Prof. P.

Gougeon/ ESCP Business School

Course Presentation

MACROECONOMICS: contemporary issues

• Introduction: the economic system at a glance

The main concern of economists is to identify the conditions that will guaranty the efficient use of
scarce resources in order to produce goods and services and make sure all participants will receive a
fair portion of the wealth created. The economic system can be described as a set of inter-relations
between the various national economic actors – firms, households, financial institutions and the state.
It describes how the total value produced circulates within the system and the connections of the
national economy with the rest of the world (exports/imports; international capital flows and
transfers)

• GDP & economic growth: current issues

The Gross Domestic Product (GDP) is the most common measure of the total value produced in a
particular country during one year. Taking the percentage of progression of the GDP we obtain the
economic growth rate – which is usually expressed in real terms (excluding inflation). Though a lot of
imperfections have been identified, as of today there is no real alternative on which economists would
agree.

Apart from the measure of the GDP important contemporary issues deserve attention. It concerns the
efficiency of the production process (productivity), how globalisation has impacted national
production (offshoring), the growing importance of intangible activities (services) and most
importantly how economic activities impact the environment (sustainability)

• Consumption, and saving

The GDP is defined as a measure of the total value produced, but it also corresponds to an amount of
money representing a global income. A large proportion of this income is allocated to consumption
expenditures, what remains is the amount of saving

To allow for the replacement of old equipment and increase the production capacity while maintaining
a sustainable financing of the economic growth a certain amount of saving is necessary. However,
since consumption – and therefore saving – result from independent non-coordinated households
decisions it is very unlikely that saving will exactly correspond to what is needed to finance investment.
Due to the possibility of a structural mismatch between saving and investment needs, analysing the
determinants of saving and investment are key. Among the main related issues ageing and income
inequality are most important today.

• Financing the economy: financial institutions & markets

Bearing in mind the difficulties above mentioned, the role of financial institutions and markets is
indeed crucial to organise an efficient transfer of available saving to investment. Particularly in a
context where fund providers and fund raisers have diverging views as to the conditions of this
transfer. Financial intermediation and capital markets provide the appropriate structure to create
the conditions for efficient financing of the economy. Indeed the recent financial crisis that occurred
raised questions about its origin and the necessary regulatory changes. The global dimension of
financial institutions and their size have undeniably added complexity and risks.

• Monetary and fiscal policy: un-conventional era?

Following the 1929 severe economic crises that started in the US and then spread to the rest of the
world, economists have challenged a pure liberal economic model. J.M. Keynes was the first to reflect
on how the crisis occurred and what should be done to avoid a repetition. Assuming a close economy,
with the idea of boosting aggregate demand – made of consumption, investment and public spending
– he provided the basis of monetary policy – dealing with supply of money to encourage consumption
and investment – and fiscal policy – stressing the importance of taxation and public spending. Does it
work? Economists have long been discussing this point without providing a definitive well-accepted
answer. To cope with the severe financial crisis in 2008, which has been compared to the 1929 shock,
governments and central banks have taken drastic measures to avoid a possible severe and long
lasting recession. It led to new controversial forms of intervention (un-conventional).

• Open economy: international trade, capital flows and foreign exchange

Opening the economy means considering trade of good and services between countries – exports and
imports - as well international capital flows. All these transactions are recorded in the balance of
payments, which constitute a most valuable source of information to assess the position of a particular
country in the global economic system. In this broader context the traditional Keynesian approach
needs to be enriched with a special attention to the level of the foreign exchange rate.

• Contemporary global economic issues: about US leadership, growing importance of

emerging economies, sustainability issues
Today the large US trade deficit, and the corresponding surpluses of a group of export driven
economies such as China or Germany, is a striking point. Is it sustainable? Probably not. Then what?
This question is not just for economists, unless they also specialise in geopolitics. A final question to
conclude: for most policy makers economic growth remains a central goal, what about the planet?

Text Book References

Economics (11th edition) by David Begg, Gianluigi Vernasca and Stanley Fischer, Rudiger Dornbush;
McGraw-Hill; 2014

• GDP, economic performance and development (Chapt. 15, 16)

• Consumption, saving and investment (Chapt. 16)
• The financial system: the need for financial intermediation (Chapt. 18)
• Government intervention (Budget and monetary policy) (Chapt. 14, 20, 21, 22, 23, 28)
• Open economy: international trade, capital flows and foreign exchange. (Chapt. 24, 25)
ECONOMIC - READINGS

Articles
I - Is productivity growth becoming irrelevant? Adair Turner, World Economic Forum, July 24
2017; https://www.weforum.org/agenda/2017/07/is-productivity-growth-becoming-
irrelevant

II - The digital disruption of productivity, by Diane Coyle,

http://www.oecd.org/internet/digital-disruption-productivity.htm

III- Supply chains are undergoing a dramatic transformation, The Economist, July 11 2019,
https://www.economist.com/special-report/2019/07/11/supply-chains-are-undergoing-a-
dramatic-transformation

IV - Changing places: The pandemic will not end globalisation, but it will reshape it, The
Economist, Special report, Oct 8th 2020, https://www.economist.com/special-
report/2020/10/08/changing-places

V - Multinational companies are adjusting to shorter supply chains: The risks of not knowing
who supplies your supplier, The Economist, Jul 11th 2019,
https://www.economist.com/special-report/2019/07/11/multinational-companies-are-
adjusting-to-shorter-supply-chains

VI - Economists grapple with the future of the labour market: The battle between techno-
optimists and productivity pessimists continues, The Economist, January 11 2018,
https://www.economist.com/finance-and-economics/2018/01/11/economists-grapple-
with-the-future-of-the-labour-market

VII - A study finds nearly half of jobs are vulnerable to automation: That could free people to
pursue more interesting careers, The Economist, Apr 24th 2018,
https://www.economist.com/graphic-detail/2018/04/24/a-study-finds-nearly-half-of-
jobs-are-vulnerable-to-automation

VIII - Demography, growth and inequality: Age invaders, The Economist Apr 26th 2014
https://www.economist.com/briefing/2014/04/26/age-invaders

IX- Slower growth in ageing economies is not inevitable: But avoiding it means tough policy
choices, The Economist, March 28 2019, https://www.economist.com/finance-and-
economics/2019/03/28/slower-growth-in-ageing-economies-is-not-inevitable

X- The Age of Secular Stagnation: What It Is and What to Do About It, Lawrence H. Summers,
February 15, 2016, published in Foreign Affairs, http://larrysummers.com/2016/02/17/the-
age-of-secular-stagnation/

XI - The Myth Of Secular Stagnation, by Joseph Stiglitz; Social Europe on 6th September 2018,
https://www.socialeurope.eu/the-myth-of-secular-stagnation

XII - Inequality v growth: Up to a point, redistributing income to fight inequality can lift
growth, The Economist, Mar 1st 2014, https://www.economist.com/finance-and-
economics/2014/03/03/inequality-v-growth

XIII - Wise fiscal policy is not about helicopter money, Claudio Borio, Head of the Monetary
and Economic Department of the BIS, BIS speech, 8 November 2019,
https://www.bis.org/author/claudio_borio.htm
XIV- Debtor alive: Economists reconsider how much governments can borrow, The
Economist, Jan 17th 2019, https://www.economist.com/finance-and-
economics/2019/01/17/economists-reconsider-how-much-governments-can-borrow

XV – The global list: Globalisation has faltered, It is now being reshaped, The Economist, Jan
24th 2019, https://www.economist.com/briefing/2019/01/24/globalisation-has-faltered

XVI - If China made the rules, Xi’s world order: July 2024, The Economist / The World If, Jul
7th 2018, https://www-economist-com.ezp.lib.cam.ac.uk/the-world-if/2018/07/07/xis-
world-order-july-2024

XVII - When Will China Rule the World? Bloomberg, New Economy Daily, Malcolm Scott, July
6 2021, https://www.bloomberg.com/news/newsletters/2021-07-06/what-s-happening-in-
the-world-economy-will-china-ever-be-number-one
I
Is productivity growth becoming irrelevant?
https://www.weforum.org/agenda/2017/07/is-productivity-growth-becoming-irrelevant

According to Adair Turner, as we get richer, measured GDP per capita may tell us less about
trends in human welfare.

This article is published in collaboration with

Project Syndicate

24 Jul 2017

Adair Turner: Chairman, Institute for New Economic Thinking

As the Nobel laureate economist Robert Solow noted in 1987, computers are “everywhere
but in the productivity statistics.” Since then, the so-called productivity paradox has become
ever more striking. Automation has eliminated many jobs. Robots and artificial intelligence
now seem to promise (or threaten) yet more radical change. Yet productivity growth has
slowed across the advanced economies; in Britain, labor is no more productive today than it
was in 2007.

Some economists see low business investment, poor skills, outdated infrastructure, or
excessive regulation holding back potential growth. Others note wide disparities in
productivity between leaders and laggards among industrial manufacturers. Still others
question whether information technology is really so distinctively powerful.

But the explanation may lie deeper still. As we get richer, measured productivity may
inevitably slow, and measured GDP per capita may tell us ever less about trends in human
welfare.

Our standard mental model of productivity growth reflects the transition from agriculture to
industry. We start with 100 farmers producing 100 units of food: technological progress
enables 50 to produce the same amount, and the other 50 to move to factories that produce
washing machines or cars or whatever. Overall productivity doubles, and can double again,
as both agriculture and manufacturing become still more productive, with some workers then
shifting to restaurants or health-care services. We assume an endlessly repeatable process.

But two other developments are possible. Suppose the more productive farmers have no
desire for washing machines or cars, but instead employ the 50 surplus workers either as low-
paid domestic servants or higher-paid artists, providing face-to-face and difficult-to-automate
services. Then, as the late William Baumol, a professor at Princeton University, argued in
1966, overall productivity growth will slowly decline to zero, even if productivity growth
within agriculture never slows.

Or suppose that 25 of the surplus farmers become criminals, and the other 25 police. Then
the benefit to human welfare is nil, even though measured productivity rises if public services
are valued, as per standard convention, at input cost.

Have you read?

Productivity, innovation and friction in the economy

US productivity growth is shrinking, and nobody knows why

The growth of difficult-to-automate service activities may explain some of the productivity
slowdown. Britain’s flat productivity reflects a combination of rapid automation in some
sectors and rapid growth of low-productivity, low-wage jobs – such as Deliveroo drivers riding
around on plain old-fashioned bicycles. In the United States, the Bureau of Labor Statistics
reports that eight of the ten fastest-growing job categories are low-wage services such as
personal care and home health aides.

The growth of “zero-sum” activities may, however, be even more important. Look around the
economy, and it’s striking how much high-talent manpower is devoted to activities that
cannot possibly increase human welfare, but entail competition for the available economic
pie. Such activities have become ubiquitous: legal services, policing, and prisons; cybercrime
and the army of experts defending organizations against it; financial regulators trying to stop
mis-selling and the growing ranks of compliance officers employed in response; the huge
resources devoted to US election campaigns; real-estate services that facilitate the exchange
of already-existing assets; and much financial trading.

Much design, branding, and advertising activity is also essentially zero-sum. It is certainly good
that new fashions can continually compete for our attention; choice and human creativity are
valuable per se. But we have no reason to believe that 2050’s designs and brands will make
us any happier than those of 2017.

Such zero-sum activities have always been significant. But they grow in importance as we
approach satiation in many basic goods and services. In the US, “financial and business
services” now account for 18% of employment, up from 13.2% in 1992.

The impact on measured GDP and productivity reflects national accounting conventions. If
people devote more of their income to competing for scarce housing, driving up property
prices and rents, GDP and “productivity” increase, because housing rent is included in GDP,
even if the aggregate supply of housing services is unchanged. Since 1985, the share of rents
in the UK economy has doubled, from 6% of GDP to 12%.

Likewise, more and better-paid divorce lawyers increase GDP, because end consumers pay
them. But more and better-paid commercial lawyers don’t raise output, because companies’
legal expenditures are an intermediate cost. Measured productivity slows as intermediate
zero-sum activities proliferate, while other zero-sum activities swell GDP but deliver no
welfare benefit.

Potentially offsetting this effect, information technology may improve human welfare in ways
not captured in measured output. Billions of hours of consumer time previously spent filling
in forms, making telephone calls, and queuing are eliminated by Internet-based shopping and
search services. Valuable information and entertainment services are provided for free.

Contrary to what some right-wing economists argue, such free services cannot make
increasing income inequality irrelevant. If rents and commuting costs are driven up by intense
competition for attractively located property, you can’t pay for them out of freely arising
“consumer surplus.” But the essential insight is still important: much that delivers human
welfare benefits is not reflected in GDP.

Indeed, measured GDP and gains in human welfare eventually may become entirely divorced.
Imagine in 2100 a world in which solar-powered robots, manufactured by robots and
controlled by artificial intelligence systems, deliver most of the goods and services that
support human welfare. All that activity would account for a trivial proportion of measured
GDP, simply because it would be so cheap.

Conversely, almost all measured GDP would reflect zero-sum and/or impossible-to-automate
activities – housing rents, sports prizes, artistic performance fees, brand royalties, and
administrative, legal, and political system costs. Measured productivity growth would be
close to nil, but also irrelevant to improvement in human welfare.

We are far from there yet. But the trend in that direction may well help explain the recent
productivity slowdown. The computers are not in the productivity statistics precisely because
they are so powerful.
II

The digital disruption of productivity

By: Diane Coyle
http://www.oecd.org/internet/digital-disruption-productivity.htm

The UK’s tallest mountain is Ben Nevis in Scotland. Recently, it became one metre taller,
standing now at 1 345m rather than 1 344m above sea level. Of course, the mountain did not
actually grow. Rather, the team of Ordnance Survey experts who re-measured it for the first
time since 1949 were able to do so more accurately because of improvements in technology,
and specifically through the use of GPS.

Many people think measuring the size of the economy–the Gross Domestic Product (GDP)–is
a task like measuring the height of a mountain. There are errors and revisions, but in principle
the experts could find ways to make the measurement more accurate. But in fact, lots of
judgements are involved in defining and measuring GDP, and over the decades there have
been criticisms of some of these. For example, we measure the economy without taking
account of the environmental costs of some activities, or overlooking the value of unpaid
work in the home.

One response to such criticism is to argue that as these do not have market values, leaving
them out is not a problem as long as we remember that GDP is nothing more than a measure
of market activity. It is a weak response; after all, government services are counted and there
is no market value for them either. Now there is an even more powerful challenge to the way
GDP is currently defined and measured because of the way digital activities are changing the
economy.

One obvious point is that lots of online activities are free, so also do not have a market price.
Those that are funded by advertising are not genuinely “free”, as everybody is becoming
aware, but even so are hard to value and incorporate into GDP. However, others are the
product of voluntary work, including open source software, personal blogs, entertaining
videos and so on. At present the statistics treat them just like volunteering at the local school
or charity shop, or to cook meals at home. This is starting to seem like quite a large omission.
So too is the rapidly growing phenomenon of the “sharing economy”, a loose term describing
digital platforms ranging from local time banks or swap schemes, through peer-to-peer
financing and freelance employment websites, to giant companies such as Airbnb. These
platforms bring together suppliers of a service and consumers, sometimes in a monetary
transaction, sometimes in a social relationship. They create value for their users on both sides
(because there is always the option of not participating), but it does not always involve a price.

Even when users pay the platform and the supplier a fee, they will be getting an extra non-
monetary benefit–for example, finding a more distinctive or cheaper or more convenient
place to stay than through a conventional hotel. Economists term this improved matching of
supply to consumer tastes the “consumer surplus”. This is how much more the consumer
values the service than they have had to pay. It is never captured in GDP, which measures
transactions at the price paid. But if innovations mean that this consumer surplus is
increasing, then it seems that GDP is missing an important phenomenon.

Besides, given the controversy about the conditions of work in the sharing economy, it would
be useful to have more statistical insight into it. How many people are actually working in this
more contingent way in OECD countries? How do their earnings and conditions actually
compare to conventional jobs? Are they content with this way of making a living or only doing
it because there is nothing better available? We don’t know. These are important questions
if we hope the digital transformation will enable an inclusive economy.

Digital business models in general pose a challenge to the statisticians. For example, there are
several sectors of the economy where business has been moving off the high street and
online–think of book retailing, travel agency, or banking. As a result, there has been declining
investment in commercial real estate, a component of business investment and therefore
GDP. So digitisation will in this way have contributed directly to some reduction in GDP, while
consumers have enjoyed at least the same service.

In addition, the fact that this is a business model choice means GDP could change if a publisher
decides to switch to a subscription based model. Digital goods are often bundled together in
packages that change frequently. Determining the price of specific goods is challenging, to
say the least. Yet without accurate price indices, it is not possible to calculate the real growth
rate of GDP, the single most important gauge of how well the economy is doing. More
generally, the information available on all services including the digital sectors is lamentable,
given the framework for classifying statistics that was set in the late 1940s, when
manufacturing was far more important. We simply have too little information of any kind
about the dynamic sectors of the OECD economies.
One of the most contentious issues is whether price indices adequately capture the pace of
technical progress in many goods. The problem is that the price of an item to consumers, such
as a laptop or mobile phone, might not decline but the quality of that item has improved
enormously, with more memory, better cameras, faster speeds and so on. Statisticians in
OECD countries do make what are called hedonic adjustments for some items in their price
indices. However, many in the tech businesses do not think the price adjustments match the
pace of technological progress they observe. In the chart below, the scale is logarithmic, so it
shows the speed of decline in the price of computer processing is still exponential, in line with
Moore’s Law–based on an observation by Intel co-founder Gordon Moore in 1965, that the
density of transistors in integrated circuits (and hence computing power) would roughly
double every two years.

If the price index is overstated, real GDP will be understated. This issue is at the heart of the
debate among economists about what part of the current slowdown in productivity in OECD
economies can be attributed to measurement issues, and remains an open question.
The question of whether the digital transformation is making existing methods of defining
and measuring the economy less useful is not just an academic one. Statistics guide policy and
allow citizens to hold politicians to account. Independent and reliable official statistics are a
public good in democratic, information-based economies. The pace of change in the OECD
countries is making the existing statistical framework decreasingly appropriate for measuring
the economy and it is therefore hindering the development of policies for higher productivity
and growth. Different statistics will not change the current reality, any more than more
accurate instruments actually increased the height of Ben Nevis; but they will help shape the
future. Statistics are not facts; they are tools.

References

Coyle, Diane (2015), "Modernising Economic Statistics: why it matters", National Institute
Economic Review, November
Coyle, Diane (2014), "The ups and downs of GDP", OECD Yearbook
Coyle, Diane (2013), "The cost of mistrust", OECD Yearbook

OECD Productivity statistics OECD work on economy
OECD work on Internet economy
OECD Observer (2014), "A sharing economy", Q4
Productivity and inclusive growth at the OECD Forum 2016
Innovation and the digital economy at the OECD Forum 2016
OECD Forum 2016 issues
OECD Observer website
OECD Yearbook 2016
III
Supply chains are undergoing a dramatic
transformation
This will be wrenching for many firms, argues Vijay Vaitheeswaran

The Economist, July 11 2019

https://www.economist.com/special-report/2019/07/11/supply-chains-are-undergoing-a-dramatic-
transformation

Tom linton, chief procurement and supply-chain officer at Flex, an American contract-
manufacturing giant, has his finger on The Pulse. That is the name of his firm’s whizzy
command centre in California, which is evocative of a Pentagon war room. The kit allows him
to monitor Flex’s 16,000 suppliers and 100-plus factories, producing everything from
automotive systems to cloud-computing kit for over 1,000 customers worldwide. Mr Linton
is one of the acknowledged kings of the supply chain—the mechanism at the heart of
globalisation of the past few decades by which raw materials, parts and components are
exchanged across multiple national boundaries before being incorporated into finished
goods. Ask him about the future, however, and he answers ominously: “We’re heading into a
post-global world.”

A few years ago that would have been a heretical thought. The combination of the
information-technology revolution, which made communications affordable and reliable, and
the entry of China into the world economy, which provided bountiful cheap labour, had
transformed manufacturing into a global enterprise. In his book “The Great Convergence”,
Richard Baldwin argues that the resulting blend of Western industrial know-how and Asian
manufacturing muscle fuelled the hyper-globalisation of supply chains. From 1990 to 2010,
trade boomed thanks to tariff cuts, cheaper communications and lower-cost transport.

The oecd, a think-tank for advanced economies, reckons that 70% of global trade now
involves global value chains (gvcs). The increase in their complexity is illustrated by the growth
in the share of foreign value added to a country’s exports. This shot up from below 20% in
1990 to nearly 30% in 2011.
Western retailers developed networks of inexpensive suppliers, especially in China, so that
they in turn could deliver “everyday low prices” to consumers back home. Multinational
corporations (mncs) that once kept manufacturing close to home stretched supply chains thin
as they chased cheap labour and economies of scale on the other side of the world. Assuming
globalisation to be irreversible, firms embraced such practices as lean inventory management
and just-in-time delivery that pursued efficiency and cost control while making little provision
for risk.

But now there are signs that the golden age of globalisation may be over, and the great
convergence is giving way to a slow unravelling of those supply chains. Global trade growth
has fallen from 5.5% in 2017 to 2.1% this year, by the oecd’s reckoning. Global regulatory
harmonisation has given way to local approaches, such as Europe’s data-privacy laws. Cross-
border investment dropped by a fifth last year. Soaring wages and environmental costs are
leading to a decline in the “cheap China” sourcing model.

The immediate threat comes from President Donald Trump’s imposition of tariffs on
America’s trading partners and renegotiation of free-trade agreements, which have disrupted
long-standing supply chains in North America and Asia. On June 29th, Mr Trump agreed a
truce with Xi Jinping, China’s president, that temporarily suspends his threatened imposition
of duties of up to 25% on $325bn-worth of Chinese imports, but leaves in place all previous
tariffs imposed during the trade war. He threatened in May to impose tariffs on all imports
from Mexico if it did not crack down on immigration, but reversed himself in June. He has
delayed till November a decision on whether to impose tariffs on automobile imports, which
would hit European manufacturers hard.

Look beyond politics, though, and you will find that supply chains were already undergoing
the most rapid change in decades in response to deeper trends in business, technology and
society. The rise of Amazon, Alibaba and other e-commerce giants has persuaded consumers
that they can have an endless variety of products delivered instantly. This is putting enormous
pressure on mncs to modify and modernise their supply chains to keep pace with advancing
innovations and evolving consumer preferences.

Arms race

The biggest force for change is technology. Artificial intelligence (ai), predictive data analytics
and robotics are already changing how factories, warehouses, distribution centres and
delivery systems work. 3d printing, blockchain technologies and autonomous vehicles could
have a big impact in future. Some even dream of autonomous supply chains requiring no
human intervention.
However, technological advances also raise the spectre of an arms race in supply-chain
security. Aggressive private hackers and state-sponsored cyber-warriors appear to have the
upper hand over beleaguered corporations and governments. Recent headlines have focused
on America’s crackdown on Huawei, a Chinese telecoms giant. But the issues involved go far
beyond one firm, given that much of the world’s electronics-manufacturing and hardware
innovation takes place in China.

If a technology cold war breaks out, it would smash today’s highly integrated technology
supply chains and force an expensive realignment. It may even lead to a bifurcation in the
rollout of 5g, a new telecoms-network technology that is the essential enabler of coming
marvels such as the internet of things (iot). With the proliferation of inexpensive sensors,
the iot will allow homes, factories and cities to be digitally monitored and managed. A
“splinternet of things” (in which America followed one standard and China another) would
not only be costly and inefficient, it would also fail to address legitimate security concerns
about future cyber-threats in the age of 5g.

Even if Huawei is eventually spared, and the truce in America’s trade war with China turns
into a frosty peace, the era of frictionless supply lines flowing from Shenzhen to San Francisco
and Stuttgart has ended. As globalisation is transformed into something messier, the
consequences for mncs and the world economy could be momentous.

This report will show that supply chains were already becoming shorter, smarter and faster
before politicians started taking a hammer to the trading system. Given today’s riskier world,
supply chains will need to become safer too. This transformation threatens firms that have
entrenched supply networks, but it also presents opportunities for those that adapt nimbly.
IV
Changing places
The pandemic will not end globalisation, but it will reshape it

The Economist, Special report, Oct 8th 2020

https://www.economist.com/special-report/2020/10/08/changing-places

FOR A TIME economic contagion seemed more threatening than the pathological kind.
Though the spread of covid-19 was mainly in China, the damage was appearing along supply
chains that produce the world’s goods, notably cars and consumer electronics. China is the
world’s second-biggest exporter of parts, so as its factories shut down, manufacturers
everywhere faced delays. Even before the virus took off in South Korea, Hyundai had halted
production because of a shortage of imported parts. The World Economic Forum (whose
annual bash in Davos epitomises globalisation) advised companies to bring production closer
to customers.

As the pandemic spread, location ceased to matter much. There was no escaping the disease:
the world economy saw its deepest, most synchronised collapse on record. Some of the least
globalised economic activities—restaurants, cinemas, fitness classes and other services—
suffered most. More than goods, people stopped crossing borders; Davos 2021 was
postponed. However, the supply-chain panic has left a lasting impression. For business, it is
further evidence of the risks of distant disruption. For governments it offers more reasons to
turn inward. The result is to accelerate changes to globalisation that were already in train.

Global supply chains were forged in the period from the mid-1980s until the financial crisis 25
years later. Trade surged in volume and changed in nature. It grew nearly twice as fast as
global output, as emerging markets in Asia were bedded in to the world economy. After China
joined the World Trade Organisation in 2001, its share of world exports of many parts and
capital goods grew from under 10% to over 30%. Countries often specialised not in specific
goods, but in bits of them. Taiwan, South Korea and Japan made semiconductors for the
consumer-electronics industry. China supplied parts to German carmakers. The rise of
computing made such complexity manageable. Globalisation brought cheaper goods to the
rich world and, thanks to what Ben Bernanke, then Fed chairman, called a “global saving glut”,
low interest rates. It also displaced many workers. Perhaps a million Americans lost their jobs
to Chinese competition.
The 2010s slammed on the brakes. Trade stagnated as a share of gdp; foreign direct
investment fell. As China’s middle class grew, it consumed domestically more of what it
produced. Its share of world exports stopped rising in 2015, but its share of world imports
continued to grow. As manufacturing became more automated, savings from locating
production where workers were cheapest shrank. The rise of social media made consumer
fads more volatile, necessitating faster production and shipment to satisfy impatient buyers.
“Just in time” delivery of parts worked better with closer suppliers. And disasters highlighted
the risk of a specialised economy. The tsunami that hit Japan in 2011 cut Toyota’s production
in America by nearly a third because of a shortage of parts, while flooding in Thailand
inundated factories producing a quarter of the world’s hard drives. Firms began to see long
supply chains as unwieldy and risky. Trade started to concentrate in regional blocks.
Globalisation became slowbalisation.

Then Donald Trump was elected in November 2016, and a trade war began between America
and China. Companies realised they were exposed to political risk from economic nationalism,
as much as from distant disruption. In 2019, as average American tariffs on Chinese imports
rose from 12% to 21%, and tariffs in the other direction rose from 17% to 21%, America’s
share of Chinese imports and exports fell to its lowest in 27 years, before China’s wto entry.
America circumvented and then sabotaged the wto, stopping the nomination of judges to its
appeal board and thus its ability to adjudicate trade disputes. In Europe Britain voted for
Brexit in June 2016. Many European leaders grew frustrated with unfettered markets, wishing
to have national champions that could compete with China’s state-backed giants.

The blow struck by covid-19 has made supply chains a “ceo and board level topic,” says Susan
Lund of McKinsey, a consultancy. Until this year, she says, many firms did not realise how
much their supply chains depended on China. In a survey conducted by McKinsey in May,
some 93% of firms reported plans to make supply chains more resilient. The firm finds 180
products for which a single country accounts for over 70% of exports and reckons the
production of 16-26% of goods exports could change location in the next five years. Firms are
worried not just about trade wars and other shocks, but about their environmental footprint
and labour standards. These are easier to monitor closer to home.

Covid-19 has also given politicians a chance to indulge their protectionist instincts. The origin
of the virus in Wuhan gave Mr Trump a stick with which to beat China, and another
multilateral institution, the World Health Organisation, on which to pour scorn (and, in this
case, begin withdrawing from). There has been an upsurge in government intervention to
protect jobs and rescue firms; by the end of April the eu had approved more than €2.2trn
($2.6trn) in state aid. Even before the pandemic France and Germany wanted Europe’s state-
aid and competition rules loosened in the name of promoting national champions.
Interdependence days

Politicians have also come to realise how much health-care systems depend on trade.
Shortages of personal protective equipment (ppe) spurred many to limit or block exports of
these and similar goods. The imf counts 120 new export restrictions this year. For many
medical goods production is highly concentrated: China accounts for 60% or more of exports
of antibiotics, sedatives, ibuprofen and paracetamol. Britain has launched “Project Defend”,
which will try to reduce reliance on Chinese production of critical products with a mix of
reshoring and guarantees that supplies pass through friendly countries.

Unhappily, the political appeal of protectionism grows during slumps. When economies lack
demand, governments covet spending that leaks overseas on imports. This is what led to a
devastating round of protectionism in the 1930s. Protection also rose after the financial crisis.
It does not help that China’s stimulus has tried to keep production going, whereas rich-world
governments have supported household incomes. Brad Setser of the Council on Foreign
Relations, a think-tank, notes that China’s current-account surplus, which was shrinking, has
exploded this year. Its exports have recovered strongly, outward flows of tourists have all but
stopped and commodity prices have fallen, making imports cheaper. Were China’s trade
surplus in July sustained for a year it would add up to $700bn, surely enough to worsen the
trade war with America even if Joe Biden replaces Mr Trump.

Such is the confluence of forces bearing down on global trade—organic slowbalisation, trade
wars, suspicion of supply chains—that some draw comparisons between today and the early
20th century. Then, a peak in globalisation collapsed under the weight of the first world war,
Spanish flu and then the 1930s depression.

The comparison is too pessimistic. Trade has not done as badly as feared. In April
the wto forecast that goods trade would fall by 13-32% this year; today it seems more likely
to be just 10%. The imf says the decline in trade will be commensurate with the slump in
demand from the recession. That is in contrast to the aftermath of the financial crisis, when
trade fell by more than its usual relationship with gdp suggested. It also shows that supply
chains have not been wholly wrecked. They were crucial for the response to ppe shortages,
argues Sébastien Miroudot of the oecd club of mostly rich countries. South Korea, which has
been exporting millions of test kits to America and Europe, was uniquely placed to ramp up
production using existing supply chains and relationships.
The logic of turning inward in response to the pandemic is shaky. A recent working paper by
Barthélémy Bonadio of the University of Michigan and three co-authors studies 64 countries
and finds that one-quarter of the drop in gdp this year was transmitted along supply chains,
but that reshoring production would not have reduced the damage. Mr Miroudot
distinguishes a supply chain’s robustness (the ability to keep working through a crisis), from
its resilience (the ability to bounce back from one). The history of supply chains is that they
are not robust but they are resilient, because companies are quick to find workarounds. Their
robustness could be improved, but not by repatriating production, since disaster can strike at
home as well. Had New York been the centre of mask production when covid-19 struck, the
result would have been a “real big mess”, argues Shannon O’Neil of the Council on Foreign
Relations.

Governments might choose to ignore all this in favour of protection. But most firms are not
about to abandon their cross-border investments. A survey by the us-China Business Council
shows little change in the number of American firms saying they have moved or plan to move
out of China. The survival of the “phase one” trade deal struck in 2019 suggests that even the
Trump administration knows there are limits to the desirability of decoupling from China.
Rather than a wholesale break, covid-19 is likely to cause an acceleration of forces already in
motion. Firms will trade off a bit of efficiency for more robustness, realising that in the long
run the robotisation of manufacturing may lead to more local production anyway.
Governments will shorten and diversify supply chains for medical equipment. But America
and China will trade under a darker cloud of mutual suspicion, balancing commercial and
geopolitical interests.

Further ahead the future of globalisation will be determined less by goods than by services.
Before covid-19 services trade was not suffering from slowbalisation: it was growing faster
than gdp. Exports of services account for around a fifth of all trade, according to
the wto(although what exactly counts as services trade is a matter of some debate). Like trade
in goods, trade in services has suffered this year as tourist flows have collapsed. But
consumers are unlikely to have suddenly lost their taste for travel, and countries have little
long-term incentive to close borders to tourists. It seems likely that tourism will eventually
rebound.

Meanwhile, the surge of investment in remote working during 2020 might open the door to
more trade in digital services. When work is carried out remotely, it does not matter where it
is done. On the more futuristic end, this involves remote presence. Whereas the export of
repair services previously required high-skilled engineers to cross borders, virtual- and
augmented-reality technologies now allow experts in one country to help lower-skilled
workers fix machines in another, says Ms Lund. Richard Baldwin of the Graduate Institute in
Geneva points to the potential for remote workers in poor countries to carry out basic office
tasks for firms in the rich world. Before the pandemic the wto was already talking up the
potential for more trade in digital services, predicting that if developing countries adopted
digital technologies, they could reap the rewards of a higher share of international services
trade.

Services trade is hard to liberalise because it often means harmonising regulations. Fields such
as education, health care, accounting and finance are littered with barriers to entry and
requirements for local credentials. The most successful model for remotely provided services
is India’s it sector, which faces few regulatory hurdles. But disputes over cross-border data
flows and the taxation of internet giants augur badly for faster digital integration. Digital
trading, just like trade in goods, is increasingly concentrated in regional regulatory blocks. Yet
Mr Baldwin argues that the rise of online services trade will bypass tensions between East
and West, because it will take place within time zones: South America will supply cheap digital
services to North America, Africa to Europe, and South-East Asia to North-East Asia.

The increased digitisation brought on by covid-19 can only help services trade, even as goods
trade continues to slowbalise. But the extent of that help depends on how much the
pandemic reshapes labour markets, the subject of the next chapter.
V
Multinational companies are adjusting to shorter
supply chains
The risks of not knowing who supplies your supplier

The Economist, Jul 11th 2019

https://www.economist.com/special-report/2019/07/11/multinational-companies-are-
adjusting-to-shorter-supply-chains

In the boom years of globalisation from 1990, one of the ideas that became gospel, spread by
authors such as Thomas Friedman, was that the world had become flat. National boundaries
mattered very little in terms of sourcing and manufacturing, went the argument.

The idea was so pervasive, says Hau Lee of Stanford University, that “companies just built
anywhere”. Now, as the outlook for globalisation grows cloudy, companies are starting to
question the wisdom of the hyper-globalised supply chains thus created. Mr Lee reckons that
managers at mncs must now build new skills as they reconfigure supply chains for a “bumpy”
new world.

A survey conducted in April of 600 mncs around Asia by Baker McKenzie, an American law
firm, found that nearly half of them are considering “major” changes to their supply chains,
and over a tenth a complete overhaul. In many sectors this will mean a rethink of the role that
China plays in sourcing. There are two main reasons to expect that, after several decades of
hyperextension, some supply chains will get shorter. First, it is now clear that stretching
supply chains thin to make goods ever cheaper carries risks. And second, global trade now
includes not just things you can drop on your foot, but a large amount of services.

In terms of the risks, most mncs do not know who supplies the supplier to their supplier, but
they might be held hostage if that distant vendor cannot fulfil its obligations. The dangers are
occasionally brought to light by external shocks. Sometimes these are delivered by natural
disasters. In the wake of the Japanese tsunami in 2011 a global semiconductor giant tried to
map its vulnerabilities to third- and fourth-tier vendors; it took a team of 100 executives more
than a year to work out which firms were in its extended supplier networks.

More recently, shocks have been political. Brexit, Britain’s messy departure from the
European Union now scheduled to take place at the end of October, could disrupt supply lines
linking Britain and the continent. mncs have warned that they may reduce operations in
Britain if it does. A survey by the country’s Chartered Institute of Procurement & Supply
indicated that a fifth of continental businesses would demand a hefty discount from British
suppliers for even a one-day delay at the border, while more than a tenth of British exporters
expect contracts to be cancelled outright.

Americans will not have to wait till October to see the impact of their political shocks, as Mr
Trump’s tariffs on steel, aluminium and Chinese imports are already biting. A working paper
by Mary Amiti and colleagues published in March by the National Bureau of Economic
Research calculated that by the end of 2018 they had cost American consumers $1.4bn a
month. Retailers are being squeezed, with Walmart and Target warning of price rises to come.
Caterpillar, a manufacturer of farm equipment, expects tariffs to cost it $250m-350m this
year. Cummins, an engine maker, expects a hit of $150m.

Despite the truce agreed with Mr Xi, Mr Trump’s tariffs on mainland imports remain in place
and Huawei’s future is still uncertain. China has imposed retaliatory tariffs, is threatening to
punish “unreliable” foreign firms and to withhold exports of rare earths used to make
electronics.

In short, a full-blown trade war may yet break out. How much would it hurt? Moody’s, a
ratings agency, estimates such a “conflagration” would cut growth in real gdp in America by
1.8% one year into the trade war, and reduce growth rates across Asia by 1% or more.
The oecd predicts that a trade war between America and China could take 0.7%, or about
$600bn, off global growth by 2021. The imf warns that many countries, including those that
benefit from trade diversion, will be net losers.

Even if such an outcome is avoided, Mr Trump’s actions may already have made an impact
on mncs. A recent survey of European firms by Credit Suisse, an investment bank, shows an
increased tendency to locate new investments in Europe, not outside it. The firm thinks that
permanent damage has been done by the recent trade disputes. mncs will “no longer plan
and source their supply chains predominantly on the basis of cost”, it argues.

The trade war has also led to a rethink at Apple, which has reportedly asked its biggest
suppliers to see how much it would cost to shift 15- 30% of its supply base out of China to
South-East Asia or India. Liu Young-way, the new chairman of Foxconn, a Taiwanese contract
manufacturer that assembles most of Apple’s devices, recently declared that his firm could
supply all iPhones for the American market from plants outside China if necessary.

As for the rise in services, these are often intermediate inputs into manufacturing. In 2017
global trade in goods amounted to $17.3trn and trade in services, such as transport and
communications, had risen to $5.1trn. The imf believes that, when measured in value-added
terms, the share of services exports in global exports is nearly twice as large as what official
numbers suggest.

By the reckoning of the McKinsey Global Institute (mgi), a think-tank attached to a

consultancy, services already create about a third of the value going into traded
manufacturing goods. Trade in services grew more than 60% faster than trade in goods over
the past decade, and two to three times faster in such fields as telecoms and information
technology. As firms look to boost the value of services and innovation, things that are often
best done close to consumers, mgi’s Susan Lund thinks they are less likely to chase the
cheapest labour globally.

Plan, source, make, deliver

“The supply chain has been viewed as a necessary evil for a long time, trapping companies
into incremental thinking,” argues Pete Guarraia of Bain, a consultancy. Mnc bosses typically
left it to mid-level managers to squeeze out 1-2% a year in cost savings through sourcing. Such
customer-centric dynamos as China’s Alibaba and America’s Amazon regularly push for 30%
improvements in efficiency. By “weaponising logistics”, argues Bain, they have shown how
supply chains can serve as a basis for competitive advantage. Inspired and terrified in equal
measure, bosses of leading mncs are now re-examining how exactly their firms “plan, source,
make and deliver”—the mantra of supply-chain managers across the world.
As they do so, they will discover that “slowbalisation” brings challenges of its own. Mark
Millar, author of “Global Supply Chain Ecosystems”, argues that just because supply chains
shrink does not mean that they simplify. Quite the opposite. The point of getting closer to the
consumer is to help companies expand customisation, accelerate innovation and speed up
delivery.

Not everyone agrees that globalisation is slowing. Frank Appel, chief executive of Deutsche
Post dhl Group, a German express-shipping and logistics giant, insists that longer-term
fundamental forces, such as the rise of middle classes globally and productivity gains from
digitisation, still favour global integration. A study published in February by his firm found that
international flows of trade, information, capital and workers increased in 2017. However,
that was before the full impact of Mr Trump’s tariffs and immigration crackdowns hit the
global economy.

A more recent analysis by The Economist of a dozen factors related to globalisation found that
eight pointed to a decline in connectedness (see chart). Pankaj Ghemawat of nyu Stern School
of Business, one of the authors of the dhl report, sees a “semi-globalised” world in which
international threats and opportunities matter but most business activities take place
domestically. For most firms, this will mean supply chains will need to become not just
shorter, but also faster and smarter.
VI
Economists grapple with the future of the labour
market
The battle between techno-optimists and productivity pessimists continues
The Economist, January 11 2018

https://www.economist.com/finance-and-economics/2018/01/11/economists-grapple-with-the-
future-of-the-labour-market

WHY is productivity growth low if information technology is advancing rapidly? Prominent in

the 1980s and early 1990s, this question has in recent years again become one of the hottest
in economics. Its salience has grown as techies have become convinced that machine learning
and artificial intelligence will soon put hordes of workers out of work (among tech-moguls,
Bill Gates has called for a robot tax to deter automation, and Elon Musk for a universal basic
income). A lot of economists think that a surge in productivity that would leave millions on
the scrapheap is unlikely soon, if at all. Yet this year’s meeting of the American Economic
Association, which wound up in Philadelphia on January 7th, showed they are taking the tech
believers seriously. A session on weak productivity growth was busy; the many covering the
implications of automation were packed out.

Recent history seems to support productivity pessimism. From 1995 to 2004 output per hour
worked grew at an annual average pace of 2.5%; from 2004 to 2016 the pace was just 1%.
Elsewhere in the G7 group of rich countries, the pace has been slower still. An obvious
explanation is that the financial crisis of 2007-08 led firms to defer productivity-boosting
investment. Not so, say John Fernald, of the Federal Reserve Bank of San Francisco, and co-
authors, who estimate that in America, the slowdown began in 2006. Its cause was
decelerating “total factor productivity”—the residual that determines GDP after labour and
capital have been accounted for. Productivity has stagnated despite swelling research
spending (see chart). This supports the popular idea that fewer transformative technologies
are left to be discovered.
Others take almost the diametrically opposed view. A presentation by Erik Brynjolfsson of MIT
pointed to recent sharp gains in machines’ ability to recognise patterns. They can, for
instance, outperform humans at recognising most images—crucial to the technology behind
driverless cars—and match dermatologists’ accuracy in diagnosing skin cancer. Mr
Brynjolfsson and his co-authors forecast that such advances will eventually lead to a
widespread reorganisation of jobs, affecting high- and low-skilled workers alike.

Productivity pessimism remains the norm among official forecasters, but more academics are
trying to understand how automation may affect the economy. In a series of papers, Daron
Acemoglu of MIT and Pascual Restrepo of Boston University present new theoretical models
of innovation. They propose that technological progress be divided into two categories: the
sort that replaces labour with machines; and that which creates new, more complex tasks for
humans. The first, automation, pushes down wages and employment. The second, the
creation of new tasks, can restore workers’ fortunes. Historically, the authors argue, the two
types of innovation seem to have been in balance, encouraged by market forces. If
automation leads to a labour glut, wages fall, reducing the returns to further automation, so
firms find new, more productive ways to put people to work instead. As a result, previous
predictions of technology-induced joblessness have proved mostly wrong.

However, the two forces can, in theory, fall out of sync. For example, if capital is cheap relative
to wages, the incentive to automate could prevail permanently, leading the economy to
robotise completely. The authors speculate that, for now, biases towards capital in the tax
code, or simply an “almost singular focus” on artificial intelligence, might be tilting firms
towards automation, and away from thinking up new tasks for people. Another risk is that
much of the workforce lacks the right skills to complete the new-economy tasks that
innovators might dream up.

These ideas shed light on the productivity paradox. Mr Brynjolfsson and his co-authors argue
that it can take years for the transformative effects of general-purpose technologies such as
artificial intelligence to be fully felt. If firms are consumed by efforts to automate, and such
investments take time to pay off, it makes sense that productivity growth would stall.
Investment has not been unusually low relative to GDP in recent years, but it has shifted away
from structures and equipment, towards research-and-development spending.

If research in automation does start yielding big pay-offs, the question is what will happen to
the displaced workers. Recent trends suggest the economy can create unskilled jobs in sectors
such as health care or food services where automation is relatively difficult. And if robots and
algorithms become far cheaper than workers, their owners should become rich enough to
consume much more of everything, creating more jobs for people.

The risk is that without sufficient investment in training, technology will relegate many more
workers to the ranks of the low-skilled. To employ them all, pay or working conditions might
have to deteriorate. If productivity optimists are right, the eventual problem may not be the
quantity of available work, but its quality.
VII
A study finds nearly half of jobs are vulnerable to
automation
That could free people to pursue more interesting careers

The Economist, Apr 24th 2018

https://www.economist.com/graphic-detail/2018/04/24/a-study-finds-nearly-half-of-jobs-are-
vulnerable-to-automation
A WAVE of automation anxiety has hit the West. Just try typing “Will machines…” into Google.
An algorithm offers to complete the sentence with differing degrees of disquiet: “...take my
job?”; “...take all jobs?”; “...replace humans?”; “...take over the world?”

Job-grabbing robots are no longer science fiction. In 2013 Carl Benedikt Frey and Michael
Osborne of Oxford University used—what else?—a machine-learning algorithm to assess how
easily 702 different kinds of job in America could be automated. They concluded that fully
47% could be done by machines “over the next decade or two”.

A new working paper by the OECD, a club of mostly rich countries, employs a similar
approach, looking at other developed economies. Its technique differs from Mr Frey and Mr
Osborne’s study by assessing the automatability of each task within a given job, based on a
survey of skills in 2015. Overall, the study finds that 14% of jobs across 32 countries are highly
vulnerable, defined as having at least a 70% chance of automation. A further 32% were slightly
less imperilled, with a probability between 50% and 70%. At current employment rates, that
puts 210m jobs at risk across the 32 countries in the study.

The pain will not be shared evenly. The study finds large variation across countries: jobs in
Slovakia are twice as vulnerable as those in Norway. In general, workers in rich countries
appear less at risk than those in middle-income ones. But wide gaps exist even between
countries of similar wealth.

Differences in organisational structure and industry mix both play a role, but the former
matters more. In South Korea, for example, 30% of jobs are in manufacturing, compared with
22% in Canada. Nonetheless, on average, Korean jobs are harder to automate than Canadian
ones are. This may be because Korean employers have found better ways to combine, in the
same job, and without reducing productivity, both routine tasks and social and creative ones,
which computers or robots cannot do. A gloomier explanation would be “survivor bias”: the
jobs that remain in Korea appear harder to automate only because Korean firms have already
handed most of the easily automatable jobs to machines.
VIII
Demography, growth and inequality: Age invaders
A generation of old people is about to change the global economy. They will
not all do so in the same way
The Economist Apr 26th 2014
https://www.economist.com/briefing/2014/04/26/age-invaders

IN THE 20th century the planet’s population doubled twice. It will not double even once in
the current century, because birth rates in much of the world have declined steeply. But the
number of people over 65 is set to double within just 25 years. This shift in the structure of
the population is not as momentous as the expansion that came before. But it is more than
enough to reshape the world economy.

According to the UN’s population projections, the standard source for demographic
estimates, there are around 600m people aged 65 or older alive today. That is in itself
remarkable; the author Fred Pearce claims it is possible that half of all the humans who have
ever been over 65 are alive today. But as a share of the total population, at 8%, it is not that
different to what it was a few decades ago.

By 2035, however, more than 1.1 billion people—13% of the population—will be above the
age of 65. This is a natural corollary of the dropping birth rates that are slowing overall
population growth; they mean there are proportionally fewer young people around. The “old-
age dependency ratio”—the ratio of old people to those of working age—will grow even
faster. In 2010 the world had 16 people aged 65 and over for every 100 adults between the
ages of 25 and 64, almost the same ratio it had in 1980. By 2035 the UN expects that number
to have risen to 26.
In rich countries it will be much higher (see chart 1). Japan will have 69 old people for every
100 of working age by 2035 (up from 43 in 2010), Germany 66 (from 38). Even America, which
has a relatively high fertility rate, will see its old-age dependency rate rise by more than 70%,
to 44. Developing countries, where today’s ratio is much lower, will not see absolute levels
rise that high; but the proportional growth will be higher. Over the same time period the old-
age dependency rate in China will more than double from 15 to 36. Latin America will see a
shift from 14 to 27.

Three ways forward

The big exceptions to this general greying are south Asia and Africa, where fertility is still high.
Since these places are home to almost 3 billion people, rising to 5 billion by mid-century, their
youth could be a powerful counter to the greying elsewhere. But they will slow the change,
not reverse it. The emerging world as a whole will see its collective old-age dependency rate
almost double, to 22 per 100, by 2035.

The received wisdom is that a larger proportion of old people means slower growth and,
because the old need to draw down their wealth to live, less saving; that leads to higher
interest rates and falling asset prices. Some economists are more sanguine, arguing that
people will adapt and work longer, rendering moot measures of dependency which assume
no one works after the age of 65. A third group harks back to the work of Alvin Hansen, known
as the “American Keynes”, who argued in 1938 that a shrinking population in America would
bring with it diminished incentives for companies to invest—a smaller workforce needs less
investment—and hence persistent stagnation.

The unexpected baby boom of 1946-64 messed up Hansen’s predictions, and unforeseen
events could undermine today’s demographic projections, too—though bearing in mind that
the baby boom required a world war to set the stage, that should not be seen as a source of
hope. But if older people work longer and thus save longer, while slowing population growth
means firms have less incentive to invest, something close to what Hansen envisaged could
come about even without the sort of overall population decline he foresaw. A few months
ago Larry Summers, a Harvard professor and former treasury secretary, argued that America’s
economy appeared already to be suffering this sort of “secular stagnation”—a phrase taken
directly from Hansen.

Who is right? The answer depends on examining the three main channels through which
demography influences the economy: changes in the size of the workforce; changes in the
rate of productivity growth; and changes in the pattern of savings. The result of such
examination is not conclusive. But, for the next few years at least, Hansen’s worries seem
most relevant, not least because of a previously unexpected effect: the tendency of those
with higher skills to work for longer, and more productively, than they have done to date.

The first obvious implication of a population that is getting a lot older without growing much
is that, unless the retirement age changes, there will be fewer workers. That means less
output, unless productivity rises to compensate. Under the UN’s standard assumption that a
working life ends at 65, and with no increases in productivity, ageing populations could cut
growth rates in parts of the rich world by between one-third and one-half over the coming
years.

Have skills, will work

Amlan Roy, an economist at Credit Suisse, has calculated that the shrinking working-age
population dragged down Japan’s GDP growth by an average of just over 0.6 percentage
points a year between 2000 and 2013, and that over the next four years that will increase to
1 percentage point a year. Germany’s shrinking workforce could reduce GDP growth by
almost half a point. In America, under the same assumptions, the retirement of the baby-
boomers would be expected to reduce the economy’s potential growth rate by 0.7
percentage points.

The real size of the workforce, though, depends on more than the age structure of the
population; it depends on who else works (women who currently do not, perhaps, or
immigrants) and how long people work. In the late 20th century that last factor changed little.
An analysis of 43 mostly rich countries by David Bloom, David Canning and Günther Fink, all
of Harvard University, found that between 1965 and 2005 the average legal retirement age
rose by less than six months. During that time male life expectancy rose by nine years.

Since the turn of the century that trend has reversed. Almost 20% of Americans aged over 65
are now in the labour force, compared with 13% in 2000. Nearly half of all Germans in their
early 60s are employed today, compared with a quarter a decade ago.

This is in part due to policy. Debt-laden governments in Europe have cut back their pension
promises and raised the retirement age. Half a dozen European countries, including Italy,
Spain and the Netherlands, have linked the statutory retirement age to life expectancy.
Personal financial circumstances have played a part, too. In most countries the shift was
strongest in the wake of the 2008 financial crisis, which hit the savings of many near-retirees.
The move away from corporate pension plans that provided a fraction of the recipient’s final
salary in perpetuity will also have kept some people working longer.

But an even more important factor is education. Better-educated older people are far more
likely to work for longer. Gary Burtless of the Brookings Institution has calculated that, in
America, only 32% of male high-school graduates with no further formal education are in the
workforce between the ages of 62 and 74. For men with a professional degree the figure is
65% (though the overall number of such men is obviously smaller). For women the ratios are
one-quarter versus one-half, with the share of highly educated women working into their 60s
soaring (see chart 2). In Europe, where workers of all sorts are soldiering on into their 60s
more than they used to, the effect is not quite as marked, but still striking. Only a quarter of
the least-educated Europeans aged 60-64 still work; half of those with a degree do.

It is not a hard pattern to explain. Less-skilled workers often have manual jobs that get harder
as you get older. The relative pay of the less-skilled has fallen, making retirement on a public
pension more attractive; for the unemployed, who are also likely to be less skilled, retirement
is a terrific option. Research by Clemens Hetschko, Andreas Knabe and Ronnie Schöb shows
that people who go straight from unemployment to retirement experience a startling increase
in their sense of well-being.

Higher-skilled workers, on the other hand, tend to be paid more, which gives them an
incentive to keep working. They are also on average healthier and longer-lived, so they can
work and earn past 65 and still expect to enjoy the fruits of that extra labour later on.

This does not mean the workforce will grow. Overall work rates among the over-60s will still
be lower than they were for the same cohort when it was younger. And even as more
educated old folk are working, fewer less-skilled young people are. In Europe, jobless rates
are highest among the least-educated young. In America, where the labour participation rate
(at 63%) is close to a three-decade low, employment has dropped most sharply for less-skilled
men. With no surge in employment among women, and little appetite for mass immigration,
in most of the rich world the workforce looks likely to shrink even if skilled oldies stay
employed.

Legacy of the void

A smaller workforce need not dampen growth, though, if productivity surges. This is not
something most would expect to come about as a result of an ageing population. Plenty of
studies and bitter experience show that most physical and many cognitive capacities decline
with age. A new analysis by a trio of Canadian academics based on the video game “StarCraft
II”, for instance, suggests that raw brainpower peaks at 24. And ageing societies may ossify.
Alfred Sauvy, the French thinker who coined the term “third world”, was prone to worry that
the first world would become “a society of old people, living in old houses, ruminating about
old ideas”. Japan’s productivity growth slowed sharply in the 1990s when its working-age
population began to shrink; Germany’s productivity performance has become lacklustre as its
population ages.

But Japan’s slowed productivity growth can also be ascribed to its burst asset bubble, and
Germany’s to reforms meant to reduce unemployment; both countries, ageing as they are,
score better in the World Economic Forum’s ranking for innovation than America. A dearth of
workers might prompt the invention of labour-saving capital-intensive technology, just as
Japanese firms are pioneering the use of robots to look after old people. And a wealth of job
experience can counter slower cognitive speed. In an age of ever-smarter machines, the
attributes that enhance productivity may have less to do with pure cognitive oomph than
motivation, people skills and managerial experience.

Perhaps most important, better education leads to higher productivity at any age. For all
these reasons, a growing group of highly educated older folk could increase productivity,
offsetting much of the effect of a smaller workforce.

Evidence on both sides of the Atlantic bears this out. A clutch of recent studies suggests that
older workers are disproportionately more productive—as you would expect if they are
disproportionately better educated. Laura Romeu Gordo of the German Centre of
Gerontology and Vegard Skirbekk, of the International Institute for Applied Systems Analysis
in Austria, have shown that in Germany older workers who stayed in the labour force have
tended to move into jobs which demanded more cognitive skill. Perhaps because of such
effects, the earnings of those over 50 have risen relative to younger workers.

Saving graces

This could be good news for countries with well-educated people currently entering old age—
but less so in places that are less developed. Nearly half of China’s workers aged between 50
and 64 have not completed primary school. As these unskilled people age, their productivity
is likely to fall. Working with his IIASA colleagues Elke Loichinger and Daniela Weber, Mr
Skirbekk tried to gauge this effect by creating a “cognition-adjusted dependency ratio”. They
compared the cognitive ability of people aged 50 and over across rich and emerging
economies by means of an experiment which tested their ability to recall words, and used the
results to weight dependency ratios. This cognition-adjusted ratio is lower in northern Europe
than it is in China, even though the age-based ratio is far higher in Europe, because the elderly
in Europe score much more strongly on the cognitive-skill test. Similarly adjusted, America’s
dependency ratio is better than India’s.

If skill and education determine how long and how well older people work, they also have big
implications for saving, the third channel through which ageing affects growth. A larger group
of well-educated older people will earn a larger share of overall income. In America the share
of male earnings going to those aged 60-74 has risen from 7.3% to 12.7% since 2000 as well-
educated baby-boomers have moved into their 60s. Some of these earnings will finance
retirement, when those concerned finally decide to take it; more savings by people in their
60s will be matched by more spending when they reach their 80s. But many of the educated
elderly are likely to accumulate far more than they will draw down towards the end of life.
Circumstantial evidence supports this argument. Thomas Piketty, a French economist,
calculates that the average wealth of French 80-year-olds is 134% that of 50- to 59-year-olds,
the highest gap since the 1930s. For the next few years at least, skill-skewed ageing is likely
to mean both more inequality and more private saving.

At the same time governments across the rich world (and particularly in Europe) are trimming
their pension promises and cutting their budget deficits, both of which add to national saving.
Reforms designed to trim future pensions mean that, regardless of their skill level, those close
to retirement are likely to save more and that governments will spend less per old person.
The European Commission’s latest forecasts suggest overall pension spending in the EU will
fall by 0.1% of GDP between 2010 and 2020, before rising by 0.6% in the subsequent decade.
That is not insignificant, but it is far less than some of the breathless commentary about the
“burden” of ageing implies.

Taken together, the net effect of high saving by educated older workers and less-generous
pensions is likely to be an unexpected degree of thrift in the rich world, at least for the next
few years. If the money saved finds productive investment opportunities it has the potential
to boost long-run growth. But where will these opportunities be? In principle, two possibilities
stand out. One is rapid innovation in advanced economies. The second is fast growth in
emerging economies—especially younger, poorer ones.

Unfortunately, more capital currently flows out of emerging economies into the rich world
than the other way. The most successful emerging economies have built up huge stashes of
foreign currency; many are leery of depending too much on foreign borrowing. Even if that
were to change, the youthful economies of south Asia and Africa are too small to absorb huge
flows of capital from those countries that are ageing fast.

And in the rich world, despite lots of obvious innovation, particularly in computer technology,
both productivity growth and investment have been tepid of late. That may be a hangover
from the financial crisis. But it could also be a structural change. The price of capital goods,
notably anything to do with computers, has fallen sharply; it may be that today’s innovation
is simply less investment-intensive than it was in the manufacturing age. And the ageing
population itself may deter investment. Fewer workers, other things being equal, means the
economy needs a smaller capital stock, even if some of those workers are clever old sticks.
And an ageing population spends differently. Old people buy fewer things that require heavy
investment—notably houses—and more services, whether in health care or tourism.

Not destiny, but not nothing

Demographic trends will shape the future, but they do not render particular outcomes
inevitable. The evolution of the economy will depend on the way policymakers respond to
the new situation. But those policy reactions will themselves be shaped by the priorities of
older people to a greater extent than has previously been the case; they will be a bigger share
of the population and in democracies they tend to vote more than younger people do.

On both sides of the Atlantic, recent budget decisions appear to reflect the priorities of the
ageing and affluent. Annuities reform in Britain increased people’s freedom to spend their
pension pots; the disappearance of property-tax reform spared homeowning older Italians a
new burden; America’s budget slashed spending on the young and poor while failing to make
government health and pension spending any less generous to the well-off. Few rich-country
governments have shown any appetite for large-scale investment, despite low interest rates.

A set of forces pushing investment down and pushing saving up, with no countervailing policy
response, makes the impact of ageing over the next few years look like the world that Hansen
described: one of slower growth (albeit not as slow as it would have been if older folk were
not working more), a surfeit of saving and very low interest rates. It will be a world in which
ageing reinforces the changes in income distribution that new technology has brought with
it: the skilled old earn more, the less-skilled of all ages are squeezed. The less-educated and
jobless young will be particularly poorly served, never building up the skills to enable them to
become productive older workers.

Compared with the dire warnings about the bankrupting consequences of a “grey tsunami”,
this is good news. But not as good as all that.
IX
Slower growth in ageing economies is not inevitable
But avoiding it means tough policy choices

The Economist, March 28

https://www.economist.com/finance-and-economics/2019/03/28/slower-growth-in-ageing-
economies-is-not-inevitable

For the first time in history, the Earth has more people over the age of 65 than under the age
of five. In another two decades the ratio will be two-to-one, according to a recent analysis by
Torsten Sløk of Deutsche Bank. The trend has economists worried about everything from
soaring pension costs to “secular stagnation”—the chronically weak growth that comes from
having too few investment opportunities to absorb available savings. The world’s greying is
inevitable. But its negative effects on growth are not. If older societies grow more slowly, that
may be because they prefer familiarity to dynamism.

Ageing slows growth in several ways. One is that there are fewer new workers to boost
output. Workforces in some 40 countries are already shrinking because of demographic
change. As the number of elderly people increases, governments may neglect growth-
boosting public investment in education and infrastructure in favour of spending on pensions
and health care. People in work, required to support ever more pensioners, must pay higher
taxes. But the biggest hit to growth comes from weakening productivity. A study published in
2016, for example, examined economic performance across American states. It found that a
rise of 10% in the share of a state’s population that is over 60 cuts the growth rate of output
per person by roughly half a percentage point, with two-thirds of that decline due to weaker
growth in productivity.

Why are older economies less productive? The answer is not, as one might suppose, that
older workers are. Though some capabilities, notably physical ones, deteriorate with age, the
overall effect is not dramatic. A study of Germany’s manufacturing sector published in 2016
failed to detect a drop-off in productivity in workers up to the age of 60. Companies can tweak
employees’ roles as they get older in order to make best use of the advantages of age, such
as extensive experience and professional connections.

Furthermore, if weak productivity growth was caused by older workers producing less, pay
patterns should reflect that. Wages would tend to rise at the beginning of a career and fall
towards its end. But that is not what usually happens. Rather, according to a recent paper by
economists at Moody’s Analytics, a consultancy, wages are lower for everyone in companies
with lots of older workers. It is not older workers’ falling productivity that seems to hold back
the economy, but their influence on those around them. That influence is potent: the authors
reckon that as much as a percentage point of America’s recent decline in annual productivity
growth could be associated with ageing.

How this influence makes itself felt is unclear. But the authors suggest that companies with
more older workers might be less eager to embrace new technologies. That might be because
they are reluctant to make investments that would require employees to be retrained, given
the shorter period over which they could hope to make a return on that training for those
near the end of their careers. Or older bosses might be to blame. Research indicates that
younger managers are more likely to adopt new technologies than are older ones. This may
seem obvious: older people’s greater aversion to new technology is a cliché. And at least
anecdotally, greying industries do seem more averse to change.

If the evidence suggested that ageing economies struggled primarily because of slow-growing
labour forces and fast-growing pension costs, it would make sense to focus policy efforts on
keeping people in work longer—by raising retirement ages, for example. But if, as seems to
be the case, reluctance to embrace new technologies is a bigger issue, other goals should take
priority—in particular, boosting competition. In America, increasing industrial concentration
and persistently high profits are spurring renewed interest in antitrust rules. The benefits of
breaking up powerful firms and increasing competition might be even bigger than thought, if
conservative old firms are thereby spurred to make better use of newer technologies.

There are other measures that could help. Removing barriers to job-switching, for example
by making benefits more portable, could shorten average tenures and help stop companies’
cultures becoming ossified. Best of all would be more immigration. An influx of young foreign
workers would address nearly all the ways in which population ageing depresses growth. It
would not only expand the labour force and create new taxpayers, but would mean more and
younger companies, and greater openness to new technologies. And there would be plenty
of willing takers in poorer countries with younger populations.

No men for old country

Societies with lots of older workers are also societies with lots of older voters, however. Those
voters are, on average, more politically conservative than younger people, and less likely to
support increased immigration. People of all ages would gain from policies that boosted
growth and productivity. But given the choice between a dynamic but unfamiliar society and
a static but familiar one, older countries tend to opt for the second. In hindsight, the
demographic boom that coincided with industrialisation in rich countries may have had an
underappreciated benefit: it created a big constituency in favour of embracing new
technologies and the opportunities they provided.
Technology may at some point overcome the stifling effect of ageing. In a new paper Daron
Acemoglu of the Massachusetts Institute of Technology and Pascual Restrepo of Boston
University find that when young workers are sufficiently scarce, manufacturers invest in more
automation, and experience faster productivity growth as a result. Robots have yet to make
a big impact in the service sector and beyond, but as their capabilities improve and jobs for
younger people go begging that may change. The world could use more flexibility and
productivity now. But stagnation may end eventually, once the robots are promoted to
management.
X
The Age of Secular Stagnation: What It Is and What to
Do About It
Lawrence H. Summers, February 15, 2016

published in Foreign Affairs

Lawrence H. Summers is the Charles W. Eliot University Professor and President Emeritus at
Harvard University. He served as the 71st Secretary of the Treasury for President Clinton and
the Director of the National Economic Council for President Obama.

As surprising as the recent financial crisis [1] and recession were, the behavior of the world’s
industrialized economies and financial markets during the recovery [2] has been even more
so.

Most observers expected the unusually deep recession to be followed by an unusually rapid
recovery, with output and employment returning to trend levels relatively quickly.

Yet even with the U.S. Federal Reserve [3]’s aggressive monetary policies, the recovery (both
in the United States and around the globe) has fallen significantly short of predictions and has
been far weaker than its predecessors [4]. Had the American economy performed as the
Congressional Budget Office fore cast in August 2009—after the stimulus had been passed
and the recovery had started—U.S. GDP today would be about $1.3 trillion higher than it is.

Almost no one in 2009 imagined that U.S. interest rates would stay near zero for six years,
that key interest rates in Europe would turn negative, and that central banks in the

G-7 would collectively expand their balance sheets by more than $5 trillion. Had economists
been told such monetary policies lay ahead, moreover, they would have confidently predicted
that inflation would become a serious problem—and would have been shocked to find out
that across the United States, Europe, and Japan, it has generally remained well below two
percent.

In the wake of the crisis, governments’ debt-to-GDP ratios have risen sharply, from 41 percent
in 2008 to 74 percent today in the United States, from 47 percent to 70 percent in Europe,
and from 95 percent to 126 percent in Japan. Yet long-term interest rates are still remarkably
low, with ten-year government bond rates at around two percent in the United States, around
0.5 percent in Germany, and around 0.2 percent in Japan as of the beginning of 2016. Such
low long-term rates suggest that markets currently expect both low inflation and low real
interest rates to continue for many years. With appropriate caveats about the complexities
of drawing inferences from indexed bond markets, it is fair to say that inflation for the entire
industrial world is expected to be close to one percent for another decade and that real
interest rates are expected to be around zero over that time frame. In other words, nearly
seven years into the U.S. recovery, markets are not expecting “normal” conditions to return
anytime soon.

The key to understanding this situation lies in the concept of secular stagnation [5], first put
forward by the economist Alvin Hansen in the 1930s. The economies of the industrial world,
in this view, suffer from an imbalance resulting from an increasing propensity to save and a
decreasing propensity to invest. The result is that excessive saving acts as a drag on demand,
reducing growth and inflation, and the imbalance between savings and investment pulls down
real interest rates. When significant growth is achieved, meanwhile—as in the United States
between 2003 and 2007—it comes from dangerous levels of borrowing that translate excess
savings into unsustainable levels of investment (which in this case emerged as a housing
bubble).

Other explanations for what is happening have been proposed, notably Kenneth Rogoff’s
theory of a debt overhang, Robert Gordon [6]’s theory of supply-side headwinds, Ben
Bernanke’s theory of a savings glut [7], and Paul Krugman’s theory of a liquidity trap. All of
these have some validity, but the secular stagnation theory offers the most comprehensive
account of the situation and the best basis for policy prescriptions. The good news is that
although developments in China [8] and elsewhere raise the risks that global economic
conditions will deteriorate, an expansionary fiscal policy by the U.S. government can help
overcome the secular stagnation problem and get growth back on track.
STUCK IN NEUTRAL

Just as the price of wheat adjusts to balance the supply of and demand for wheat, it is natural
to suppose that interest rates—the price of money—adjust to balance the supply of savings
and the demand for investment in an economy. Excess savings tend to drive interest rates
down, and excess investment demand tends to drive them up. Following the Swedish
economist Knut Wicksell, it is common to refer to the real interest rate that balances saving
and investment at full employment as the “natural,” or “neutral,” real interest rate. Secular
stagnation occurs when neutral real interest rates are sufficiently low that they cannot be
achieved through conventional central-bank policies. At that point, desired levels of saving
exceed desired levels of investment, leading to shortfalls in demand and stunted growth.

This picture fits with much of what we have seen in recent years. Real interest rates are very
low, demand has been sluggish, and inflation is low, just as one would expect in the presence
of excess saving. Absent many good new investment opportunities, savings have tended to
flow into existing assets, causing asset price inflation.

For secular stagnation to be a plausible hypothesis, there have to be good reasons to suppose
that neutral real interest rates have been declining and are now abnormally low.

And in fact, a number of recent studies have tried to look at this question and have generally
found declines of several percentage points. Even more convincing is the increasing body of
evidence suggesting that over the last generation, various factors have increased the
propensity of populations in developed countries to save and reduced their propensity to
invest. Greater saving has been driven by increases in inequality and in the share of income
going to the wealthy, increases in uncertainty about the length of retirement and the
availability of benefits, reductions in the ability to borrow (especially against housing), and a
greater accumulation of assets by foreign central banks and sovereign wealth funds. Reduced
investment has been driven by slower growth in the labor force, the availability of cheaper
capital goods, and tighter credit (with lending more highly regulated than before).

Perhaps most important, the new economy [9] tends to conserve capital. Apple and

Google, for example, are the two largest U.S. companies and are eager to push the frontiers
of technology [10] forward, yet both are awash in cash and are under pressure to distribute
more of it to their shareholders. Think about Airbnb’s impact on hotel construction, Uber’s
impact on automobile demand, Amazon’s impact on the construction of malls, or the more
general impact of information technology on the demand for copiers, printers, and office
space. And in a period of rapid technological change, it can make sense to defer investment
lest new technology soon make the old obsolete.

Various studies have explored the impact of these factors and attempted to estimate the
extent to which they have reduced neutral real interest rates. The most recent and thorough
of these, by Lukasz Rachel and Thomas Smith at the Bank of England, concluded that for the
industrial world, neutral real interest rates have declined by about

4.5 percentage points over the last 30 years and are likely to stay low in the future.

Together with the current price of long-term bonds, this suggests that the kind of Japan style
stagnation that has plagued the industrial world in recent years may be with us for quite some
time.

DIFFERENTIAL DIAGNOSIS

Not all economists are sold on the secular stagnation hypothesis. Building on the monumental
history of financial crises he wrote with Carmen Reinhart, for example, Rogoff ascribes current
difficulties to excessive debt buildups and subsequent deleveraging. But although these surely
contributed to the financial crisis, they seem insufficient to account for the prolonged slow
recovery. Moreover, the debt buildups theory provides no natural explanation for the
generation-long trend toward lower neutral real interest rates. It seems more logical to see
the debt buildups decried by Rogoff as not simply exogenous events but rather the
consequence of a growing excess of saving over investment and the easy monetary policies
necessary to maintain full employment.

Gordon, meanwhile, has argued for what might be called supply-side secular stagnation

— a fundamental decline in the rate of productivity growth relative to its golden age, from
1870 to 1970. Gordon is likely right that over the next several years, the growth in the
potential output of the American economy and in the real wages of American workers will be
quite slow. But if the primary culprit were declining supply (as opposed to declining demand),
one would expect to see inflation accelerate rather than decelerate.

For a decade, Bernanke has emphasized the idea of a savings glut emanating from cash
thrown off by emerging markets. This was indeed an important factor in adding to excess
saving in the developed world a decade ago, and it may well be again if emerging markets
continue to experience growing capital flight. But both the timing and the scale of capital
export from emerging markets make it unlikely that it is the principal reason for the major
recent declines in neutral real interest rates.

Krugman and some others have sought to explain recent events and make policy
recommendations based on the old Keynesian concept of a liquidity trap [11]. As

Krugman has emphasized, this line of thinking is parallel to the secular stagnation one.

But most treatments of the liquidity trap treat it as a temporary phenomenon rather than a
potentially permanent state of affairs, which is what the evidence seems to be showing.

Perhaps the most comforting alternative view is that secular stagnation may have indeed
occurred in the past but is no longer operating in the present. With the unemployment rate
down to five percent and the Fed embarked on a tightening cycle, the argument runs,
indicators will start returning to earlier, higher growth trends. Perhaps. But markets are
betting that the Fed will not be able to tighten monetary policy nearly as much as it expects,
and if another recession starts in the next few years, cuts will soon bring interest rates back
down to the zero lower bound.

LET’S GET FISCAL

Up to the 1970s, most economists believed that if governments managed demand properly,
their countries’ economies could enjoy low unemployment and high output with relatively
modest inflation. The proper task of macroeconomists, it followed, was to use monetary and
fiscal policy to manage demand well. But this thinking was eventually challenged from two
directions—in theory, by Milton Friedman [12], Robert Lucas, and others, and in practice, by
the experience of high inflation together with high unemployment.

The emergence of such “stagflation” in the late 1970s [13] led to general acceptance of the
natural-rate hypothesis, the idea that abnormally low unemployment causes inflation to
accelerate. According to this view, since policymakers would not accept permanently rising
rates of inflation, economies would tend to fluctuate around a natural rate of unemployment,
determined by factors such as labor flexibility, the availability of benefits, and the
effectiveness of hiring and job searches. By skillfully managing demand, policymakers could
aspire to reduce the amplitude of the fluctuations—and although they could determine the
average rate of inflation, they could not raise the average level of output.

By the mid 1980s, once inflation had been brought down from double-digit levels, a consensus
on macroeconomic policy emerged. The central objective of policy, most mainstream
economists believed, should be to achieve a low and relatively stable rate of inflation, since
there were no permanent gains to be had from higher inflation. This could best be
accomplished, it was thought, by firmly establishing the political independence of central
banks and by setting inflation targets in order to control expectations. Fiscal policy,
meanwhile, was not considered to have a primary role in managing demand, because it was
slow acting and might push interest rates up and because monetary policy could do what was
needed.

Seen through the lens of the secular stagnation hypothesis, however, all these propositions
are problematic. If it were possible to avoid secular stagnation, then it would indeed be
possible to increase average levels of output substantially, raising the stakes for demand
management policy. The danger in monetary policy, moreover, lies not in politicians eager to
inflate away problems but in bankers refusing to generate enough demand to bring inflation
up to target levels and permit reductions in real interest rates. And fiscal policy, finally, takes
on new significance as a tool in economic stabilization.

As of yet, none of these principles has been fully accepted by policymakers in the advanced
industrial world. It is true that central banks have sought, through quantitative easing, to
loosen monetary conditions even with short-term interest rates at rock bottom. But they have
treated these policies as a short-term expedient, not a longer term necessity. More
important, these policies are running into diminishing returns and giving rise to increasingly
toxic side effects. Sustained low rates tend to promote excess leverage, risk taking, and asset
bubbles.

This does not mean that quantitative easing was mistaken. Without such policies, output
would likely be even lower, and the world economy might well have tipped into deflation.

But monetary-policy makers need to acknowledge much more explicitly that neutral real rates
have fallen substantially and that the task now is to adjust policy accordingly. This could
include setting targets for nominal GDP growth rather than inflation, investing in a wider
range of risk assets, making plans to allow base rates to turn negative, and underscoring the
importance of avoiding a new recession.

When the primary policy challenge for central banks was establishing credibility that the
printing press was under control, it was appropriate for them to jealously guard their
independence. When the challenge is to accelerate, rather than brake, economies, more
cooperation with domestic fiscal authorities and foreign counterparts is necessary.

The core problem of secular stagnation is that the neutral real interest rate is too low.
This rate, however, cannot be increased through monetary policy. Indeed, to the extent that
easy money works by accelerating investments and pulling forward demand, it will actually
reduce neutral real rates later on. That is why primary responsibility for addressing secular
stagnation should rest with fiscal policy. An expansionary fiscal policy can reduce national
savings, raise neutral real interest rates, and stimulate growth.

Fiscal policy has other virtues as well, particularly when pursued through public investment.
A time of low real interest rates, low materials prices, and high construction unemployment
is the ideal moment for a large public investment program. It is tragic, therefore, that in the
United States today, federal infrastructure investment, net of depreciation, is running close
to zero, and net government investment is lower than at any time in nearly six decades.

It is true that an expansionary fiscal policy would increase deficits, and many worry that
running larger deficits would place larger burdens on later generations, who will already face
the challenges of an aging society. But those future generations will be better off owing lots
of money in long-term bonds at low rates in a currency they can print than they would be
inheriting a vast deferred maintenance liability.

Traditional concern with fiscal deficits has focused on their impact in pushing up interest rates
and retarding investment. Yet by setting yields so low and bond prices so high, markets are
sending a clear signal that they want more, not less, government debt. By stimulating growth
and enabling an inflation increase that would permit a reduction in real capital costs, fiscal
expansion now would crowd investment in rather than out. Well intentioned proposals to
curtail prospective pension benefits, in contrast, might make matters even worse by
encouraging increased saving and reduced consumption, thus exacerbating secular
stagnation.

The main constraint on the industrial world’s economy today is on the demand, rather than
the supply, side. This means that measures that increase potential supply by promoting
flexibility are therefore less important than measures that offer the potential to increase
demand, such as regulatory reform and business tax reform. Other structural policies that
would promote demand include steps to accelerate investments in renewable technologies
that could replace fossil fuels and measures to raise the share of total income going to those
with a high propensity to consume, such as support for unions and increased minimum wages.
Thus, John Maynard Keynes, writing in a similar situation during the late 1930s, rightly
emphasized the need for policy approaches that both promoted business confidence—the
cheapest form of stimulus—and increased labor compensation.
TO HANGZHOU AND BEYOND

If each of the countries facing secular stagnation today were to confront it successfully on its
own, the results would be very favorable for the global economy. But international focus and
coordination have crucial additional roles to play.

Secular stagnation, after all, increases the contagion from economic weakness. In normal
times, if the rest of the world economy suffers, the United States or any other affected
economy can offset the loss of demand and competitiveness through monetary easing.

With monetary policy already at its lower limit, however, additional easing is impossible (or
at least much more difficult), and so each country’s stake in the strength of the global
economy is greatly magnified.

Secular stagnation also increases the danger of competitive monetary easing and even of
currency wars. Looser money, starting with near-zero capital costs, is likely to generate
demand primarily through increases in competitiveness. This is a zero-sum game, since
currency movements switch demand from one country to another rather than increase it
globally. Fiscal expansions, in contrast, raise demand on a global basis. International
coordination is thus necessary to avoid an excessive and self-defeating reliance on monetary
policy and achieve a mutually rewarding reliance on fiscal policy to address problems.

Movements in commodity prices in recent months have shown that events in emerging
markets, especially China, can have significant impacts globally. It now appears likely that
more capital will flow out of emerging markets and less will flow in than has been the case in
recent years. These capital outflows and the consequent increases in net exports will further
reduce demand and neutral real rates in the developed world, thereby exacerbating secular
stagnation. Policies that help restore confidence in emerging markets, therefore, will also
strengthen the global economy.

These issues were recognized at the successful G-20 summit in London in April 2009 (although
the problems were misdiagnosed as cyclical and temporary rather than secular and enduring).
The common commitments undertaken there to engage in fiscal expansion, strengthen
financial regulation, resist trade protection, and enhance the capacity of international
financial institutions to respond to problems in emerging markets were effective in halting
the collapse of the global economy. Unfortunately, subsequent G-20 summits returned to
their traditional lethargy and misguided preoccupation with fiscal austerity, monetary
normalization, and moral hazard, ending up missing opportunities to accelerate the recovery.
This year, the Chinese will host a G-20 summit in September. If China chooses to recognize
how important global growth is for its economy, and how important its economy is for global
growth, it could perform a great service by reinvigorating international economic
cooperation. The key priority in Hangzhou—as it was in London back in 2009—should be
increasing global demand and making sure that it picks up particularly in those countries
where there is the most economic slack.

In this regard, China’s decisions about its own economic affairs will be crucial. To date, the
international community has joined Chinese financial officials in urging China’s political
leadership to pursue financial liberalization. This is surely correct for the long run. But it may
well be in China’s and the global interest that the liberalization process proceed more
gradually than is currently envisioned, so that capital outflows from China do not threaten
China’s own financial stability and spread weakness to the global economy at large.

As the euro has declined sharply, meanwhile, any recovery that Europe has achieved has
come largely from increases in competitiveness that reduce growth elsewhere. Germany now
leads the world with a trade surplus equal to a whopping eight percent of GDP. The global
community should encourage Europe to generate domestic demand as it seeks to expand its
economy.

One more priority in Hangzhou should be promoting global infrastructure investment. In this
regard, the Chinese-led Asian Infrastructure Investment Bank [14] is a valuable step forward,
and it should be strongly supported by the global community, even as it is encouraged to
respect international norms and standards relating to issues such as environmental
protection and integrity in procurement. And efforts to support infrastructure investment
elsewhere, such as the Obama administration’s Power Africa initiative, should be carried
forward.

Secular stagnation and the slow growth and financial instability associated with it have
political as well as economic consequences. If middle-class living standards were increasing
at traditional rates, politics across the developed world would likely be far less surly and
dysfunctional. So mitigating secular stagnation is of profound importance.

Writing in 1930, in circumstances far more dire than those we face today, Keynes still
managed to summon some optimism. Using a British term for a type of alternator in a car
engine, he noted that the economy had what he called “magneto trouble.” A car with a
broken alternator won’t move at all—yet it takes only a simple repair to get it going. In much
the same way, secular stagnation does not reveal a profound or inherent flaw in capitalism.
Raising demand is actually not that difficult, and it is much easier than raising the capacity to
produce. The crucial thing is for policymakers to diagnose the problem correctly and make
the appropriate repairs.

Source URL: https://www.foreignaffairs.com/articles/united-states/2016-02-15/agesecular-

stagnation

Links
[1] https://www.foreignaffairs.com/reviews/2015-02-16/can-economists-learn
[2] https://www.foreignaffairs.com/reviews/review-essay/second-great-depression
[3] https://www.foreignaffairs.com/articles/united-states/2012-04-23/all-presidentscentral-
bankers
[4] https://www.foreignaffairs.com/articles/united-states/2011-06-29/america-s-
weakrecovery
[5] http://www.economist.com/blogs/graphicdetail/2014/11/secular-stagnation-graphics
[6] https://www.foreignaffairs.com/reviews/review-essay/2016-01-28/innovation-over
[7] http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/01-why-interest-
rateslow-
global-savings-glut
[8] https://www.foreignaffairs.com/articles/china/2016-01-11/end-chinas-rise
[9] https://www.foreignaffairs.com/articles/2015-12-12/fourth-industrial-revolution
[10] https://www.foreignaffairs.com/reviews/review-essay/thinkers-and-tinkerers
[11] http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-in-a-liquidity-trap/?
_r=0
[12] https://www.foreignaffairs.com/reviews/capsule-review/2007-05-01/miltonfriedman-
biography
[13] https://www.foreignaffairs.com/articles/united-states/1979-09-01/stagflation-howwe-
got-it-how-get-out
[14] https://www.foreignaffairs.com/articles/china/2015-05-07/whos-afraid-aiib
XI
The Myth Of Secular Stagnation
by Joseph Stiglitz; Social Europe on 6th September 2018
https://www.socialeurope.eu/the-myth-of-secular-stagnation
In the aftermath of the 2008 financial crisis, some economists argued that the United States,
and perhaps the global economy, was suffering from “secular stagnation,” an idea first
conceived in the aftermath of the Great Depression. Economies had always recovered from
downturns. But the Great Depression had lasted an unprecedented length of time. Many
believed that the economy recovered only because of government spending on World War II,
and many feared that with the end of the war, the economy would return to its
doldrums.Something, it was believed, had happened, such that even with low or zero interest
rates, the economy would languish. For reasons now well understood, these dire predictions
fortunately turned out to be wrong.Those responsible for managing the 2008 recovery (the
same individuals bearing culpability for the under-regulation of the economy in its pre-crisis
days, to whom President Barack Obama inexplicably turned to fix what they had helped
break) found the idea of secular stagnation attractive, because it explained their failures to
achieve a quick, robust recovery. So, as the economy languished, the idea was revived: Don’t
blame us, its promoters implied, we’re doing what we can.

The events of the past year have put the lie to this idea, which never seemed very plausible.
The sudden increase in the US deficit, from around 3% to almost 6% of GDP, owing to a poorly
designed regressive tax bill and a bipartisan expenditure increase, has boosted growth to
around 4% and brought unemployment down to a 18-year low. These measures may be ill
conceived, but they show that with enough fiscal support, full employment can be attained,
even as interest rates rise well above zero.

The Obama administration made a crucial mistake in 2009 in not pursuing a larger, longer,
better-structured, and more flexible fiscal stimulus. Had it done so, the economy’s rebound
would have been stronger, and there would have been no talk of secular stagnation. As it was,
only those in the top 1% saw their incomes grow during the first three years of the so-called
recovery.

Some of us warned at the time that the downturn was likely to be deep and long, and that
what was needed was stronger and different from what Obama proposed. I suspect that the
main obstacle was the belief that the economy had just experienced a little “bump,” from
which it would quickly recover. Put the banks in the hospital, give them loving care (in other
words, hold none of the bankers accountable or even scold them, but rather boost their
morale by inviting them to consult on the way forward), and, most important, shower them
with money, and soon all would be well.
XII
READ

Inequality v growth: Up to a point, redistributing

income to fight inequality can lift growth
The Economist, Mar 1st 2014

https://www.economist.com/finance-and-economics/2014/03/03/inequality-v-growth

ON THE campaign trail in 2008 Barack Obama stumbled into a memorable encounter with Joe
“the Plumber” Wurzelbacher. Explaining the logic of a proposal to raise taxes on the rich, Mr
Obama mused that “when you spread the wealth around, it’s good for everybody”. The
soundbite, soon an attack-ad mainstay, failed to derail the Obama campaign. But the
disagreement between Joe the Plumber and Barack the Senator still trips up governments
around the world: is there a trade-off between economic growth and redistribution?

Some inequality is needed to propel growth, economists reckon. Without the carrot of large
financial rewards, risky entrepreneurship and innovation would grind to a halt. In 1975 Arthur
Okun, an American economist, argued that societies cannot have both perfect equality and
perfect efficiency and must choose how much of one to sacrifice for the other.

While most economists continue to hold that view, the recent rise in inequality has prompted
a new look at its economic costs. Inequality could impair growth if those with low incomes
suffer poor health and low productivity as a result. It could threaten public confidence in
growth-boosting policies like free trade, reckons Dani Rodrik, of the Institute for Advanced
Study, in Princeton. Or it could sow the seeds of crisis. In a 2010 book Raghuram Rajan, now
governor of the Reserve Bank of India, argued that governments often respond to inequality
by easing the flow of credit to poorer households. When the borrowing binge ends everyone
suffers.

Pinning down the precise relationship between growth and inequality is a challenge. Some
studies reckon inequality is mildly bad for growth. Others suggest the relationship changes as
poor countries grow rich, while still others reckon it is the trend in inequality rather than its
level that matters.

Research by economists at the International Monetary Fund aims to add clarity to the debate.
In a 2011 paper Andrew Berg and Jonathan Ostry argued that it is the duration of spells of
growth that is most important for long-run economic performance: getting an economy
growing in the first place is much easier than keeping the growth spell rolling. They reckon
that when growth falters, inequality is often a culprit. Latin America’s Gini index is about 50,
well above that in emerging Asia, which has a Gini of about 40. (A Gini index is a measure of
income concentration that ranges from 0, representing perfect equality to 100, where all
income flows to a single person.) Were Latin America to close half of that gap in inequality,
its typical growth spurt might last twice as long, on average.

Others reckon that it may not be inequality itself that harms growth but rather governments
that tax and spend to try to reduce it. In a new paper Messrs Berg and Ostry and Charalambos
Tsangarides tease out the separate effects of inequality and redistribution. They turn to a data
set put together by Frederick Solt, a political scientist at the University of Iowa, containing
Gini indices for 173 economies spanning a period of five decades. Mr Solt provides Ginis for
both market income and net income (after taxes and transfers). The difference between the
two gives the authors a measure of redistribution (see chart). In America, which does
relatively little of it, redistribution trims the Gini index by roughly ten points. In Sweden, in
contrast, it cuts the Gini by 23 points—more than half. Using these figures, the economists
can separate out the different effects of redistribution and inequality on growth.

Redistributing prejudice

The authors find that governments in more unequal countries redistribute more, and rich
economies do more than poor ones. As a result, differences in inequality across rich countries
are mostly down to the generosity of redistribution; Germany is more unequal than Britain
before redistribution but much less so after.
Up to a point, spreading the wealth around carries no growth penalty: growth in income per
person is not meaningfully lower in countries with more redistribution. But economies that
redistribute a lot may enjoy shorter growth spells, the authors reckon. When the gap between
the market and net Ginis is 13 points or more (as in much of western Europe) further
redistribution shrinks the typical expansion. The authors caution against drawing hasty
conclusions. Details surely matter; nationalising firms and doling out profits would
presumably be worse for growth than taxing property to fund education.

Inequality is more closely correlated with low growth. A high Gini for net income, after
redistribution, corresponds to slower growth in income per person. A rise of 5 Gini points
(moving from the level in America to that in Gabon, for instance) knocks half a percentage
point off average annual growth. And holding redistribution constant, a one-point rise in the
Gini raises the risk an expansion ends in a given year by six percentage points. Redistribution
that reduces inequality might therefore boost growth.

If redistribution is benign, that could be because it substitutes for shaky borrowing. In their
2011 paper Messrs Berg and Ostry note that more unequal societies do poorly on social
indicators such as educational attainment, even after controlling for income levels. This
suggests that households with lower incomes struggle to finance investments in education.
In a recent paper Barry Cynamon of the Federal Reserve Bank of St Louis and Steven Fazzari
of Washington University in St Louis reckon most Americans borrowed heavily before 2008 to
prop up their consumption. That kept the economy growing—until crisis struck. Sensible
redistribution could mean the difference between a healthy growth rate and one that is
decidedly subprime.

Sources
"Inequality and unsustainable growth: Two sides of the same coin?", Andrew Berg and
Jonathan Ostry, IMF Staff Discussion Note, April 2011.
"Redistribution, inequality, and growth", Andrew Berg, Jonathan Ostry, and Charalambos
Tsangarides, IMF Staff Discussion Note, February 2014.
"Inequality, the Great Recession, and slow recovery", Barry Cynamon and Steven Fazzari,
January 2014.
XIII
Wise fiscal policy is not about helicopter money
Op-ed by Mr Claudio Borio, Head of the Monetary and Economic Department of the BIS, published
in Il Sole 24 Ore, 8 November 2019

https://www.bis.org/speeches/sp191108a.htm

Before the Great Financial Crisis it would have been inconceivable. But there is a growing recognition
that monetary policy in some key advanced economies is nearing its limits. It has taken the brunt of
nursing the recovery. And now, like an exhausted runner, it needs to take a breather and regain
energy. A more balanced policy mix is needed.

The limits are not technical. If they wanted, central banks could push interest rates further into
negative territory. They could engage in bigger and broader asset purchases. They could provide more
generous funding to banks.

The limits are of an economic and political economy nature. The longer central banks extend
extraordinary measures and the further they take them, the smaller the benefits and the larger the
costs. These costs reflect, for example, the impact on financial intermediation, risk-taking, debt
accumulation and the allocation of capital across sectors and firms.

A wise use of fiscal policy can help make up for the shrinking monetary policy room for manoeuvre.
"Wise" means that its deployment should not endanger long-run sustainability. Even with interest
rates as such low levels, not all countries can prudently expand, especially once society's looming aging
costs are taken into account. "Wise" means reversible, to avoid a further upward creep in debt-to-
GDP ratios, now at peacetime peaks globally. Automatic stabilisers are important. And "wise" means,
above all, growth-friendly: designed to improve countries' longer-term productivity and resilience,
such as by reducing taxes on employment, removing subsidies to debt, or executing efficiently well-
chosen infrastructure projects.

"Wise" also means avoiding the deceptive lure of variants of so-called "helicopter money" or, in less
colourful language, debt monetisation. Given the considerable confusion surrounding this topic, it is
worth dwelling on it for a moment.

Helicopter money conjures up a powerful image -- money falling from the sky directly into people's
pockets. Choreography aside, though, it amounts to two rather mundane steps. The first is simply
crediting individual accounts, just like the government does when paying out unemployment benefits
or tax rebates. The second, less well understood, step is allowing the additional money to swell banks'
deposits with the central bank (technically, boost "excess reserves") -- that is where the money ends
up.

We have a pretty good idea of what their respective impact is; neither step is new. Transfers are the
largest component of government spending. And the main central banks have operated with excess
reserves for quite some time now. There is a consensus that simply adding to the reserves has little
effect of its own on economic activity. It pushes on a string. The action is on the asset side of the
central bank's balance sheet, ie with the large-scale purchases of government securities that drive
down bond yields, even into negative territory. But, as already noted, this is precisely what people
look at when concluding that monetary policy is reaching its limits. It would simply be more of the
same.

What is different with helicopter money is the explicit link with government deficits and its
governance. Neither aspect speaks in favour of the scheme, regardless of the variant. It is simply
politically unrealistic to expect that the central bank could be in charge of deciding how much to
transfer, when to transfer and, above all, when to stop - as some proposals suggest. Not least, raising
rates when exiting would require absorbing back the excess reserves or paying interest on them. Both
would lower central bank remittances to the government, resulting in an outsize cost on public
finances. Thinking of the consolidated government-cum-central bank balance sheet, large-scale
central bank purchases of long-term government debt financed with bank reserves amount to a big
debt management operation: replacing long-term debt with short-term (overnight) debt. This would
make little sense economically: the government would be better off locking in the unusually low bond
yields by extending maturities rather than relying on monetary financing. And it would also risk putting
political pressure on the central bank to avoid raising rates regardless of the economic circumstances
- a form of fiscal dominance.

All the talk about monetary financing diverts attention from the main task. The only way of boosting
sustainable growth is to work hard on structural reforms that make economies more competitive,
more vibrant and better able to embrace innovation. Central banks do not have a magic wand.
XIV
Debtor alive
Economists reconsider how much governments can
borrow
The profession is becoming less debt-averse
The Economist, Jan 17th 2019

https://www.economist.com/finance-and-economics/2019/01/17/economists-reconsider-
how-much-governments-can-borrow

In the last three months of 2018 America’s federal government borrowed $317bn, or about
6% of quarterly gdp. The deficit was 1.5 percentage points higher than in the same quarter
the year earlier, despite the fact that the unemployment rate fell below 4% in the intervening
period. In cash terms America borrowed in a single quarter as much as it did in all of 2006,
towards the peak of the previous economic cycle.

Such figures might once have sent the country’s deficit scolds into conniptions. But scolds are
in short supply, at least within the halls of Congress. Republicans were the architects of
President Donald Trump’s budget-busting tax plan. Some Democrats are less content than
ever to tie their hands with the fiscal rules that Republicans routinely flout. Early this year
progressive Democrats urged Nancy Pelosi, the speaker of the House of Representatives, to
abandon “paygo” rules, which require that new spending be paid for with matching tax
increases or offsetting spending cuts.

Even more surprising is the reaction among economists. Heterodox schools of thought have
long questioned the view that government spending must be paid for by taxes. “Modern
monetary theory”, which synthesises such views, is proving increasingly popular among left-
wing politicians. The charismatic new congresswoman from New York, Alexandria Ocasio-
Cortez, is a fan.

Orthodox economists have traditionally been more cautious. “Government spending must be
paid for now or later,” wrote Robert Barro, of Harvard University, in a seminal paper published
in 1989. “A cut in today’s taxes must be matched by a corresponding increase in the present
value of future taxes.”

Interest-rate wobbles once sent shock waves across Washington. In 1993 James Carville, a
Democratic political adviser, mused that if reincarnation existed he wanted to come back as
the bond market. “You can intimidate everybody,” he quipped. More recently Carmen
Reinhart of Harvard University, Vincent Reinhart of Standish Mellon Asset Management and
Kenneth Rogoff, a former chief economist of the imfnow at Harvard, have published research
that argues that periods in which government debt rises above 90% of gdp are associated
with sustained slowdowns in economic growth.

But government borrowing looks less scary than it used to, and some mainstream economists
are reconsidering the profession’s aversion to debt. They once feared “crowding out”—that
government bonds would lure capital that would otherwise finance more productive private-
sector projects. But real interest rates around the world have been falling for most of the past
40 years, suggesting that there are too few potential investments competing for available
savings, rather than too many. Indeed, government borrowing could “crowd in” new private
investment. Public spending on infrastructure might raise the returns to private investment,
generating more of it.

That still leaves bills to be paid. Yet here, too, things are less clear cut than one might suppose.
The experience of Japan, where gross debt as a share of gdp exceeds 230%, suggests that
even very high levels of debt may not scare away creditors, at least in advanced economies
that borrow in their own currencies. And in a recent lecture Olivier Blanchard, another former
chief economist of the imf, pointed out that when the pace of economic growth exceeds the
rate of interest on a country’s debt, managing indebtedness becomes substantially easier. In
such cases debt incurred in the past shrinks steadily as a share of gdp without any new taxes
needing to be levied. Debt might nonetheless rise if annual deficits are sufficiently large, as
they are in America now. Even so, at prevailing interest and growth rates and with deficits
continuing to run at 5% of gdp, it would take more than a century for America’s ratio of gross
debt to gdp to reach the current Japanese level.

Of course, interest rates could rise. But most commonly growth rates tend to exceed the rate
of interest. Since 1870, Mr Blanchard noted in his lecture, the average nominal interest rate
on one-year us government debt has been 4.6%, while the average annual growth rate of
nominal gdp has been 5.3%. Growth rates have surpassed interest rates in every decade since
1950, except the 1980s. Nicholas Crafts of the University of Warwick wrote that the difference
between growth and interest rates did more to reduce British debt loads in the 20th century
than budget surpluses. Indeed, austerity-induced deflation in the 1920s frustrated attempts
to pay down war debts.

In a pinch, governments have tools to manage unwieldy debt burdens. Ms Reinhart and Belen
Sbrancia, of the imf, noted that financial repression was a critical debt-reduction tool in the
decades after the second world war. During this period inflation pushed real interest rates (ie,
adjusted for inflation) into negative territory. This effectively imposed a tax on savers that,
owing to restrictions on the movement of capital, could not easily be avoided. Repression is
not costless; it limits the extent to which capital flows towards its most productive uses. But
it is unlikely to be devastating for a mature modern economy.

Bonds away

Governments cannot borrow without limit. Whether or not creditors mind, a government can
throw only so much cash at its citizens before their spending exhausts the economy’s
productive capacity and pushes up prices at an accelerating pace.

Yet for much of the past decade politicians have stimulated economies too little. Rich
countries have spent far more time below their productive capacity than above it—at grave
economic cost. An overdeveloped fear of public debt, nurtured by economists, is partly to
blame. But experience suggests that governments face looser budget constraints than once
thought, and enjoy more freedom to support struggling economies than previously believed.
Economists, happily, are taking note.
XV
The global list
Globalisation has faltered
It is now being reshaped
The Economist, Jan 24th 2019,,
https://www.economist.com/briefing/2019/01/24/globalisation-has-faltered

Large and sustained increases in the cross-border flow of goods, money, ideas and people
have been the most important factor in world affairs for the past three decades. They have
reshaped relations between states both large and small, and have increasingly come to affect
internal politics, too. From iPhones to France’s gilets jaunes, globalisation and its discontents
have remade the world.

Recently, though, the character and tempo of globalisation have changed. The pace of
economic integration around the world has slowed by many—though not all—measures.
“Slowbalisation”, a term used since 2015 by Adjiedj Bakas, a Dutch trend-watcher, describes
the reaction against globalisation. How severe will it become? How much will a trade war
launched by America’s president, Donald Trump, exacerbate it? What will global commerce
look like in the aftermath?

There have been periods of more and less globalisation throughout history. Today’s era
sprang from America’s sponsorship of a new world order in 1945, which allowed cross-border
flows of goods and capital to recover after years of war and chaos. After 1990 this bout of
globalisation went into warp speed as China rebounded, India and Russia abandoned autarky
and the European single market came into its own. Containerising freight sent shipping costs
plummeting. America signed nafta, helped create the World Trade Organisation and
supported global tariff cuts. Financial liberalisation freed capital to roam the world in search
of risk and reward.
Harder blew the trade winds

World trade rocketed as a result, from 39% of gdp in 1990 to 58% last year. International
assets and liabilities rose too, from 128% to 401% of gdp, as did the stock of migrants, from
2.9% to 3.3% of the world’s population. On the first two of those measures the world is far
more integrated than in 1914, the peak of the previous age of globalisation. Nonetheless,
parts of the world remain poorly integrated into the global economy. About 1bn people live
in countries where trade is less than a quarter of gdp. World trade can be split into tens of
thousands of separate potential corridors between pairs of countries: America and China, say,
or Gabon and Denmark. In a quarter of those corridors there was no recorded commerce at
all.

When did the slowdown begin? Consider a dozen measures of global integration (see chart
1). Eight are in retreat or stagnating, of which seven lost steam around 2008. Trade has fallen
from 61% of world gdp in 2008 to 58% now. If these figures exclude emerging markets (of
which China is one), it has been flat at about 60%. The capacity of supply chains that ship half-
finished goods across borders has shrunk. Intermediate imports rose fast in the 20 years to
2008, but since then have dropped from 19% of world gdp to 17%. The march of multinational
firms has halted. Their share of global profits of all listed firms has dropped from 33% in 2008
to 31%. Long-term cross-border investment by all firms, known as foreign direct investment
(fdi), has tumbled from 3.5% of world gdp in 2007 to 1.3% in 2018.
As cross-border trade and companies have stagnated relative to the economy, so too has the
intensity of financial links. Cross-border bank loans have collapsed from 60% of gdp in 2006
to about 36%. Excluding rickety European banks, they have been flat at 17%. Gross capital
flows have fallen from a peak of 7% in early 2007 to 1.5%. When globalisation boomed,
emerging economies found it easy to catch up with the rich world in terms of output per
person. Since 2008 the share of economies converging in this way has fallen from 88% to 50%
(using purchasing-power parity).

A minority of yardsticks show rising integration. Migration to the rich world has risen slightly
over the past decade. International parcels and flights are growing fast. The volume of data
crossing borders has risen by 64 times, according to McKinsey, a consulting firm, not least
thanks to billions of fans of Luis Fonsi, a Puerto Rican crooner with YouTube’s biggest-ever
hit.

Braking point

There are several underlying causes of this slowbalisation. After sharp declines in the 1970s
and 1980s trading has stopped getting cheaper. Tariffs and transport costs as a share of the
value of goods traded ceased to fall about a decade ago. The financial crisis in 2008-09 was a
huge shock for banks. After it, many became stingier about financing trade. And straddling
the world has been less profitable than bosses hoped. The rate of return on all multinational
investment dropped from an average of 10% in 2005-07 to a puny 6% in 2017. Firms found
that local competitors were more capable than expected and that large investments and
takeovers often flopped.

Deep forces are at work. Services are becoming a larger share of global economic activity and
they are harder to trade than goods. A Chinese lawyer is not qualified to execute wills in Berlin
and Texan dentists cannot drill in Manila. Emerging economies are getting better at making
their own inputs, allowing them to be self-reliant. Factories in China, for example, can now
make most parts for an iPhone, with the exception of advanced semiconductors. Made in
China used to mean assembling foreign widgets in China; now it really does mean making
things there.

What might the natural trajectory of globalisation have looked like had there been no trade
war? The trends in trade and supply chains appear to suggest a phase of saturation, as the
pull of cheap labour and multinational investment in physical assets have become less
important. If left to their own devices, however, financial flows such as bank loans might have
picked up as the shock of the financial crisis receded and Asian financial institutions gained
more reach abroad.

Instead, the Trump administration has charged in. Its signature policy has been a barrage of
tariffs, which cover a huge range of goods, from tyres to edible offal. The revenue America
raised from tariffs, as a share of the value of all imports, was 1.3% in 2015. By October 2018,
the latest month for which data are available, it was 2.7%. If America and China do not strike
a deal and Mr Trump acts on his threats, that will rise to 3.4% in April. The last time it was
that high was in 1978, although it is still far below the level of over 50% seen in the 1930s.

Tariffs are only one part of a broad push to tilt commerce in America’s favour. A tax bill passed
by Congress in December 2017 was designed to encourage firms to repatriate cash held
abroad. They have brought back about $650bn so far. In August 2018 Congress also passed a
law vetting foreign investment, aimed at protecting American technology companies.

America’s control of the dollar-based payments system, the backbone of global commerce,
has been weaponised. zte, a Chinese technology firm, was temporarily banned from doing
business with American firms. The practical consequence was to make it hard for it to use the
global financial system, with devastating results. Another firm, Huawei, is being investigated
as a result of information from an American monitor placed inside a global bank, who raised
a flag about the firm busting sanctions. The punishment could be a ban on doing business in
America, which in effect means a ban on using dollars globally.

The administration’s attacks on the Federal Reserve have undermined confidence that it will
act as a lender of last resort for foreign banks and central banks that need dollars, as it did
during the financial crisis. The boss of an Asian central bank says in private that it is time to
prepare for the post-American era. America has abandoned climate treaties and undermined
bodies such as the wto and the global postal authority.

On the counterattack

Other countries have reciprocated in kind if not in degree. As well as raising tariffs of its own,
China used its antitrust apparatus in July to block the acquisition of nxp, a Dutch chip firm, by
Qualcomm, an American one. Both do business in China. It is also pursuing an antitrust
investigation against a trio of foreign tech firms—Samsung, Micron and sk Hynix—which its
domestic manufacturers complain charge too much. Since November the French state has
taken an overt role in the row between Renault and Nissan, having sat in the back seat for
years.

Most multinational firms spent 2018 insisting to investors that this trade war did not matter.
This is odd, given how much effort they spent over the previous 20 years lobbying for
globalisation. The Economist has reviewed the investor calls in the second half of 2018 of
about 80 of the largest American firms which have given guidance about the impact of tariffs.
The hit to total profits was about $6bn, or 3%. Most firms said they could pass on the costs to
customers. Many claimed their supply chains were less extended than you might think, with
each region a self-contained silo.
This blasé attitude has begun to crumble in the past eight weeks, as executives factor in not
just the mechanical impact of tariffs but the broader consequences of the trade war on
investment and confidence, not least in China. On December 18th Federal Express, one of the
world’s biggest logistics firms, said that business was slowing. Estimates for the firm’s profits
have dropped by a sixth since then. On January 2nd Apple said that trade tensions were
hurting its business in China, and five days later Samsung gave a similar message.

Temporary manoeuvring by firms to get round tariffs may have created a sugar high that is
now ending. Some firms have been “front-running” tariffs by stockpiling inventories within
America. Reflecting this, the price to ship a container from Shanghai to Los Angeles soared in
the second half of 2018, compared with the price to ship one to Rotterdam. But this effect is
unwinding and prices to Los Angeles are falling again as global export volumes slow.

America has had bouts of protectionism before, as the historian Douglas Irwin notes, only to
return to an open posture. Nonetheless investors and firms worry that this time may be
different. Uncle Sam is less powerful than during the previous bout of protectionism, which
was aimed at Japan. Its share of global gdp is roughly a quarter, compared with a third in
1985. Fear of trade and anger about China is bipartisan and will outlive Mr Trump. And
damage has been done to American-led institutions, including the dollar system. Firms worry
that the full-tilt globalisation seen between 1990 and 2010 is no longer underwritten by
America and no longer commands popular consent in the West.

Few quick fixes

Faced with this, some things are easy to fix. The boss of one big multinational is planning to
end its practice of swapping board seats with a Chinese firm, in order to avoid political flak in
America. Supply chains take longer to adjust. Multinationals are sniffing out how to shift
production from China. Kerry Logistics, a Hong Kong firm, has said that trade tensions are
boosting activity in South-East Asia. Citigroup, a bank, has seen a pickup in deal flows between
Asian countries such as South Korea and India.

An exodus cannot happen overnight, however. Vietnam is rolling out the red carpet but its
two big ports, Ho Chi Minh City and Haiphong, each have only a sixth of the capacity of
Shanghai. Apple, which has a big supply chain in China, is committed to paying its vendors
$42bn in 2019 and the contracts cannot be cancelled. It relies on a long tail of 30-odd barely
profitable suppliers and assemblers of components, which it squeezes. If these firms were
asked to shift their factories from China they might struggle to do so quickly—the cost could
be anywhere between $25bn and $90bn.
Over time, however, firms will apply a higher cost of capital to long-term investments in
industries that are politically sensitive, such as tech, and in countries that have fraught trade
relations. The legal certainty created by nafta in 1994 and China’s entry into the wto in 2001
boosted multinational investment flows. The removal of certainty will have the opposite
effect.

Already, activity in the most politically sensitive channels is tumbling. Investment by Chinese
multinationals into America and Europe sank by 73% in 2018. Overall global fdi fell by 20% in
2018, according to unctad, a multilateral body. Some of that reflects an accounting quirk as
American firms adjust to recent tax reforms. Still, in the last few weeks of 2018, one element
of fdi, cross-border takeovers, slipped compared with the past few years. If you assume that
the rate of tax repatriation fades and that deal flows are subdued, fdi this year might be a
fifth lower than in 2017.

These trends can be used as a crude indicator of the long-run effect of a continuing trade war.
Assume that fdi does not pick up, and also that the recent historical relationship between the
stock of fdi and trade can be extrapolated. On this basis, exports would fall from 28% of
world gdp to 23% over a decade. That would be equivalent to a third of the proportionate
drop seen between 1929 and 1946, the previous crisis in globalisation.

Perhaps firms can adapt to slowbalisation, shifting away from physical goods to intangible
ones. Trade in the 20th century morphed three times, from boats laden with metals, meat
and wool, to ships full of cars and transistor radios, to containers of components that feed
into supply chains. Now the big opportunity is services. The flow of ideas can pack an
economic punch; over 40% of the productivity growth in emerging economies in 2004-14
came from knowledge flows, reckons the imf.

Overall, it has been a dismal decade for exports of services, which have stagnated at about 6-
7% of world gdp. But Richard Baldwin, an economist, predicts a cross-border “globotics
revolution”, with remote workers abroad becoming more embedded in companies’
operations. Indian outsourcing firms are shifting from running functions, such as Western
payroll systems, to more creative projects, such as configuring new Walmart supermarkets.
In November tcs, India’s biggest firm, bought w12, a digital-design studio in London. Cross-
border e-commerce is growing, too. Alibaba expects its Chinese customers to spend at least
$40bn abroad in 2023. Netflix and Facebook together have over a billion cross-border
customers.
Services rendered

It is a seductive story. But the scale of this electronic mesh can be overstated. Typical
American Facebook users have 70% of their friends living within 200 miles and only 4%
abroad. The cross-border revenue pool is relatively small. In total the top 1,000 American
digital, software and e-commerce firms, including Amazon, Microsoft, Facebook and Google,
had international sales equivalent to 1% of all global exports in 2017. Facebook may have a
billion foreign users but in 2017 it had similar sales abroad to Mondelez, a medium-sized
American biscuit-maker.

Technology services are especially vulnerable to politics and protectionism, reflecting

concerns about fake news, tax-dodging, job losses, privacy and espionage. Here, the dominant
market shares of the companies involved are a disadvantage, making them easier to target
and control. America discourages Chinese tech firms from operating at scale within its borders
and American companies like Facebook and Twitter are not welcome in China.

This sort of behaviour is spreading. Consider India, which Silicon Valley had hoped was an
open market where it could build the same monopolistic positions it has in the West. On
December 26th India passed rules that clobber Amazon and Walmart, which dominate e-
commerce there, preventing them from owning inventory. The objective is to protect local
digital and traditional retailers. Draft rules revealed in July would require internet firms to
store data exclusively in India. A third set of rules went live in October, requiring financial
firms to store data locally, too.

Furthermore, trade in services might bring the kind of job losses that led manufacturing trade
to become unpopular. Imagine, for example, if India’s it services firms, experts at marshalling
skilled workers, doubled in size. Assuming each Indian worker replaced a foreign one, then
1.5m jobs would be lost in the West. And even the flow of raw ideas across borders could be
slowed. The White House has considered restricting Chinese scientists’ access to research
programmes. America’s new investment-vetting regime could hamper venture-capital
activity. Technology services will not evade the backlash against globalisation, and may make
it worse.
As globalisation fades, the emerging pattern of cross-border commerce is more regional. This
matches the trend of shorter supply chains and fits the direction of geopolitics. The picture is
clearest in trade. The share of foreign inputs that cross-border supply chains source from
within their own region—measured using value added—has risen since 2012 in Asia, Europe
and North America, according to the oecd, a club of mostly rich countries (see chart 2).

The pattern changes

Multinational activity is becoming more regional, too. A decade ago a third of the fdi flowing
into Asian countries came from elsewhere in Asia. Now it is half. If you put Asian firms into
two buckets—Japanese and other Asian firms—each made more money selling things to the
other parts of Asia than to America in 2018. In Europe around 60% of fdi has come from within
the region over the past decade. Outside their home region, European multinationals have
tilted towards emerging markets and away from America. American firms’ exposure to
foreign markets of any kind has stagnated for a decade as firms have made hay at home.

The legal and diplomatic framework for trade and investment flows is becoming more
regional. The one trade deal Mr Trump has struck is a new version of nafta, known as usmca.
On November 20th the eu announced a new regime for screening foreign investment. China
is backing several regional initiatives, including the Asian Infrastructure Investment Bank and
a trade deal known as rcep. Tech governance is becoming more regional, too. Europe now
has its own rules for the tech industry on data (known as gdpr), privacy, antitrust and tax.
China’s tech firms have rising influence in Asia. No emerging Asian country has banned
Huawei, despite Western firms’ security concerns. The likes of Alibaba and Tencent are
investing heavily across South-East Asia.

Both Europe and China are trying to make their financial system more powerful. European
countries plan to bring more derivatives activity from London and Chicago into the euro area
after Brexit, and are encouraging a wave of consolidation among banks. China is opening its
bond market, which over time will make it the centre of gravity for other Asian markets. As
China’s asset-management industry gets bigger it will have more clout abroad.

Yet the shift to a regional system comes with three big risks. One is political. Two of the three
zones lack political legitimacy. The eu is unpopular among some in Europe. Far worse is China,
which few countries in Asia trust entirely. Traditionally, economic hegemons are consumer-
centric economies which create demand in other places by buying lots of goods from abroad,
and which often run trade deficits as a result. Yet both China and Germany are mercantilist
powers that run trade surpluses. As a result there could be lots of tensions over sovereignty
and one-sided trade.

The second risk is to finance, which remains global for now. The portfolio flows sloshing
around the world are run by money-management firms that roam the globe. The dollar is the
world’s dominant currency, and the decisions of the Fed and gyrations of Wall Street influence
interest rates and the price of equities around the world. When America was ascendant the
patterns of commerce and the financial system were complementary. During a boom healthy
American demand lifted exports everywhere even as American interest rates pushed up the
cost of capital. But now the economic and financial cycles may work against each other. Over
time this will lead other countries to switch away from the dollar, but until then it creates a
higher risk of financial crises.

The final danger is that some countries and firms will be caught in the middle, or left behind.
Think of Taiwan, which makes semiconductors for both America and China, or Apple, which
relies on selling its devices in China. Africa and South America are not part of any of the big
trading blocks and lack a centre of gravity.

Many emerging economies now face four headwinds, worries Arvind Subramanian, an
economist and former adviser to India’s government: fading globalisation, automation, weak
education systems that make it hard to exploit digitalisation fully, and climate-change-
induced stress in farming industries. Far from making it easier to mitigate the downsides of
globalisation, a regional world would struggle to solve worldwide problems such as climate
change, cybercrime or tax avoidance.

Viewed in the very long run, over centuries, the march of globalisation is inevitable, barring
an unforeseen catastrophe. Technology advances, lowering the cost of trade in every corner
of the world, while the human impulse to learn, copy and profit from strangers is irrepressible.
Yet there can be long periods of slowbalisation, when integration stagnates or declines. The
golden age of globalisation created huge benefits but also costs and a political backlash. The
new pattern of commerce that replaces it will be no less fraught with opportunity and danger.
XVI
If China made the rules
Xi’s world order: July 2024

As America defies and dismantles the international rules-based order, a report

from the future imagines what might replace it
The Economist / The World If, Jul 7th 2018, https://www-economist-
com.ezp.lib.cam.ac.uk/the-world-if/2018/07/07/xis-world-order-july-2024

NEWS OUTLETS call him “China’s Edward Snowden”. His fans worldwide call him “Brother Fu”—a tag
now seen on T-shirts and in internet memes. Both labels are said to mortify Fu Xuedong, the shy
Canadian-educated software engineer whose allegations about Chinese cyber-spying have been the
summer surprise of 2024. Mr Fu has thrown this, the final year of Donald Trump’s second term, into
turmoil with his allegation that China’s intelligence services, working with the country’s technology
firms, have turned millions of cars in America, Europe and Asia into remote spying devices, letting
Beijing track vehicles in real time, identify passengers with facial-recognition and even eavesdrop on
them.

China denies the claims, which if confirmed would amount to the largest espionage operation in
history. Yet the fury of its response sits uneasily with its talk of Mr Fu as a “fantasist” and “a historic
liar”. A cyber-security specialist at an innovation laboratory in Shenzhen, he has now been on the run
from Chinese agents for five weeks—the past four of which he has spent holed up in the American
consulate in Istanbul, as diplomats and politicians wrangle over his fate. So far Mr Fu’s saga is one with
no winners, but many losers—including some of the world’s largest firms and governments that have
buckled at the first hint of Chinese anger.

But the most important loser may be an abstract principle: namely, the idea of an international rules-
based order in which predictable, transparent legal principles bind even the mightiest states. The
ordeal of Fu Xuedong—an owlish, soft-spoken man who seems stunned by his sudden notoriety—has
vividly revealed the extent to which China’s commitment to the rule of law is conditional. As one senior
diplomat ruefully puts it: “What China wants is really vague rules, and the right to interpret them.”

The earliest commercial casualties of Mr Fu’s whistleblowing were carmakers in America, Europe and
Japan, whose share prices plunged after he posted a YouTube video describing how he stumbled on a
secret backdoor seemingly built into millions of advanced, semi-autonomous vehicles. It allows access
to the encrypted channels that send data back to carmakers and—in the other direction—carry
messages such as traffic alerts, navigation advice and software updates to vehicles. Nearly three-
quarters of the high-tech cars on the road today use Chinese-designed 5G mobile chips for these data
transfers, after foreign carmakers bowed to Chinese pressure to adopt its technology as part of a deal
to allow greater access to the mainland’s vast car market.

The cyber-espionage scandal has also hurt the reputations of more than one foreign government.
After fleeing to Turkey from China Mr Fu, who was born in Hong Kong and who carries British-issued
travel documents that afford some of the protections of full citizenship, initially sought sanctuary at
the British consulate, having evaded alleged Chinese agents at Istanbul airport. But after some hours
in a waiting room Mr Fu was asked to leave by British diplomats, who cited his dual Canadian and
Hong Kong-Chinese nationality and urged him to seek consular help from those countries instead.

The British government denied claims by Senator Marco Rubio of Florida, a Republican with hawkish
views on China, that this decision was a “craven surrender” linked to London’s ambitions to become
a legal and financial hub for Chinese companies. Specifically, Mr Rubio charged that London, having
lost ground to New York and Frankfurt in the wake of Brexit, is “desperate” to host a new standards-
setting forum and venture-capital hub serving the Global Infrastructure Centre. The GIC is a Beijing-
based clearing house for projects linked to what used to be called the Belt and Road Initiative, China’s
ambitious project to link itself with Europe, Africa and the Middle East with new railways, ports, roads
and data cables.

In addition to physical links, president-for-life Xi Jinping has also promoted less tangible bonds,
including Chinese standards and norms of governance, through the GIC. Crucially, it decides which
schemes are eligible for billions of dollars in Chinese loans and grants, and picks foreign firms as
partners using opaque rules devised by Communist Party planners. London hopes to become the GIC’s
favoured gateway to global capital markets, to the benefit of British-based bankers, lawyers and
consultants.

Mr Fu never even made it to the Canadian consulate, whose diplomats informed him by telephone
that they needed more time to study an urgent “red notice” issued by Interpol, the global police
organisation, at the request of Chinese authorities. The notice, which is not legally binding, asked all
192 Interpol member countries to hold Mr Fu on suspicion of espionage, theft and undermining state
security. Canadian opposition politicians have accused the prime minister, Doug Ford, of sacrificing
Mr Fu in a bid to secure a controversial agreement opening Canada’s Arctic waters to Chinese oil
tankers and other shipping, as sea-ice retreats.

After obtaining refuge at the American consulate, Mr Fu initially gave a flurry of media interviews by
Skype. But internet access to the consulate was severely restricted the next day. American diplomats
say Turkey has erected a version of China’s Great Firewall around the consulate under the terms of a
previously secret bilateral security pact with China, ostensibly intended to curb Islamist militancy
among Uighurs, a Turkic-speaking minority from China’s restive far-western region of Xinjiang.
All this has left the United States as Mr Fu’s superpower protector. The White House press secretary,
Laura Ingraham, has repeatedly urged Turkey to allow the engineer to leave the country unmolested,
calling Chinese criminal charges against him “fake news”. In Congress, both the House and Senate
intelligence committees have issued subpoenas for Mr Fu to give evidence in Washington, DC, as soon
as possible. Mr Rubio has offered to collect Mr Fu from Istanbul in person. But sadly for the software
engineer, Mr Trump’s America is a distracted superpower, which has taken a wrecking-ball to the
rules-based order. So its criticism of China’s disregard for long-standing rules and norms now rings
hollow.

Mr Trump’s advisers remain as divided as they were when he first took office. The economic
nationalists want him to use his so-called Section 301 powers to punish China for obliging carmakers
to install technology that “steals American secrets and jobs through the same backdoor”, as Lou
Dobbs, Mr Trump’s national economic-security adviser, put it. An unusual coalition including the
bosses of Ford and General Motors, the European Union and the governments of Japan, Germany,
Britain and France, wants Mr Trump to take China to the World Trade Organisation. But America has
made a mockery of the WTO by picking trade fights with friends and enemies alike, and by refusing to
appoint judges to its appeals body—opening the way for China to set up a rival body of its own.

America’s disdain for the rules-based order means its criticism of China now rings hollow

An obscure Chinese arbitration panel, originally created to hear disputes linked to the Belt and Road
Initiative, was rebranded in 2022 as the Global Infrastructure Tribunal. With its first cases this
embryonic trade court has offered glimpses of how a Chinese-led commercial order might work.
Unlike the WTO, it draws no distinction between nations with state-directed and market economies.
Its judges take a benign view of subsidies that claim to support national development. And though
they talk a good game about intellectual-property protection, they have consistently taken the view
that sovereign governments, rather than individual businesses, should have final say in patent
disputes.

Attempts by the West to mount a united challenge to such Chinese swagger are hindered by another
fight that the Trump administration has picked with its own allies, after the president’s withdrawal
from the Iran nuclear deal in 2018. When US Treasury officials sought to punish companies and banks
that used dollars to buy and sell Iranian goods, notably oil, China created an alternative system for
international payments in Chinese yuan, euros and Russian roubles, aimed at the Eurasian countries
that form the backbone of the Belt and Road Initiative. The new system, powered by Chinese
technology and encryption standards, has weakened both the dollar’s dominance in international
business and the grip over cross-border banking long enjoyed by the SWIFT consortium, based in
Belgium. Russia has used the new system to create banks immune to dollar-based American sanctions,
with customers said to include the governments of Iran, Syria, Sudan and North Korea.

As Treasury officials find it harder to impose financial sanctions, American naval commanders are
struggling to tighten the noose on China. In theory, China remains at loggerheads with its Asian
neighbours over contested rocks in the South China Sea. But Chinese efforts to expand and fortify
those reefs have been matched by diplomatic victories. It has pressed neighbours to declare much of
the South China Sea off-limits to military exercises involving outside powers, using an innocent-
sounding “code of conduct” between countries that border those contested waters. Some, like
Singapore, have resisted calls to make the code binding. Others, like the Philippines and Vietnam, are
being offered a share of oil- and gasfields controlled by China, and are wavering. For its Asian
neighbours the political and economic costs of defying China, and of helping America police the high
seas, are rising.

All in all, it would be unsurprising if Mr Fu felt a bit friendless just now. He has told interviewers that
he decided to risk his career, and even his freedom, after concluding that autonomous vehicles were
being turned into a global surveillance network by Chinese spies. Few others in this saga display so
clear a sense of right and wrong. China’s vision for a new world order has emerged sooner than
expected because the West, led by Mr Trump’s America, has beaten so hasty a retreat. Rarely
mounting direct challenges, China has instead tested, probed and introduced ambiguities into every
aspect of global governance. Established powers have not so much acquiesced as proved too weary
to resist. Mr Fu mis-timed his display of principle, defending a rules-based order that is being
abandoned by its original designers, America first.
When Will China Rule the World?
Bloomberg, New Economy Daily, Malcolm Scott, July 6 2021

https://www.bloomberg.com/news/newsletters/2021-07-06/what-s-happening-in-the-world-
economy-will-china-ever-be-number-one

Today we look at when (and if) China will become the world’s largest economy, surging rental
costs in America, and how the proportion of manufacturing workers influences the length of
recessions.

China’s Ascent

Could America’s more than century-long reign as the world’s biggest economy be over within
a decade?

If President Xi Jinping Xi delivers on growth-boosting reforms and his U.S. counterpart

President Joe Biden is unable to push through his proposals for renewing infrastructure and
expanding the workforce, forecasts from Bloomberg Economics suggest China could grab the
top spot as soon as 2031.

But that’s a big if.

As chief economist Tom Orlik notes, China’s reform agenda is already languishing, tariffs and
other trade curbs are disrupting access to global markets and advanced technologies, and
Covid stimulus has lifted debt to record levels. Under what he describes as a “nightmare
scenario” for Xi, China stalls in much the same way as Japan did three decades ago.
Three factors determine an economy’s growth rate: the first is the size of the workforce, the
capital stock, and productivity, or how effectively those first two can be combined. In each of
these areas, China faces an uncertain future, Orlik writes.

• China’s working age population has already peaked

• Signs of overinvestment means it brings fewer returns
• That leaves productivity as the key, and boosting that will require sometimes painful
reforms

Which all brings us to the risk that stalling reforms and international isolation lead to
a financial crisis.

China’s credit-to-GDP ratio has rocketed from 140% in 2008 to about 290% now. In other
countries, such a rapid increase in borrowing has heralded trouble ahead.

— Malcolm Scott