My recipe for stimulating growth in sluggish economies

Europe's World

Asia, Africa & Emerging Economies

Picture of Marek Dabrowski
Marek Dabrowski

Non-Resident Scholar at Bruegel, Professor at the Higher School of Economics in Moscow, and co-founder and Fellow at CASE - Center for Social and Economic Research in Warsaw

Almost all countries are facing difficulties as a consequence of the financial and economic crises that started with subprime mortgages in the U.S. and spread globally in 2009 and to Europe from 2010 to 2014. Advanced economies have been the major victims, with growth paths that decelerated dramatically, especially in the U.S., the EU and Japan.

The attention of policymakers and analysts concentrated naturally enough on the immediate causes of the crisis and on anti-crisis remedies like diagnosing and repairing the financial industry, facilitating orderly deleveraging in sectors most affected by bursting bubbles (like housing) and helping over-indebted governments to avoid default. They have also been preoccupied with short-term growth stimulation by means of monetary and fiscal policies.

Unfortunately, this short-term policy bias has too often led to us overlooking the fundamental problem of the declining long-term growth trajectory in major advanced economies – a process which began long before this crisis. The result is that the share of world output of the U.S., the EU and Japan decreased substantially over the last 30 years, and especially that of the EU, which fell from 31% to 19%. The shares of China, India and other emerging market economies of course increased, with China’s GDP based on purchasing-power-parity (PPP) growing from 2% of the global economy to 15%.

Too much protection for those people who are in work increases labour costs, decreases labour market flexibility and discourages enterprises from investing and creating new jobs

The increasing share being taken by emerging market economies of global GDP is not only the result of more developed countries’ economic problems, but also their own market reforms since the 1980s. In the past three decades, there has been a gradual restoration of balance in a world economy that in the 19th century and most of the last century was heavily compromised by two factors: rapid economic growth in Western Europe and the U.S., and the negative consequences of colonialism. It is worth noting that at the start of the 19th century, China accounted for more than 30% of the world’s GDP and Asia as a whole for more than half.

The slowing down of growth in advanced economies has been partly determined by such objective factors as demographics. In the 1990s, the populations of Europe and Japan (including their working age cohorts) began to stagnate and then to decline. The U.S. population continues to grow, but at a much slower pace than in previous decades. Population decline and ageing of course have negative impacts on a country’s total GDP dynamics; per capita GDP statistics will look more favourable.

Other consequences of ageing include rapidly expanding imbalances in pension and healthcare systems. These in turn create serious challenges for fiscal accounts, the savings rates and key public services like education, infrastructure and long-term care for the elderly.

But these challenges being created by demographics can be partly addressed in advanced economies by more flexible migration and labour market policies. Immigration can increase the available labour force and help eliminate structural mismatches between labour demand and supply. Labour market reforms and improvements in social welfare and education can increase participation rates in the domestic labour force and so lead to an increase in supply.

Reforms of this sort are most urgently needed in Europe, where the consequences of population decline and ageing look to be the most dramatic. But Europe is also where immigration is meeting the strongest cultural and political resistance, against U.S., Canada or Australia, which are countries of migrant origin. In Europe, higher retirement ages and the elimination of privileged pension schemes in the public sector are progressing only slowly, against much opposition, and most national labour markets are still heavily over-regulated.

Too much protection for those people who are in work increases labour costs, decreases labour market flexibility and discourages enterprises from investing and creating new jobs. The same effect is produced by excessive social welfare programmes and associated higher payroll taxes. The result is that several EU economies suffer from high unemployment rates, especially among the youthful, low rates of labour force participation, large black economies and poor international competitiveness. In these circumstances, slow growth or none at all should come as no surprise.

There is a much room for improvement in the global economic order to help all countries, including the advanced economies. It’s urgent either to revive Doha or launch an alternative global trade negotiation framework

Over-generous welfare programs, low rates of labour force participation and high unemployment – coupled with negative demographic trends – are also starting to have a negative fiscal impact. Several EU economies already suffer from the burden of high public expenditure. In 2012, the ratio of government spending to GDP exceeded 50% in Austria, Belgium, Greece, Italy, Netherlands and Sweden, and 55% in Denmark, Finland and France. In the U.S. and Japan, the level is closer to 40%, although it’s on the rise.

In most advanced economies, governments’ revenues are not sufficient, in spite of high taxation, to cover rising spending commitments. The result is that all G7 countries together with the EU as a whole have accumulated large public debts. These were already high before the crisis, and expanded further as result of recession, counter-cyclical fiscal policies and financial sector rescue programmes. Between 2007 and 2013, public debt increased by 33.7 percentage points of GDP in all advanced economies: an overall 28.8 p.p for the eurozone, 46.4 p.p in the UK, 40.5 p.p in the U.S., and 60.2 p.p in Japan. Among the G7 countries, Germany is the only one to have brought its public debt under control. In the cases of Japan and Italy, there are legitimate concerns over their long-term solvency that are similar to those regarding Greece and Portugal.

Apart from sovereign default concerns, these record high levels of public debt in times of peace will obviously have negative consequences for growth. High public sector borrowing decreases the pool of savings available for private investment, and high taxation needed to repay debt aggravates the business climate. To avoid falling into a debt trap, radical fiscal adjustment is needed to focus on the expenditure side (social programmes) as well as the rationalisation of tax systems, notably in the U.S. and Japan.

There is a much room for improvement in the global economic order to help all countries, including the advanced economies. To concentrate on international trade, which plays such a crucial role, the rapid growth of the world economy in 1990s and early 2000s was partly a result of the success of the GATT Uruguay Round and the Marrakech Agreement of 1994. Unfortunately, the WTO’s Doha Development Round of 2001 has so far brought only limited trade facilitation under the agreement in Bali last December. Based on this partial success, it’s urgent either to revive Doha or launch an alternative global trade negotiation framework.

The U.S., the EU, Japan and other countries in the Asia-Pacific region should, meanwhile, speed up negotiations on lesser deals like the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP). These are second-rate solutions from a global trade liberalisation viewpoint, but both agreements could offer substantial economic gains and serve as an example for key emerging market partners. At the same time, efforts need to be made to complete the EU Single Market, especially for services.

Advanced economies’ share of the world output will continue to shrink as developing countries catch up with them, but their growth capacity will always remain an important engine for the entire global economy. To get advanced economies growing again as once they did will be challenging. They can only begin to avoid the stagnation trap and continue growing at a moderate pace if they espouse economic policies that will ensure they are more open to migration, that correct excesses in their welfare programmes, make labour and other markets more flexible, bring to a halt the expansion of public debt (and then reverse it), and accomplish real progress in trade liberalisation.

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