The opposite of MEW/HDI etc...

Just published, not sure what the value for the exam is, but hey, just knowing this is good, right?


The most miserable countries infographic

Infrastructure - a critique of HS2

"If India can send a mission to Mars for £47 million, why does a rail line to Birmingham and beyond have a potential cost of £80bn+"

Free market think tank IEA has published a critique of HS2, suggesting the bill will top £80bn. On top of this, there is talk of cutting costs by axing some key stations, reducing its viability. The Treasury has a senior civil servant reviewing the whole project, and serious concerns are leaking out.

The paper (linked below) looks at HS1 as an example; the cost over-run there was (2013 prices) an initial projection of £1bn, but ending up at £11bn. Substantial. In addition the government still has to subsidise the operating companies to get some use out of it, and train fares across the South East are higher as a whole.

The paper talks about "high benefit" projects, and sees HS2 as a low benefit project. Why is it being pursued then? Special interests - a really nice evaluation point is that widely dispersed groups - e.g. the taxpayers funding it - don't have much incentive to rally against it, whereas those groups that benefit directly are very skilful at getting there way.

Clearly infrastructure is critical; if you get an "infrastructure" question, there is some really specific high-level material in here; a quick skim of the first 15 pages or so (with notes) should give you at least four or five points you could bring in about how the wrong project can damage infrastructure in the long run, and (tying it into our QE/infrastructure essay) how separating projects from government control would make unviable projects less likely. To paraphrase Milton Friedman, "if it's your own money, you use it with care; if it's the taxpayers', who cares?"


IEA HS2 - a special report

Some evaluation regarding productivity in the UK

Hopefully you are aware that we have a "productivity puzzle" in the UK - strong growth, but poor productivity improvement. From class you should recall that one issue is the influx of cheap labour - why invest in capital goods if you can hire cheap, hard-working East Europeans? Not only that, but their spending creates GDP growth - what's not to like?


Dig deeper, and we start to stumble over a few awkward issues - which is where this fits into evaluation:

1. Does our standard measure of the economy (GDP/output) really capture productivity gains?
2. Does it take into account structural changes, such as the "sharing economy"?

Read on; I have highlighted key passages (later in the post). Skip to these if you must, but the whole is really quite a good recap of key points.


Posted on May 6, 2016 by notayesmanseconomics 
      

A regular feature of economic analysis in the credit crunch era has been where has the productivity growth gone? The knee-jerk reaction from establishment economists was as usual to assume that reality was wrong and their models correct and so they assumed that it would rise even faster in the future to make up the gap. For example back in June 2010 the hapless UK Office for Budget Responsibility forecast that UK productivity growth would have recovered such that wage growth would have been  be running at above 4% since 2013/14. Problem solved! Except that only in their Ivory Towers did such a solution work as below the clouds the situation changed little if at all.


To my mind it is the last 3 years or so that have really illustrated the issue as we have seen the official measure of economic growth rise on a sustained basis. On that measure the recovery has become mature and one would therefore have hoped that productivity growth would have picked up and risen noticeably. So it is especially troubling that we find ourselves wondering what happened to it right now. Even worse if this week’s Markit business surveys indicate a new trend of slowing economic growth.


The establishment could not ignore it for ever


Half way through 2014 someone at the Bank of England must have decided that enough was enough and that maybe something had changed.

Since the onset of the 2007–08 financial crisis, labour productivity in the United Kingdom has been exceptionally weak. Despite some modest improvements in 2013, whole-economy output per hour remains around 16% below the level implied by its pre-crisis trend………This shortfall is sometimes referred to as the ‘UK productivity puzzle’,

Indeed the comparison with past recessions was stark.

Even six years after the initial downturn, the level of productivity lies around 4% below its pre-crisis peak, in contrast to the level of output, which has broadly recovered to its pre-crisis level.

However the response of the establishment followed a disappointing theme as another hapless body gave us Forward Guidance on productivity.

A key judgement in the May 2014 Inflation Report is for productivity growth to pick up.

We can skip the cyclical arguments presented back then as we have cycled on so to speak but there were issues raised then partially dismissed which do apply.

Growth rates in output per hour  have been persistently weaker than GDP, reflecting strong employment growth over the past few years.

This reflects two factors in my view. Firstly ( and the Bank of England either forgot or redacted this) is that for years and indeed decades economists in the UK had wanted us to be more like Germany and keep more workers employed when a recession hits. The other has been an increase in supply of labour as more people have moved to the UK to find work. This is a politically charged issue and the Bank of England tip-toed around it.

In addition, it may be that the financial crisis led to an increase in labour supply in the United Kingdom.

But they have to face up to some of the consequences.

The crisis is likely to have reduced both current real incomes and expected future labour incomes, which may have encouraged more people to seek work and participate in the labour market.

In other words the labour supply curve shifted downwards as labour became cheaper and more of it was used. On that road there was less pressure to improve productivity as wages were lower. You may also note that right up to now we have been discussing weak wage growth and the establishment continues to expect a turn higher at every turn.


Output per individual


The Bank of England tried to shuffle past this issue but I think it matters a lot because there are strong hints of an issue from the GDP per head numbers.

GDP is now 7.3% above its pre-downturn peak and has been growing for 13 consecutive quarters.

We know that the population has grown however so that GDP per head is lower. If we look at the boom phase since 2013 then this has continued with GDP growth being 8.3% but per head only 5.2%.


Sectoral Issues


The Office for National Statistics has been listening to this debate and offered some views on Wednesday and today.

Administrative and support service activities has grown by the largest amount, with a growth rate of 22.3% for the 4 year period, closely followed by professional, scientific and technical activities at 19.1%.

Okay so they have been the leaders so who are the laggards?

production industries made up 3 of the 5 slowest growing industries. One production industry – electricity, gas, steam and air conditioning supply – was one of only two industries to experience negative growth across the four-year period.

I think that the recent mild winter may be a factor in the energy supply industry as it has high fixed costs but it is revealing that it is another area where production has been struggling. Shakespeare was ahead of the game with his point that troubles like this come in “battalions” rather than “single spies”.
Oh and I wonder if those calculating the numbers have overrepresented their own productivity!

However, administration and support service activities features toward the top end of both distributions,

It has had another go this morning and confined itself to the market-sector of the economy.

These estimates also suggest that lower capital service per hour worked and weaker than normal improvements in labour quality held back productivity growth in 2014.

So 2014 was a bit better but still below past experience. I was pleased that such numbers exclude matters such as imputed rent and see that as a success for my arguments and campaigns.


The Services Problem


This is the issue of how we measure this and it is twofold. Firstly there is the problem that many services are intangible and thus output measures are problematic. The other is that some gains here are from products which are in effect free but GDP measurements need a price (that is not zero). For example it is only anecdotal but a friend told me last week that Linkedin and Facebook were very useful for his business but he only used the free versions. So his productivity was in his opinion higher but our national accounts cannot measure it.
Back in 2014 an effort was made but it was vague. At least Price Waterhouse had a go.

Total revenues for the five most prominent sharing economy sectors – peer-to-peer (P2P) finance, online staffing, P2P accommodation, car sharing and music/video streaming – could rise to around £9 billion in the UK by 2025, up from just £0.5 billion today, according to new analysis by PwC.

Professor Diane Coyle has been looking into this and suggested some numbers to give us an idea of scale.

it is highly likely that more than a million people are providing services via these platforms. This is equivalent to about 3% of the workforce, although many or most of them probably do not regard this as employment in the conventional sense.

We wonder what is employment quite regularly on here of course. But it is missed also by the productivity numbers.

The debate about the UK’s productivity performance should take account of the fact that the sharing economy acts as a kind of technological progress, equivalent to increasing the amount of capital available in the economy. But this effect is not recorded in the measured statistics and productivity.

Actually as she points out it may even reduce it as things which are measured are replaced by things which are not measured.


Comment


At times of large structural change there are always going to be issues for official statistics. We have seen and indeed are seeing three large moves at one. The credit crunch blitzed some sectors and sent the whole economy into reverse. The official response has been to try to pump up sectors such as housing and banking. Meanwhile there has been enormous change in technology and the virtual world which we are often missed by the old ways of measurement.


Thus we need ch-ch-changes but the initial problem is the way that we have become wedded to GDP as a measure. Or to be more precise it would as a beginning be helpful if the UK returned to publishing more openly the three different GDP measures adding Income and Expenditure to Output. Why? Well the income figures from the US have added value but when I tried to get similar data for the UK I was told that Nigel Lawson scrapped much of it as I guess it “frightened the horses” to coin a phrase. Yet as Diane Coyle points out something seems to be happening.

In the past, the statistical discrepancy was of the order of £1bn, and more recently £2-3bn.. In 2014 it reached an extraordinary £9bn.

We can do much more to get data from the online world using so-called big data and web scraping. This will not give us a complete answer but it will be better and I believe there will be more cheer in it than the official data we get now. As the sun is out let’s have a little optimism and hope it will wean our establishment off pumping up the housing market.

Fiscal policy and tax revenue - evaluation points:

More in my bid to get you prepared to spice up your essays; this is an extract from a Mauldin newsletter, and I've highlighted the bits that you could use if you get a question about spending, and you are stuck for a way to say how to generate the revenue (NB this applies to ALL spending, transfers, current & investment). If you want to read the whole thing you'll have to ask me to forward you the email (I won't hold my breath). As usual, this is very US-centric, but broadly it applies here. Let's start with income taxes  - not much meat here:

[And now the points behind this:]

"And while incomes have stagnated, the real cost of goods and services has increased much more than the purported inflation rate suggests. The cost of housing, utilities, and local taxes has certainly increased beyond inflation levels. And don’t even get me started on how much has gone up, crushing families who can least afford it.

This next chart paints our economic situation in even starker terms. The bottom 90% of Americans have seen their overall income drop. Low interest rates and quantitative easing have dramatically helped the top 10%, and we could break out the numbers to show that it’s actually the top 25% that have benefited, though the further down the income chain you go, the less the Fed’s tinkering has helped. The financialization of America is directly responsible for this turn of events, and rather than helping GDP growth as it was intended to do, it has thwarted growth.

You need to do something, something radical, to shake up the system, to make sure those at the bottom get an increase in income all the while making sure that you don’t push the economy, which is already stalling, into a dive. Economics and politics as usual simply will not cut it.

Giving Everybody Some of What They Want…
But Not Everything They Want

Here is the basic political reality you’re dealing with. Republicans want supply-side tax cuts and flat taxes, spending cuts, and a balanced budget, or some combination of all of them. Democrats want more spending for healthcare and other consumer-related items, an agenda that means higher taxes; and many, if not most, would at least give a nod to balancing the budget. Everyone is for “the little guy.”

So let’s start with the easy part. You’re going to want the Republicans to go along with an increase in the total tax revenue. If you forget for a moment where you want to extract that revenue from (by taxing the rich, for instance) and just say that your goal is to get more tax revenue, then you will have a lot more flexibility. And the reality is that you could significantly raise taxes on the rich (and by “the rich” I mean the top 20% in income) and still get nothing close to the amount you need. The sad reality is that you would have to raise taxes not only on the rich but on the middle class in order to make a difference. And I’m going to assume that raising taxes on the beleaguered and shrinking middle class is a nonstarter for pretty much everyone.

So to get what you want, give the Republicans a tax cut that will get every one of their little supply-side hearts absolutely quivering in anticipation. Give them so much of what they want that it becomes almost impossible for them to say no. That means you can’t be halfhearted; you’re going to have to go the whole hog.

[this bit is controversial - I like it, but I don't expect you to buy into it:] Offer a 20% flat tax on income over $100,000. Period. No deductions for anything. Dividends, interest income, municipal income tax revenues, all are taxed at 20% above the total $100,000 income level. Every sacred cow goes. No mortgage deductions, no charitable contribution deductions, no child tax credit, no nothing. Every penny over $100,000 is taxed at 20%. Now, you can make an argument that income from say $50,000–$100,000 should be taxed at 10%, but that’s not going to give you enough money to do what you need to do in order to be able to get the support of the Democrats. There is, on the other hand, a case to be made that people making over $50,000 should contribute something to the overall general welfare of the economy.

That still gives everyone up and down the ladder a major tax cut. There is not a supply sider in America who is not going to like that tax structure. Your income tax filing is done on a 3”x5” card. If you made between $50,000 and $100,000, you pay 10%. If you made more than that, you pay $10,000 plus 20% of everything you made above $100,000. This is going to be surprisingly popular with millennials: survey after survey shows that one of their big fears is dealing with the IRS. In a world where 40% of America is now getting some form of non-salaried income, dealing with the IRS is becoming more complicated. Millennials are increasingly part of the gig economy, and a flat tax will make their lives easier. You are going to be surprised at the level of support this tax proposal will get from young people.

Now, this tax structure is, of course, going to make people who want to soak the rich unhappy, as they don’t see how the little guy benefits. So here is where we have to get really creative. And this is why you are giving the Republicans something that’s going to be very difficult for them to walk away from: you’re going to combine their tax cut with two additional items.

To the Democrats, offer to abolish the Social Security tax on both sides of the equation, both business and personal. That means an individual making $30,000 a year gets an approximately $2000 pay raise immediately. Every working man and woman gets a pay increase in the form of no deductions for Social Security taxes from their wages.

So where do you get the money? You’re certainly not going to get the support of senior citizens or anyone else for that matter if you start messing around with the ability to pay Social Security benefits. So that means we have to find another revenue source.

[and here is the main bit you can use:]

And for that revenue source you need to turn to the tax that is the most efficient in economic terms: a consumption tax. But not one that looks like a sales tax. Rather, it should be a version of what almost every other country in the world uses, and that is a value-added tax, or VAT. I would modify it to look more like a business transfer tax (BTT).

Basically, with a BTT, a company pays tax on the revenue it receives net of what it pays for the services and products it is selling. Netflix pays on the revenue it receives after deducting the money it sends to television and movie producers for the rights to show their products. This is all transparent to the end user.

You can tinker around the margins to make this tax more politically acceptable. You can exempt groceries, but then you’re going to have to charge a higher rate on everything else. You can exempt nonprofits, but I wouldn’t: they pay Social Security tax on their employees now. But that may be the price of getting the deal done.

A BTT in the low teens (12-14%) will get you all the revenue that you need. You look the Republicans square in the eye and say I want to get 2% of GDP more tax revenue in the form of the BTT in return for the income flat tax on individuals. By the way, the BTT is legally deductible by US corporations under WTO rules when they ship products overseas – which is what every other country does to us, and why they have a tax advantage over us when shipping products to us. The BTT is going to be a huge boon to US producers. Talk about a cheap way to boost the economy – this is it.

Shocks Pt3 - Protectionism

Another article from Project Syndicate, this time by the wonderful Stephen Roach. I can't see you getting a question that is as US-centric as this article, but you may get a shocks question based on increasing protectionism, or possibly exclusion from trade agreements. This article goes into the reason for the US trade deficit, and much of it won't be of use in an essay, but if you can grasp the underlying principles you should find them useful.

America’s Trade Deficit Begins at Home

NEW HAVEN – Thanks to fear mongering on the US presidential campaign trail, the trade debate and its impact on American workers is being distorted at both ends of the political spectrum. From China-bashing on the right to the backlash against the Trans-Pacific Partnership (TPP) on the left, politicians of both parties have mischaracterized foreign trade as America’s greatest economic threat.

In 2015, the United States had trade deficits with 101 countries – a multilateral trade deficit in the jargon of economics. But this cannot be pinned on one or two “bad actors,” as politicians invariably put it. Yes, China – everyone’s favorite scapegoat – accounts for the biggest portion of this imbalance. But the combined deficits of the other 100 countries are even larger.

The Brazil Syndrome

Renowned economist Anders Åslund engages the views of Dani Rodrik, Nouriel Roubini, Joseph Stiglitz, and others on the growing turmoil in emerging markets.

PS On Point: Your review of the world’s leading opinions on global issues.

What the candidates won’t tell the American people is that the trade deficit and the pressures it places on hard-pressed middle-class workers stem from problems made at home. In fact, the real reason the US has such a massive multilateral trade deficit is that Americans don’t save.

Total US saving – the sum total of the saving of families, businesses, and the government sector – amounted to just 2.6% of national income in the fourth quarter of 2015. That is a 0.6-percentage-point drop from a year earlier and less than half the 6.3% average that prevailed during the final three decades of the twentieth century.

Any basic economics course stresses the ironclad accounting identity that saving must equal investment at each and every point in time. Without saving, investing in the future is all but impossible.

And yet that’s the position in which the US currently finds itself. Indeed, the saving numbers cited above are “net” of depreciation – meaning that they measure the saving available to fund new capacity rather than the replacement of worn-out facilities. Unfortunately, that is precisely what America is lacking.

So why is this relevant for the trade debate? In order to keep growing, the US must import surplus saving from abroad. As the world’s greatest economic power and issuer of what is essentially the global reserve currency, America has had no trouble – at least not yet – attracting the foreign capital it needs to compensate for a shortfall of domestic saving.

But there is a critical twist: To import foreign saving, the US must run a massive international balance-of-payments deficit. The mirror image of America’s saving shortfall is its current-account deficit, which has averaged 2.6% of GDP since 1980.

It is this chronic current-account gap that drives the multilateral trade deficit with 101 countries. To borrow from abroad, America must give its trading partners something in return for their capital: US demand for products made overseas.

Therein lies the catch to the politicization of America’s trade problems. Closing down trade with China, as Donald Trump would effectively do with his proposed 45% tariff on Chinese products sold in the US, would backfire. Without fixing the saving problem, the Chinese share of America’s multilateral trade imbalance would simply be redistributed to other countries – most likely to higher-cost producers.

I have estimated that Chinese labor compensation rates remain far less than half of those prevailing in America’s other top-ten foreign suppliers. If those countries were to fill the void left by a penalty on China, like the one that Trump has proposed, higher-cost producers would undoubtedly charge more than China for products sold in the US. The resulting increase in import prices would be an effective tax hike on the American middle class. That underscores the futility of attempting to find a bilateral solution for a multilateral problem.

The same perverse outcome could be expected from the reckless fiscal policies proposed by other politicians. Take, for example, the ten-year $14.5 trillion federal government spending binge proposed by Democratic presidential candidate Bernie Sanders – a program judged to be without any semblance of fiscal integrity by leading economic advisers within the very party whose nomination he seeks.

Government budget deficits have long accounted for the largest share of America’s seemingly chronic saving shortfall. The added deficits of Sandersnomics, or for that matter those of any other politician, would further depress America’s national saving – thereby exacerbating the multilateral trade imbalance that puts such acute pressure on middle-class families.

Seen through the same lens, mega trade deals, such as the TPP, would also have an important bearing on pressures that squeeze American workers. The TPP would effectively divert trade flows from those countries that are not a part of the agreement to those that are. With China excluded from the TPP, the same phenomenon noted above would result: American middle-class families would be taxed by the diversion of trade away from low-cost non-TPP producers such as China toward higher-cost TPP signatories such as Japan, Canada, and Australia.

In short, trade bashing is a foil for the vacuous promises that politicians of both parties have long made to American voters. Saving is the seed corn of economic growth – the means to boost American competitiveness by investing in people, infrastructure, technology, and new manufacturing capacity. The US government, through decades of deficit spending and advocacy of policies that encourage households to consume rather than save, has forced America to rely on foreign saving for far too long. This has undermined US competitiveness, punishing workers with the job losses and wage compression that trade deficits invariably spawn.

America’s 101 trade deficits don’t exist in a vacuum. They are a symptom of a deeper problem: a US economy that has lived beyond its means for decades. Saving is but a means to an end – in this case the sustenance of a thriving and secure middle class. Without saving, the American Dream is in danger of becoming a nightmare. The trade debate of the current presidential campaign heightens that risk.

Shocks Pt2 - Debt and Confidence

Another article from Project Syndicate that crosses over with the prior article; again, I have highlighted key elements that could be brought into a "shocks" essay:

The Next Global Boom – and Bust

WASHINGTON, DC – The mood at the International Monetary Fund-World Bank spring meetings here earlier this month was grim. The latest IMF forecast for global growth has been revised downward yet again – suggesting the world will grow at an annual rate of just over 3% this year and again in 2017.

If realized, this would be a dismal performance. Before 2007, global growth (using the IMF’s methodology) was in the 4.5-5% range, based on steady productivity improvements in industrial countries and rapidly rising living standards in large emerging markets such as China, Brazil, and Russia.

The Brazil Syndrome

Renowned economist Anders Åslund engages the views of Dani Rodrik, Nouriel Roubini, Joseph Stiglitz, and others on the growing turmoil in emerging markets.

PS On Point: Your review of the world’s leading opinions on global issues.

Now the US faces the uncertainty of a presidential election, weaker parts of the eurozone continue to struggle, and Japan is teetering on the edge of outright economic contraction. Brazil is in the midst of a political crisis, China is dealing with the after effects of prolonged fiscal expansion and explosive growth in its shadow banking system, and lower commodity prices are undermining economic performance in many other emerging markets. On top of all this, the British may vote in June to leave the European Union.

Economic activity is affected by confidence: Do consumers believe their incomes are likely to rise (or even prove secure), and do companies believe that future growth will be buoyant enough to warrant current investment? And today’s macro mood is shared pessimism.

Yet the medium-term scenario is unlikely to be global stagnation. New technologies continue to be invented, and billions of people aspire to improve their standard of living through education and hard work. Leading industrial economies have demonstrated remarkable resilience in the face of large negative financial-sector shocks over the past decade – as has China.

Unemployment in the United States is down to 5%, and parts of Europe are doing fine. And the most important point about the commodity price cycle is that it is indeed a cycle: Demand for commodities rises and falls, while supply changes only slowly. We should expect volatility in commodity prices – as well as in the price of oil.

The biggest question is whether we can get off the economic roller coaster and return to robust global growth without debt-fueled overconsumption (as seen in the pre-2008 US), overinvestment (as in China), and overexpansion of government spending (still an issue in some parts of Europe).

Debt can fund productive investments and improvement in human capital. But why do we always seem to like it too much? Part of the reason stems from tax systems, which in some countries allow some consumer interest payments (for example, mortgages in the US) to be deducted from taxable income. Corporate interest payments are typically deductible, too.

But the main appeal of debt is that it is a very simple contract: Either you pay the agreed amount or you don’t. And when things go well, a highly leveraged enterprise – a company or your house – will show a great return on equity. But those returns are not risk-adjusted, which means that when the economy slumps, big losses are allocated – as American homeowners learned in 2008, Korean conglomerates learned in 1997, and governments in emerging markets learn repeatedly.

Policymakers know that excessive debt brings financial fragility, of course, and some efforts at reform over the past decade have aimed to scale back leverage. But financial reform is hard to do during a slump, when the main task is to revive growth. Official intentions often remain just that; time and again, political leaders find it easier simply to keep in place the existing system of rules, incentives, and guarantees. And, because large financial firms do very well with a great deal of leverage, they continue to devote abundant lobbying resources to resisting efforts to ensure that they are better capitalized (with more shareholder equity relative to their total balance sheets).

Indeed, the largest banks in the US – but also in most other countries – are even bigger today than they were before 2008. All candid accounts indicate their internal incentives are not much changed, and restrictions on their activities are unlikely to prove effective as global growth picks up.

In the US, officials hold out hope that the largest financial firms will eventually be forced to comply with a provision of the 2010 Dodd-Frank financial reform legislation requiring that they draw up credible “living wills.” Yet most big banks have repeatedly failed to produce plausible plansexplaining how they could fail in bankruptcy without any government assistance and without damaging the world economy, and none has faced meaningful consequences for noncompliance.

Growth will return. Entrepreneurs will start new companies, and they will fund their risk-taking with equity investments provided by venture capital funds. Established nonfinancial firms have learned the hard way that they need to be careful with leverage and keep large cash cushions.

It’s the big banks that continue to prefer being highly leveraged. And too many policymakers are deferring to them. Like it or not, that means we are in line for another stomach-turning round on the global economy’s wild ride.

Shocks Pt1 - Debt

I have been trying to come up with a good question so we can tackle a "shock"-style topic appropriate for the exam. I think this works, albeit coming at the issue from an oblique angle:

Assess the implications for an economy of a global slow down when it is heavily in debt/over-leveraged.

I have deliberately not said "the UK" because this leaves the question open to different angles and approaches. Read the following article by Michael Spence on Project Syndicate, which I have highlighted in key areas, and consider your approach. We will look at this in class:

Managing Debt in an Overleveraged World

MILAN – What ever happened to deleveraging? In the years since the 2008 global financial crisis, austerity and balance-sheet repair have been the watchwords of the global economy. And yet today, more than ever, debt is fueling concern about growth prospects worldwide.

The McKinsey Global Institute, in a study of post-crisis debt trends, notes that gross debt has increased about $60 trillion – or 75% of global GDP – since 2008. China’s debt, for example, has increased fourfold since 2007, and its debt-to-GDP ratio is some 282% – higher than in many other major economies, including the United States.

The Brazil Syndrome

Renowned economist Anders Åslund engages the views of Dani Rodrik, Nouriel Roubini, Joseph Stiglitz, and others on the growing turmoil in emerging markets.

PS On Point: Your review of the world’s leading opinions on global issues.

A global economy that is levering up, while unable to generate enough aggregate demand to achieve potential growth, is on a risky path. But to assess how risky, several factors must be considered.

First, one must consider the composition of the debt across sectors (household, government, non-financial corporate, and the financial sector). After all, distress in these sectors has very different effects on the broader economy.

As it turns out, economies with similar and relatively high levels of gross debt relative to GDP exhibit sharp differences when it comes to the composition of the debt. Excessive household debt is particularly risky, because a shock in the price of assets (especially real estate) translates quickly into reduced consumption, as it weakens growth, employment, and investment. Recovery from such a shock is a long process.

The second factor to consider is nominal growth – that is, real growth plus inflation. Today, real growth is subdued and may even be slowing, while inflation is below target in most places, with some economies even facing the risk of deflation. Because debt is a liability for borrowers and an asset for creditors, these trends have divergent effects, increasing value for the asset holder, while increasing the liability of the debtor. The problem is that, in a low-growth environment, the probability of some form of default rises considerably. In that case, nobody wins.

The third key factor for assessing the risk of growing debt is monetary policy and interest rates. Though no one knows exactly what a “normal” interest-rate environment might look like in the post-crisis world, it is reasonable to assume that it will not look like it does today, when many economies are keeping rates near zero and some have even moved into negative territory.

Sovereigns with high and/or rising debt levels may find them sustainable now, given aggressively accommodative monetary policy. Unfortunately, though such accommodation cannot be sustained forever, today’s conditions are often viewed as semi-permanent, creating the illusion of stability and reducing the incentive to undertake difficult reforms that promote future growth.

The final, and arguably most important, factor shaping debt risk relates to investment. Increasing debt to sustain current consumption, whether in the household or government sector, is rightly viewed as an unsustainable element of a growth pattern. Here, China’s case is instructive.

In a sense, the frequent refrain that China’s debt is on an unsustainable path is true. After all, high levels of debt increase vulnerability to negative shocks. But, in another sense, this misses the point.

Many governments nowadays are accumulating debt in order to buttress public or private consumption. This approach, if overused, can amount to borrowing future demand; in that case, it is clearly unsustainable. But, if used as a transitional measure to help jump-start an economy or to provide a buffer from negative demand shocks, such efforts can be highly beneficial.

Moreover, in a relatively high-growth economy, ostensibly high debt levels are not necessarily a problem, as long as that debt is being used to fund investments that either yield high returns or create assets worth more than the debt. In the case of sovereign debt, the return on investment can be viewed as the increment to future growth.

The good news is that, in China, much of the accumulated leverage has indeed been used to fund investment, which in principle creates assets that will augment future growth. (Whether the results of the government’s recent decision to increase the fiscal deficit to stimulate the economy follow this long-term growth-enhancing pattern remains to be seen.)

The bad news is that directed lending and the relaxation of credit standards in China, particularly after the crisis, have led to investment in assets in real estate and heavy industry with a value well below the cost of creating them. The return on them is negative.

China’s so-called debt problem is thus not really a debt problem, but an investment problem. To address it, China must reform its investment and financial systems, so that low- or negative-return investments are screened out more reliably. That means tackling the mispricing of risk that results from the government’s backing of the country’s state-owned banks (which surely could not be allowed to fail).

Many developed countries are also failing to invest in high-return assets, but for a different reason: Their tight budgets and rising debts are preventing them from investing much at all. As this weakens growth and reduces inflation, the speed at which their sovereign-debt ratios can be reduced declines considerably.

In order to spur growth and employment, these economies must start paying closer attention to the kind of debt they accumulate. If the debt is financing growth-promoting investment, it may be a very good idea. If, however, it is financing “current operations” and raising short-term aggregate demand, it is highly risky.

Of course, the situation is not cut and dried. The return to public investment is affected by the presence or absence of complementary reforms, which vary from country to country. And there is some potential for abuse, with expenditures being misclassified as investments.

Yet, in an environment of low long-term interest rates and deficient short-term aggregate demand (which means there is little risk of crowding out the private sector), it is a mistake not to relax fiscal constraints for investment. In fact, the right kind of public investment would probably spur more private-sector investment. Identifying such investment is where today’s debt debate should be.

A good article that highlights the different types of debt (to boost consumption vs for investment - harking back to our essay on using QE for the real economy), as well as who is incurring the debt. The China situation is very instructive - they are in the process of building new economic zones around brand new huge airports, while at the same time rolling out a huge programme of high speed train development. Will both (funded by debt) earn a good return? It is likely some will not, but we won't know for sure for several years.

The other hugely relevant point is that we have had low interest for so long it now feels normal; it isn't, and rates will have to rise at some point (for numerous reasons), and countries that are heavily in debt will have to allocate more resources to servicing their debt. This is hugely deflationary. So much to write about - structure will be key!