the economies of low. especially highly polluting coal. Singapore). and infra- China and India 9 25 2. including the significant excess prof- its sometimes associated with oil and gas exports. For example. will dramati. companies were 12. fossil fuel exports are often a key source of Former Soviet Union 28 19 36 59 209 97 government cash—accounting for over 50 percent of govern- Central and South 63 42 5 56 11 73 ment budgets in the top 15 oil. Not only is They are the indirect target of climate policies that seek to it more difficult for countries to shift capital and capabilities limit carbon emissions—probably through taxes and quotas into renewable energy technologies or other activities than it on carbon and the fostering of new low-carbon technolo. and authors’ calculations.5 6 245 95 Global 449 35 100 52 887 88 on how long it takes and how much it costs to convert fos- Sources: McGlade and Ekins 2015. Analysts have warned that carbon market risk could strand Korea. and coal. also remain undeveloped if governments impose policies to in 2013. a large portion of the world’s fossil fuels must their richer counterparts and those less endowed with fossil remain unburned. these countries are To keep the average global temperature from rising more than more at risk if there is a permanent decline in prices than 2 degrees Celsius. gas.

countries are fully controlled by the state. China China National Petroleum Corporation 576. State- Fossil-fuel-rich developing countries hold oil. Research shows that Under current levels of annual production as a percentage of petroleum and coal producers emit a significantly larger reserves. unless they can find ways to significantly may wish to limit investment in these areas. National Resource promote domestic participation in supply chains that process Governance Institute. 250 Policy prospects 200 There are four policy implications arising from this carbon 150 market risk that governments of fossil-fuel-rich developing 100 countries should consider.5 long that declining oil. and coal owned companies and energy-related infrastructure and assets that are harder to turn into cash—typically they can be investments to enable the country to participate in supply converted into other assets only after the countries develop. Nigeria National Petroleum assets vulnerable to a decline in fossil fuel demand. 48   Finance & Development March 2017 . Using past reserve-to-production ratios as a try if the world reduces its use of fossil fuels.004 0. If the expected life of these assets is so Malaysia Petronas 164. increase their rates of production. Cust. Petroamazonas. Sociedad Nacional de Gas. the assets of sovereign wealth funds owned by governments (assets in billions of dollars) of fossil-fuel-rich developing countries represent on average Total State Country State-Owned Company Assets Share only 3 percent of the value of their fossil fuel reserves. few resource-rich governments have successfully diversified their revenue streams.0 167. governments need to reconsider all their energy-related investments.0 maximizing revenue.7 30. gas. Second. especially alternative export Venezuela Libya Turkmenistan Iran Iraq Kazakhstan Russia South Sudan Nigeria Chad Indonesia Ecuador Yemen Azerbaijan Uzbekistan Vietnam China Gabon Equatorial Guinea Myanmar Malaysia Bolivia sectors. Unidade Empresarial Estatal pany—especially one intended to operate abroad—may be Indonesia Pertamina 50.8 85. Nigeria. Finally. gas. If Because it is difficult to develop new sources of national local suppliers and labor can relatively easily adapt to changed wealth. through sovereign wealth funds—has been limited State owned by the rate at which they can extract their reserves and the Most of the national oil companies in fossil-fuel-rich developing pressure to spend rather than save revenues. such as manufacturing and agricultural processing. common in oil-rich countries. and authors’ calculations. The first is that diversification of the economy is more 50 important than ever. specialized in fossil fuel extraction may become obsolescent.7 exposing national wealth and public assets to carbon market Azerbaijan State Oil Company of the Azerbaijan Republic 30. and authors’ calculations. Note: The table does not include a number of smaller national oil companies in fossil-fuel-rich and/or transport fossil fuels may expose a country to car.3 9. For example.004 of fossil-fuel-rich developing countries. and certain services. Myanmar Oil and Gas Enterprise. we found that. pro. Bolivia Yacimientos Petroliferos Fiscales Bolivianos 103. chains may also fail to provide a sufficient return to the coun- duce. Moreover. it would take most countries 45 years or more to amount of carbon per dollar of GDP than countries that pro- liquidate their fossil fuel wealth. First.7 50. Sources: BP Statistical Review 2015. Equatorial Guinea. years) fossil-fuel-rich countries tend to subsidize consumption of 300 fuels.2 increase their exposure to carbon market risk. Governments guide. Turkmengaz. or coal prices will affect returns. A major reason is that the (weighted reserves to production. Gabon Oil Company.0 •  Domestic political pressure to develop fossil fuel China Sinopec Group 321. policies to Sources: Most recent annual reports of companies (2014 or 2015). most countries must wait 45 Some value of local businesses may decline.6 227. Moreover.5 54.3 state ownership in some of the largest national oil companies Timor-Leste TIMOR GAP 0. because it is not only reserves that become endangered by falling prices and demand. and a workforce years on average to liquidate their fossil fuel wealth (see chart). But it also means the tax base must be widened to wean the government off dependence on fossil fuel revenues.0 China China National Offshore Oil Corporation 167.7 Kazakhstan Kazmunaigaz 49.5 164. Myanmar.1 or a government cannot liquidate them at a reasonable value.5 then governments that invest now in a national oil com.8 226.0 200. Chad.6 oil companies.0 321. Corporation.8 state investment in fossil fuel assets for reasons other than Iran National Iranian Oil 200.3 32. such as gasoline (Friedrichs and Inderwildi 2013). duce neither petroleum nor coal. corrected 1/12/2017 fossil-fuel-rich countries have tended to develop economies Cashing in on fossil fuels that use a lot of carbon-based products. Gabon. This means countries should expand 0 nonfuel sectors of the economy. Sociedade Nacional de Combustiveis de Angola Angola 54.0 reserves pushes these countries into choices that might Russia Gazprom 319. Algeria.0 576. Table 2 shows the significant amount of Ecuador Petroecuador 9. and sell fuel.2 319.7 risk. their ability to use fossil fuel revenue to invest in foreign nonfuel assets—for Table 2 example. Consequently. developing countries for which data are not available: Sontrach. national Russia Rosneft 227. Turkmenistan. Uzbekistan. Société des Hydrocarbures bon market risk by increasing the total share of a country’s du Tchad. often involve Venezuela Petroleos de Venezuela 226. such as information and communication technology. and Uzbekneftegaz. Ecuador.

“Unburnable Carbon 2013—Wasted Capital and related to fossil fuel consumption. both at the Natural Resource Governance tion). Paris.” Oxford Review of Economic Policy 30 (3): 492–512. London.circumstances and participate in supply chains outside the fos. the fairness Senior Economic Analyst and Giorgia Cecchinato a former of its judicial system (which reduces the threat of expropria. poorly negotiated deals that reduce the tax burden of com. Cust. so it may be worthwhile for certain countries to References: allow exploration for reserves that may be less expensive to Arezki. “The Resource promote exploration in the hope of realizing extraction reve. if all producers do the same sil fuel sector without protection or subsidies. such as and Moral Incentives. such as openness to foreign investors. Anthony J.” OxCarre Research Paper Series 127. a country may be thing. Studies wait for the next commodity price boom. Development and Centre for the Analysis of Resource Rich Countries at the University of Oxford. Consumption subsidies. a result known as the able to benefit from educating workers in the fossil fuel sector.” Carbon Tracker Initiative. 2013. Frederik G. Curse Revisited. Paul. “Global Oil and Gas Reserves Study. might make EY. this stranding will occur. Centre for Economic Policy Research. However. and Oliver Inderwildi.­ Arezki. “Global Warming However. “green paradox” (van der Ploeg and Withagen 2015). moment to develop other sectors of the economy rather than it may be possible to mitigate the stranding of reserves by remaining an attractive destination for production. optimum strategy for one country. Paul.” CEPR Discussion Paper Third. Stevens. “Institutions and the Location panies—may encourage too much exploration or extraction of Oil Exploration. London. But for policymakers in fossil-fuel- rich developing economies. nues before climate policies or new technologies fully kick in. “The Carbon Curse: Are Fuel more dependent on fossil fuels.” Chatham House Research Paper. Centre for the Analysis of Resource Rich Countries. It is unclear when. 2012.Toscani. but the danger 2 °C. even after a carbon tax is factored in. but by reducing the costs investors face. Oxford. This creates the risk Fossil-fuel-rich countries tend to of “stranded nations” whose vast fossil fuel reserves are no longer worth extracting. it does not follow that exploration should stop Policy Implications for Fossil Fuel-Rich Developing Countries” from the Oxford entirely in the lowest-income countries. Venables. government time to upgrade institutions and potentially earn Venables. subsidize consumption of fuels. 2013. 2015. This may seem icy approaches. James. Rabah. or by how much. Further. if training workers or building company capability to While still highly uncertain. 2015. “Closing Coal: Economic side—either explicit. and Cees Withagen. and Frederick van der Ploeg. ■ suggest that oil and gas development is determined not only James Cust is an Economist in the Office of the Chief Econo- by geography but also by the quality of a country’s political mist for Africa at the World Bank. The right Distribution of Fossil Fuels Unused When Limiting Global Warming to answer may be different for different countries. governments and citizens should carefully con. but by emerging evidence that global economic activ- the human capital that the workers and firms represent. Glada Lahn. Research Associate.” London. Subsidies on the production Collier. for example) Friedrichs. to drive less and use more-efficient forms of transportation— International Energy Agency (IEA).” Nature 517 (7533): 187–90. such as tax breaks. extraction are costly. United Kingdom. Second. 2016. Christopher. McGlade.” low-income countries. or not at all. Toscani. other sectors of the economy (transportation. and Jaakko Kooroshy. and van der Ploeg 2016). and Anthony J. extract. London. governments should avoid subsidizing fossil fuel DP11553. Frederick. slower. “Shifting Frontiers in Global Resource Wealth. James. and David Manley is a institutions. These countries should seek to harness the counterintuitive. Oxford University and keep the country dependent on fossil fuels for too long. and the ease of doing business (Cust and Harding 2015. governments should continue to promote the how to deal with declining demand for their resources will competitiveness of their fossil fuel sectors so long as they be an ever more critical question and will call for new pol- moderate public investment in these sectors. a slower pace of licensing may give the Review of Environmental Economics and Policy 9 (2): 285–303. stuck between the effects of a warming planet and global action to prevent such warming. or implicit. Lahn. 2014. but costs vary significantly across differ- ent geology. such as on gasoline. 2015. 2016. Stranded Assets. and Kooroshy (2015) argue that for and the Green Paradox: A Review of Adverse Effects of Climate Policies. and Paul Ekins. Institute. van der Ploeg. Jörg. such as railroads or mass transit—or encourage investment Leaton. of being “last to the party” may encourage some countries to Stevens. supply may rise and prices fall. there is a growing likelihood supply the fossil fuel sector takes decades—and if these skills that fossil fuel consumption overall will decline. World Energy Outlook. Finance & Development March 2017  49 . ity is using less carbon per dollar of GDP and by the prom- ise of technological breakthroughs in alternative energy sources such as solar and wind power. such as highways. Fourth. “Using Natural Resources for more future income by reducing investor risk and improving Development: Why Has It Proven So Difficult?” Journal of Economic negotiating capacity. This is indi- and products are not transferable to other industries—not only cated not only by the outcome of the Paris climate change will state capital invested in this effort be wasted. “The Geographical sider whether to extract faster. and Torfinn Harding. even if faster development is an Perspectives 30 (1): 161–84. 2013. Although the world may have more reserves than can be This article is based on the authors’ paper “Stranded Nations? The Climate safely burned. 2015. use and the fossil fuel sector. but so may talks. reduce consumer incentives Rich Countries Doomed to High CO2 Intensities?” Energy Policy 62: 1356–65.

and $50 and $100 notes entered the scene. the central bank reintroduced the $50 bill. each a different color. But the fifty was pulled from circulation just two years later. the country’s coat of arms took center stage on the notes. replacing Queen Elizabeth. $5. its central bank. Trinidad and Tobago’s coat of arms. for example. But it wasn’t readily accepted by the public. the bills featured Queen Elizabeth II. An oil rig was featured on the 1964 $1 note. $10. In denominations of $1. Introducing the fifty In 1977. a year after becoming a republic. To mark Trinidad and Tobago’s 50th year of independence in 2012. two years after obtaining inde- pendence from Great Britain. after a shipment of unissued bills was stolen. and $20. Senior citizens had Front of the 2012 commemorative $50 note. T RINIDAD AND TOBAGO got its first national currency in 1964. CURRENCY NOTES Fifty Marks the Spot Marie Boursiquot Carnival masquerader featured on the newest $50 bill. 50   Finance & Development March 2017 . and an illustration representing a local industry—an offshore oil rig.

tion per capita than any other country in the years after the olive-green bills came out. The bill’s golden In November 2015. People weren’t using the fifty. The $50 also has enhanced security features. Trinidad and Tobago had more banknotes in circula. Part of the reason for problems with the $50 note issued in 2012 was insufficient consulta- tion with stakeholders. businesses. stakeholders as banks. The $50 bill has a checkered history. $50 polymer note that removed the commemorative text matic design includes a red hibiscus flower. But the country is now leading The design won the country the International Bank Note the way with an ultramodern currency that is striking in its Society’s Banknote of the Year award. French. be able to withdraw the new $50 bill from ATMs. much like the small green iridescent hibiscus flower changes color as you move industrial and high-income economy. try’s natural beauty and cultural heritage. which has been colo- the bill around. British. the central bank issued an updated color celebrates the central bank’s 50-year jubilee. and the micro text of the number 50 can be nized by the Spanish. The central bank decided it was time for a new and improved $50 banknote. Front of the newest $50 note. Crowning glory In December 2014 the new note debuted. Some peo- ple considered the banknotes collector’s items and were reluctant to spend them. so that citizens would The new $50 note is rich in color and highlights the coun. Its dra. the central bank in 2014 engaged in strong consultation with such key Back of the newest $50 note. Finance & Development March 2017  51 . welcoming to those who cannot see it. and protected cash-counting machines weren’t prepared to handle the new polymer notes. According to the central bank. is poised for flight visually impaired. The bird. tiny Duchy of Courland. and even the seen only under a magnifier. and experts in history and art. and handling of the polymer notes.1962–2012” and added raised dots to help those who are colors are those of the country’s flag. a young woman “Celebrating 50 years of Trinidad and Tobago’s Central in carnival attire. But they were using the $20 and $100 notes. And banks and stores were not prepared for the change: cash drawers had no slot for the new bill. A small gold. of the red-capped cardinal as an additional security feature. ■ mercial banks to upgrade technology vital to the processing Marie Boursiquot is F&D’s Online Editor. It was produced by the central bank of Trinidad and Tobago and UK currency printer De La Rue. And a red banner was added across the tail against a transparent polymer plastic window. whose Bank. Because many older beauty. and a red-capped cardinal.Trinidad and Tobago’s new $50 bill is dressed for a celebration trouble distinguishing the new olive-green bill from the green $5 and gray $10 bills. the central bank teamed up with com- from those who would dare compromise it. Dutch. both to save and to make payments—so much so that the central bank had to print more of them.

marginal utility Bank’s 1993 study of how nations in East Asia achieved eco- of consuming too much beer (not an irrelevant example on nomic success and was looking for a researcher to help apply college campuses). history. Forbes soon realized that investment Morton (“Marty”) Schapiro (later. Forbes did indeed end up going to Williams College. capital controls. how eco- nomic problems spread from country to country—cross-bor- der capital flows. Still. among other places. New Hampshire. and political science (enjoying the interplay between So Forbes went to the World Bank for a year—and got her the subjects). PEOPLE IN ECONOMICS PARALLEL PATHS Atish Rex Ghosh profiles Kristin Forbes. the World Bank. economics research). or the US Treasury Department. and Sabot inspired Forbes to become a career economist like 52   Finance & Development March 2017 . she dithered between economics. markets (knowledge that would later come in handy for her ogy—and economics. psychol. luck or coincidence played a crucial role. Forbes’s counselors were bemused when she aspired to more prestigious colleges. Forbes pondered what to do next—vac- illating between law or following in her father’s footsteps A wealth of choices and becoming a doctor—but ended up in Morgan Stanley’s At Williams. who has spent most of her professional career straddling academia and policymaking. Growing up in Concord. But in an early instance of forging her own path. its insights to Latin America. who is also an external member of the Bank of England’s Monetary Policy Committee. but finally majored in economics and gradu. most of her classmates set their sights on the University of New Hampshire. first taste of policy-oriented research. and how economic policies in one country have spillover effects in others. Working with Birdsall ated summa cum laude. Though it was hardly a low- performing school (about half of the class would go on to col- lege). He spoke touch with Nancy Birdsall. one of her professors at Williams. who straddles academia and policymaking D EWORMING children seems an unlikely interest for economist Kristin Forbes. she helped form a charity aimed at deworming kids. Forbes. and eventually negative. president of Williams banking was not for her. she developed a passion for the outdoors and attended a public high school. academic research and policymaking absorb most of Forbes’s time—whether at MIT. has focused on such international issues as financial contagion—that is. After graduation. who was finishing up the World of the diminishing. religion. such as Amherst or Williams. Though she learned about and wound up in courses on astrophysics. Yet her path was not predestined—and more than once. put her in applying basic economic concepts to everyday life. She credits her Econ 101 professor. Forbes was confronted by a wealth of choices investment banking program. But the professor at the Massachu- setts Institute of Technology’s (MIT’s) Sloan School of Man- agement has been willing to tread unlikely paths as well. And then she caught a lucky break— College) with inspiring her interest in the subject—mostly by Richard Sabot. But when presented with evidence by colleagues that one of the most cost-effective ways to keep children in develop- ing economies in school was to rid them of parasitic worms. the Bank of England. Still.

Forbes’s next opportunity to be involved flipped! Comparing across countries. who had just been appointed Under Secretary of the Treasury ing theme of her life’s work. It was. the experience taught Forbes the importance of careful ana. Ever since of the leaders in the empirical analysis of contagion. variables changes over time. senior act enough.” and policy circles. into a host of other issues that she had never thought about inflow-fueled credit boom is a prudential measure. for a chat. . she found that one day in 2001 to find a message on her answering machine growth and rising inequality are positively related. Her her World Bank days. she had felt the pull of both the aca- papers are a tour de force for anyone interested in measuring demic and policy worlds and believed the two did not inter- its importance. tion of the impact of income inequality on growth was typically pick up only the short-term positive association published in the American Economic Review in 2000. But Birdsall and Sabot had found that income inequal. yet keeps the policy rel. Forbes was undecided. “a fascinating experience to try to apply academic without risks—particularly of misinterpretation by oth. She was writing in the aftermath for International Affairs in the new George W. Forbes looked at the impact of her off the phone until she had started to pack her suitcase. In the mid-1990s. “She sets the academic bar very high. Forbes reexamined official circles. the US central bank.” Her time at Treasury also pulled Forbes the main policy alternative for a country facing a capital. going beyond traditional analyses “This is why we do the academic research we do . Prank call? ity was bad for growth. nearly erased the message. Forbes’s findings on the impact of capital you’re not telling everyone that contagion will happen controls on financing for small and medium-sized enter. But as an aspiring assistant professor at MIT.them and made her realize that she needed a PhD to do so ate impact on small enterprises. “Kristin is one Asian and Russian crises. and found that the sign had at the World Bank. on the sample chosen. He refused to let In another oft-cited paper. Subsequent research shows that results depend application to real-world problems. He was inviting her to Beyond getting her published in a distinguished journal. For example. The between inequality and growth. At MIT Forbes’s perspective was. Bush admin- of the financial crises in Asian and other emerging market istration. but looking within a country. and—at least in policy circles—that Forbes. therefore. After her stint recently developed) techniques. which tend to rely more on and to affect the world the way they did. Yet an overly So Forbes went back to Washington in 2001. come down to the Treasury Department in Washington. Forbes is perhaps best knew who Taylor was—the Stanford University professor known for her work on financial contagion. her advisor at the Federal Reserve Board. You actually have to do it ahead prises are often taken to mean that governments should of time. says: gallivant in the corridors of power in Washington. and extent. research to the real world with real-world data.” Stijn Claessens. a co-author tor vulnerability around the world in the aftermath of the and fellow professor at MIT once remarked. and it turned out that term hitherto used very loosely—and thereby helped clarify he wanted her to set up a new Treasury division to moni- when and why it occurs. One was working on the US Millennium Challenge measure would likely have an even greater disproportion. Of course she lytical work in policy conclusions. And it does introduce a whole new set of issues of avoid controls on capital inflows because of the burden on how we can take what we write about and make it appli- smaller compared with larger firms. previously ignored by academics and policymakers alike. existence. not quite Similarly. her former advisor at MIT and a leading interna- pointing out big gaps in our understanding. income inequality is directly in policy work came when she returned from a run bad for growth. Account—a program to help make US foreign aid more Finance & Development March 2017  53 . Such a before. who has spent a considerable part of her career in finding had made somewhat of a splash. DC. who tend to be enthralled should not be interpreted as implying that inequality is good more by the models and theories themselves than by their for growth. nine months after the fact. Real-world data tion for policy-oriented academic research. called to admonish her. priority was to publish in leading academic journals—not who has also done research with Forbes on the topic. and estimates based solely on how spective that earned Forbes prestige when her examina. bank financing than do larger firms. income inequality was hardly a hot topic. But why would he want to talk to her? She very countries when “contagion” seemed rife. but cable in real time. You need to go and do small and medium-sized enterprises’ access to financing— this. It was just that per. across countries. using newer data and more sophisticated (and demic research to draw policy conclusions. Hausman’s tified by analyzing how a variable changes both over time and econometrics course at MIT. As Roberto Rigobon. she thought it was a joke. from someone named John Taylor. That may be true. she narrow focus on analytical work for policy purposes is not says. where ers. to actu- of their macroeconomic effects to study how controls affected ally affect policy and affect the world. The negative impact is iden- study was part of an assignment for Jerry A. . until the late Rudiger evance of the work always in mind and motivates others by Dornbusch. Forbes’s paper on income inequality and growth like that of most grad students. Such analysis has earned Forbes a well-deserved reputa. Her papers dissected what was meant by contagion—a In the end.” he told her. the technique Forbes used. is well aware of the subtleties of applying aca- the question. This is a defin. imposing capital controls. she returned Taylor’s call. At first. She turned down the offer twice. And she delivers tional economist who had made his name in both academic her insights in an easy digestible way.

” demic papers on some of the issues she had encountered in Much of Forbes’s professional life has been devoted to inter- the policy context—including financial contagion—until the national economics—she even got married in Bretton Woods. there is incredible frustration and An open mind fear about change—eventually manifested in the British vote to This interplay between academia and policy—research inform. facts-don’t-matter attitude that seems to one pill a year. anti-elite. she also have a compelling case. academics—get out and talk to businesses. income triate funds. and talk to the man tries would be eligible. sometimes it has recent studies on capital controls’ role in mitigating financial an impact on the personal.” the proud mother of three says enthusiasti- sistent with her theme that policy decisions should be based cally. but often rewarding paths. At the same time. her analytical skills to bear in debunking popular myths. There. policy questions inspiring research—has and policymakers—must better understand and better explain become a hallmark of Forbes’s work. she is also willing to keep an open mind and to shift her views in light of new studies and evidence. The findings Forbes will not discuss current policy issues because she is a prompted them to form a charity dedicated to deworming member of the Bank of England’s Monetary Policy Committee. They are not as lethargic. By now. So—incredibly easy. which was quashed only by Forbes’s believes that the impact of globalization on inequality should subsequent research. for instance. or Brexit. “It’s amazing. some 25 to 30 million children have how important decisions are made. that often make them too ill to attend school. how globalization can benefit all. as than investing in physical plants or employing more workers. Yet. at least. she is obviously perturbed by the significant amounts of money in donations. she urges academics to spend more time talking to people outside their been dewormed—all thanks to good academic research!” ■ ivory towers: “we really need to—all of us. But As elevated as academic research can be. It is an example of how open economies there is little practical distinction between she has applied her skills broadly. where the IMF and World Bank were con- US President’s Council of Economic Advisers. Just give children anti-expert. which showed that when firms do repa. leave the European Union. most cost-effective ways of ensuring that children in develop- lectually inquisitive. children in developing economies. This time it was an invitation to join the New Hampshire. of new evidence. “how the power of good economic research can raise on firm empirical evidence. Part of the On an issue that was then in the headlines—the huge sums problem. To Forbes and her colleagues on the economic council. Forbes ceived in 1944 (though she hastens to explain that she chose worked on many hot topics in international economics. a one-time tax holiday to help spur investment in the United States. the hotel more for its convenient location than for its histori- including possible currency manipulation by major trading cal associations).effective by developing criteria to determine which coun. be intel. and it gets rid of their worms and they can have crept into popular discourse. 54   Finance & Development March 2017 . phone rang again. and Forbes volunteered her although she recently announced she is returning to MIT and business school savvy to help establish the organization. Through her research. Her early work on capi. Economists—academics ing policy decisions. erals in food. therefore. that did not ring true—but without solid evidence. they are worried about and what they are thinking about. Deworming children tal controls. prudential measures and capital controls. Unlike many. she learn more. they are healthier. But con. In the United Kingdom. not be exaggerated. is economists’ inability to communi- of money parked abroad by US multinational corporations to cate to the general public in ways that are understandable and avoid high corporate taxes—Forbes was again able to bring applicable to people’s lives. will be unable to seek another term on the committee. incred- lic and to policymakers—in the hope of positively influencing ibly effective. she believes. The corporations seemed to concerns about extreme income and wealth inequality. A few years ago. Not surprisingly. taking many different. policymakers and Atish Rex Ghosh is the IMF’s historian. wages in lower brackets have risen faster than in some higher brackets. Forbes of their potential to bolster financial resilience. then base ing economies stay in school is to rid them of parasitic worms your conclusions on solid analytics. on the street. among many. or at least not increased. have persuaded sometimes unexpected. Forbes began writing aca. found that one of the about. they typically use them to pay dividends rather inequality in recent years has fallen. she notes. they had While some of the antiglobalization sentiment stems from no way of refuting this claim. These corporations commonly complained that they could not finance investment in the United States because it would She is willing to keep an open cost so much to repatriate the funds. explore all angles of the issue. tended to emphasize their costs. ask yourself why you are doing this work. together with vein: choose topics that are important and that you care Michael Kremer of Harvard University. academic research by fellow MIT profes- Her advice to young researchers is very much in the same sors Rachel Glennerster and Esther Duflo. about the current backlash against globalization. and talk to people and better understand what Back at MIT the following year. they absorb more min- continues to try to explain basic economic facts—to the pub. which is why Forbes became stability risks and the growing awareness that in financially involved in the deworming project. she is concerned partners and international taxation. however. The natural implication mind and shift her views in light was that they should receive.

by big US banks—a crucial fact that politicians we elect to run the real unknown risks into our economy.­ Clearly. The derail a potential crash and reces. central bankers government bailouts he later sup. but also that empirical.” player in global markets—some. given the efficiency five years with Greenspan’s coop- gains that businesses were seeing eration while working as a senior from globalization and new tech. then there was no he had never bought totally into The Man Who Knew reason to hike interest rates. many lessons in sley Born on derivatives. the book underplays).­ Trading Commission chair Brook. But Greenspan in. tallying sideways references to “irrational numbers rather than relying on exuberance” by the late 1990s. others who played a part in the market—terribly damaging ones (he es—and some well-deserved policy events leading up to the 2008 crisis did a seminal paper on the topic in home runs—made him less willing and Great Recession failed to do so. believ. had been a “flaw” in his thinking. believing this prefer. He made he was deep in the weeds. since “rational” markets. Like most Fed about whether interest rates finance-friendly regulators. I disagree. as potentially damaging as she economics should move toward the thought they might be. The result? The maestro was right. Once a staunch opponent of craft). Rana Foroohar Despite this. The Reserve chair Alan Greenspan. heating in the economy. he rising. actually rising. biography of former US Federal industries and four decades. He dismissed economy itself. depend far too much on central themselves have become the major ported bailouts of emerging markets bankers being those “who know. Greenspan was well aware data and too much ego in the room. since ideologically. $40. ing a mistake of any kind is one of that easy monetary policy and stock The praise and political power that the things that redeems him. Assistant Managing Editor Greenspan’s legacy are relevant to ing incorrectly that they weren’t Time magazine Finance & Development March 2017  55 . Wages were When it did. ivory tower models. to his great credit. 800 pp. fellow at the Council on Foreign nologies. knew didn’t know perhaps the key takeaway sisted that Fed researchers go back from Sebastian Mallaby’s epic new and re-tally the numbers across 155 everything. Greenspan’s admis- inflate anyway. Nearly every eco- (hardcover) nomic guru at the time—from Larry The man who T oo much success can be a Summers to Janet Yellen—worried dangerous thing. and (to this reviewer at least) somewhat cially lowering the overall rate. The central and productivity in services was artifi. 1959). For one. central banker (one that he helped great irony is that thanks in large sion.. BOOK REVIEWS Judging Greenspan today’s economic problems. and the stock market was up issued a mea culpa. Many prices could create bubbles in the came with his many lucky hunch. Actions matter. pan didn’t want the music to stop. Greens- should be hiked to ward off over. the economy—faltered were intellectual one than a moral one. rates. like Mexico (whose debt was held It’s time to demand more from the thing that has introduced huge.­ Greenspan took responsibility for shocking revelation of the book is The times that Greenspan—and as his. low Man Who Knew. the man who knew didn’t warnings by US Commodity Futures know everything. 2016. even when it was clear that sion marked an important departure able to more dramatic government this really was what was needed to from the fiction of the omniscient interference in the market. Yet productivity figures seemed Mallaby—who wrote this book over oddly weak. That is about inflation. In the summer but backed off on curbing it when of 1996. there was a debate at the the markets stabilized. admitting there 45 percent over the course of a year.­ The Life and Times of Alan workers making more widgets could Greenspan also be paid more without trigger- Penguin Press.00 ing inflation. And yet he allowed them to to rock the boat and raise interest What’s more. While his “flaw” was less an that far from being a blind follower a result. The world has come to part to Greenspan. Greenspan had what was it would be too politically tricky to arguably his biggest insight when push through regulation. Solving the conundrum Relations—believes it was mistake Sebastian Mallaby was crucial—if productivity was for him to do so. of “markets know best” efficiency usually when there was too little the fact that he admitted to mak- theory.

If we want to revive our 1 percent. tion. Lewis proposed tion so that families can escape the low- that economic growth and development skill trap and more coherently integrate did not conform to national bound. though. bers of the FTE sector seek to keep attention to education—the United the United States grew ever richer. Among other things. by 61 percent.95 (hardcover) detoured for decades now. fundamental problems Temin identi- Economy ing source of cheap labor. lies to get into the richer FTE capital. and disenfran. tence sector. their profits. In these two sectors’ symbiotic Alas. and electronics. One sector. middle decades of that century also 1980 and 2014 pretax income grew. aries. Within countries. developed nation ter than they did. War II opened college doors to genera- and services in 2016.” is composed of poor Peter Temin farmers who supply a vast surplus of labor. This is why Temin’s top policy Executive Director and new book. He argues A mericans tend to assume that that “the vanishing middle class has that the US economy is on a trend history marches forward and left behind a dual economy. neither of these recommenda- The Vanishing Middle Class tions is potent enough to overcome the relationship the capitalist sector seeks to Prejudice and Power in a Dual keep wages down to maintain an ongo. calls “subsistence. but that is exactly tal tenet of the American Dream and to Lewis’s capitalist sector—and the nature of the distributional struc- a core deliverable of the economy over low-skill work. These developments play out boasted high taxation on estates and top on average. but spotty. he saw that “economic progress was not uniform. there are brunt of the vagaries of globaliza. Arthur Lewis. This is a fundamen. those in the top 1 percent paths for children of low-wage fami. The other sector. Explaining rising inequality in the for children from African-American Heather Boushey United States is the aim of Peter Temin’s families. their own taxes low and suppress the States was among the first to provide the gains from this growth have not wages they pay so as to maximize universal access to primary education been shared. most of the course of the 20th century. There are four decades. Equitable Growth 56   Finance & Development March 2017 . which Temin snagged 205 percent income growth. States more equality in the middle of detours.” is the home of modern production. but Temin argues that there more to undermine the dual economy Dream was expected to play out.. or FTE—akin may seem jarring. technol. The idea the United States today. and the GI bill after World duced $18 trillion worth of goods housing segregation. Temin applies this framework to sion toward greater equality has been 208 pp. where develop. fies. Data show that between in a subservient labor market posi. Massachusetts. The US economy pro. The Vanishing Middle recommendation is universal access Chief Economist. which the American Dream Lewis calls “capitalist. especially structures he so accurately details. The US path of natural progres- MIT Press. He builds on reverse policies that repress poor folk the dual sector model developed in the of any race. was expected to ment is limited only by the amount of capital. Class. akin to the subsis. in broader economic growth—yet both top.Reinventing the Past today make the United States look like His second recommendation is to a developing economy. For the bottom 50 percent of the The bridge between these two sides have been seriously eroded over the past US population incomes grew only of the economy is education. Temin argues that the distribu. ture of the world’s richest economy. 2017. so eloquently describes. vanishing middle class. nationwide. which he play out. He advises an end to mass 1950s by W.” His more like that of a developing econ- that their children will do bet. the 20th century certainly included Even though over the past 40 years. dual sectors are finance. are many more obstacles. Cambridge. Mass incarceration. we’ll need to do This is not the way the American ist group. yet most of along racial lines set by the nation’s incomes—money that could be invested these gains went to those at the very history of slavery.” His model explains how development and lack of development This is not the way progress side by side. $26. the on record. ogy. Looking at incarceration and housing discrimina- developing economies. tion. more than any chisement all serve—among other tions of students—but that was not the other country that year—or any year things—to keep the low-skill sector only policy. omy than of a rich. into the broader economy and society. The book lays out how mem. whose workers bear the The steps that brought the United Sometimes. to high-quality preschool and greater Washington Center for tion of gains from economic growth financial support for public universities.

Both ogy. encouraged a quest that led to sustained economic growth. but were a conse. in the marketplace for both material must-read for anyone interested in ity to use science to control their des. And all of economy of the future.Culture at the Roots of Growth over the forces of nature.” wrote ate—it had produced nothing like Bacon. through the 18th. which lowered the cost of communi- to old ideas. What this culture means.” says Mokyr. enjoyable for the general reader as roughly two centuries. a period that brought about of property rights. in their time because competition in Europe. globalization). illustrating his big-picture quence of a change in attitudes attachment to old ideas. and the relative unimportance The Origins of the Modern Economy Bacon and Newton altered thinking of competition compared with Princeton University Press. the selection of administrators for onstrate that the “rules”—the math. Francis Bacon and rapid development of a culture Isaac Newton. $35 (hardcover) the marketplace of ideas allowed their tives that fostered success in other J oel Mokyr’s A Culture of ideas “to be distributed and shared. This occurred over a single central authority in Europe. how Western society got where it is tiny and. of fundamental change in Europe? ence a ‘failure. thereby unlocking the rather than of science and technol- A Culture of Growth mysteries of the natural world. Mokyr on the Enlightenment was instru. the author insists. tion and ongoing and self-reinforcing How did the Enlightenment turn indeed unique. International Affairs. previously been at least as techno- “The true and legitimate goal of the logically advanced as Europe. the new ideas led to advances in sci. the enforcement well as for the specialist in economic and 1700. “It seems growth and industrialization brought come about and spread in the period wrong to dub the Chinese experi- about by the first Industrial Revolu. areas of Chinese culture but did Growth: The Origins of the and hence challenged. goods and ideas. Mokyr proposes that the cation and increased the benefits of Enlightenment and the Industrial literacy. Barry R. A Culture of Growth is a a change in beliefs about people’s abil. if not sciences is to endow human life with more so—and certainly more liter- new discoveries and resources. who changed thinking of growth. He uses the example of Nudging this process were two China as a counterpoint to Europe’s prominent figures. today and what this implies for the The Enlightenment. and competition history. which eighteenth-century Europe. These changes thesis with a myriad of fascinating (which he sums up as “culture”) in were also helped by the absence of details. corrected and not stimulate the ideas and actions Modern Economy gives culture supplemented.” a certain type of culture that is the in turn was the starting point of reason growth-inducing change sustained growth? Mokyr paints a occurred in Europe and not. to factors such as veneration of tion that “natural inquiry” through classical Chinese literature. of thinking elsewhere and reduced issues. sci. the natural world. is the topic of this provocative analysis. These developments opened This book is the latest example of Revolution were not exogenous minds to new ideas and new ways Mokyr’s ability to explicate complex developments. He writes with clarity— Western Europe. It is into the Industrial Revolution. so is analyzing why Washington University Finance & Development March 2017  57 . is what happened in in Western Europe ever since. 400 pp. Mokyr then shows that although Professor of Economics and ence and technology—that resulted in looking at why something hap. plum government positions based Joel Mokyr ematical regularities—of nature could on knowledge of Chinese literature be identified. associated with an industrial revo- center stage in the rapid economic But how did these cultural changes lution.’ What is exceptional. His and his followers’ impact the Industrial Revolution. Although China had in Western Europe and then the world. The George permanent and sustained command pened is useful. New Jersey. and what made it dif- shipbuilding that opened Europe to new products and new ideas (early reduced attachment ferent in Europe. it did not. tralized government that discour- nomic growth and human well-being. Newton’s contribution was to dem.. a cen- experimentation is essential for eco. attributes slow progress in China mental in bringing about the convic. Princeton. in backdrop of improved navigation and These developments China. Among other things. especially. taking off ence and technology that we now call spread of technology in the global in the late 17th century and lasting the Industrial Revolution. between 1500 individual freedom. Chiswick for “useful knowledge”—that is. and the printing press. say. These provided incen- 2017. Mokyr concludes. aged competition among regions.

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