Why hasn't America's economy recovered more robustly? Economists have an unsettling answer
In the wake of the 2008 financial crisis, conventional wisdom among economists, business leaders, and policy makers was fairly straightforward: Once the banks were bailed out, the stimulus spent, and businesses had a few years to recover, the U.S. economy would return to its usual healthy growth. Time, in other words, would heal the wounds of the subprime collapse and subsequent turbulence. But if any recovery has turned conventional wisdom on its head, it’s this one.
Over the last eight years, America’s economic prospects have lagged even the most pessimistic early predictions. In 2011, the Federal Reserve predicted that U.S. real GDP would, at worst, grow by 3.5% in 2013 and that the economy would expand between 2.5% and 2.8% annually in the long run. In every year since, the Fed has revised its predictions downward. (The most recent estimate predicts 2.2% annual growth in 2016, and 2% growth in the long run—a rate more than one-third lower than the post-war average.) Even employment, a source of uplifting headlines in recent weeks, is deceptively weak. The unemployment rate—which ignores those who gave up looking for a job—has hit new lows, but the percentage of Americans (between ages 25 and 54) who are actually working is over three points lower than its pre-crisis peak.
These confounding circumstances have led many economists to rally behind the concept of so-called “secular stagnation.” As a diagnosis, secular stagnation is simple: It’s the idea that the economic problems the U.S. continues to face aren’t a product of the “business cycle,” the ebb and flow of boom times and recession (hence the “secular” part), but may well be permanent drags on the modern economy. “It’s a kind of long term and sustained slow-down in economic growth,” says Larry Summers, who served as Bill Clinton’s treasury secretary and is widely credited with dusting off the concept of secular stagnation and bringing it into the mainstream.
The phrase was originally coined in a 1938 address by economist Alvin Hansen to the American Economic Association. Grappling with the sluggish recovery that followed the Great Depression, Hansen predicted that slower population growth and a lower speed of technological progress would combine to thwart full employment, wage increases, and general economic expansion. In both cases, Hansen’s reasoning was the same: without new people entering the work force and new inventions coming onto the market, there would be less investment in new goods, employees and services. Without investment, fewer businesses would open or expand, growth would slow, and more workers would be unable to find jobs.
Hansen painted an eerily familiar picture: “This is the essence of secular stagnation,” he explained, “sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.” He could have been describing 1938 or 2016.
World War II effectively solved at least one of Hansen’s concerns. The U.S. population exploded, thanks to a post-war baby boom. Meanwhile, high government spending during the conflict boosted the economy, and new inventions like jet airplanes, interstate highways, and eventually computers kept productivity and growth churning. Hansen’s theory was mothballed—until 2013 when Summers reintroduced the idea as an explanation to America’s sluggish economic recovery in a speech at the International Monetary Fund.
Since Summers’ IMF address, economists have piled on with many different ideas on exactly what is causing America’s current growth crisis—so much so that Berkeley professor Barry Eichengreen has referred to secular stagnation as “an economist’s Rorchach Test.”
Though the consensus around what secular stagnation means is loose, one factor almost everyone agrees on is the lack of population growth that concerned Hansen has re-emerged as a problem. Population growth means people need more stuff—especially capital-intensive things like housing that require especially large expenditures—and businesses invest in new workers and equipment to provide that stuff. The reverse is also true: as U.S. population growth has fallen and the baby boom generation approaches retirement age, the number of new consumers and workers who can produce and buy things has dropped off. “Slow or negative growth in the working-age population means low demand for new investments,” Nobel prize winner Paul Krugman explained in a 2014 article.
Changing technological trends have also been blamed for discouraging investment. Summers notes that this has happened in two ways: first, the internet revolution has allowed companies like WhatsApp—which had just 55 employees when it was acquired for $19 billion by Facebook in 2014—to reach a higher market valuation than Sony. Growing a multi-billion dollar company used to require hiring lots of workers, constructing offices and factories and so on. Nowadays, all you need is a loft and a couple of Macbooks.
Summers also identifies a related problem: the types of capital companies actually do need to invest in—computers and software—have gotten drastically cheaper. The result is that as businesses open or expand, they no longer need to spread their wealth around by purchasing costly machinery. Eichengreen, who considers himself a secular stagnation agnostic, finds this argument particularly persuasive. He adds that all types of capital goods, not just computers, have fallen in price over time as manufacturing has gotten increasingly efficient. “The one factor I’m most convinced by is the relative price of capital goods has being going down for 30 to 40 years,” the professor says. “Firms can do the same things spending less.”
Beyond demographics and technological change, there are a myriad of other explanations for lack of investment. Growing inequality means those most likely to spend their money, the middle class and people with lower incomes, have seen their wages grow the least. That means less spending and less demand, which ultimately means less production and hiring. Another proposed factor is high levels of consumer debt, which depresses spending as consumers divert money they would have used at the mall, say, toward paying their credit card interest.
Some, like Northwestern economics professor Robert J. Gordon, place less emphasis on lack of investment and more on Hansen’s other idea: that technological innovation has faltered—for real this time. Gordon agrees with many of Summers’ concerns, but blames much of the slowdown over the last fifty years on a lack of important new inventions. “We had a complete transformation of human life in the special century between 1870 and 1970,” Gordon says. “Since then we’ve had plenty of innovation, but in a narrower sphere; in entertainment, communication, and information technology.” Gordon argues those recent innovations have failed to increase productivity in the same way running water, the combustion engine, and indoor plumbing did for the previous generation. As a result, economic growth has been comparatively sluggish—especially now that the gains from the internet boom have largely been absorbed.
Secular stagnation also has its fair share of prominent skeptics. Harvard Professor Kenneth Rogoff agrees with some of the stagnation theory, such as lower population growth hurting output, but attributes most of the slowdown to a passing “debt supercycle” where post-recession economies are dragged down by high levels of debt that hold back growth until deleveraging is complete. Former Federal Reserve Chair Ben Bernanke chalks up slow post-recession growth to a global savings glut where investment is held back by various trade and economic policies, such as the decision by some countries to build large hoards of foreign currency reserves. If Bernanke is right, there is nothing fundamentally wrong with the economy and those bad policies must simply be reversed.
What makes secular stagnation so disconcerting for economists who do believe in the theory is that it defies traditional remedies for poor growth. In the past, if the economy had too little investment and growth stalled, the Federal Reserve could simply lower interest rates, which reduces returns on savings and makes borrowing and investing cheaper. If interest rates go low enough, business owners often decide that spending on expanding their business or research and development will yield higher returns than saving. At the same time, individuals are more inclined to spend or invest than to let their money sit in a bank. That typically kicked the economy back into gear.
Ideally, a central bank like the Fed can fine tune the interest rate so that investment is sufficiently desirable that the economy reaches full employment—a point known as the “full employment real interest rate,” or the moderately catchier “FERIR.” Summers and his colleagues suspect all the factors behind secular stagnation make investment so unattractive that, in order to get enough spending to reach full employment, the FERIR would have to be well below zero. In other words, companies would have to be losing money on savings to have an incentive to spend it on creating jobs.
If negative rates are necessary to reach full employment, that could pose a major problem. Economists generally think there is a limit to how negative the U.S. Federal Reserve can push interest rates before it triggers a financial revolt. If rates drop low enough, banks would theoretically pass on those costs to customers, charging people for depositing funds. In response, businesses and consumers might withdraw their cash and store it themselves, neutralizing any impact negative rates might have in stimulating spending. In Japan, where negative interest rates were recently introduced, there has been a surge in demand for home safes.
Even if the Federal Reserve could successfully take real interest rates to historical lows, Summers says that essentially forcing firms to invest in something could create a host of “adverse consequences,” ranging from dangerous financial schemes to more asset bubbles like housing booms that end with excruciating busts. “The investments that firms would undertake at a quarter of a percent that they wouldn’t undertake at half of a percent are probably not likely to be that good,” Summers warns. Secular stagnation has essentially forced America to choose between dangerous financial instability and painfully sluggish growth. Either way, average consumers seem to lose.
This gloomy prospectus hasn’t stopped economists from working on solutions. One possible fix: instead of lowering rates, have the government fill in the investment gap with its own spending. “I think there’s an overwhelming case for increased public investment, which I think is likely to raise economic growth,” Summers says. He recommends a massive, 10-year infrastructure renewal program that would upgrade existing infrastructure like roads, bridges, and airports and build new capacity in areas like broadband, green technology and health care.
One downside to that plan is it’s unclear exactly when the economy would stop having to use government spending as a crutch for growth. “In the secular stagnation environment, [the need for high public investment or debt] is a permanent state of affairs as long as the slow moving factors are not reverting,” says Gauti Eggertsson, an associate professor of economics at Brown University. The good news is high government investment may improve at least some of the dismal economic fundamentals that power stagnation. For example, better infrastructure and more spending on education could increase productivity and stimulate growth. Investments in green technology and health innovations could likewise produce new inventions and new industries.
Moreover, some of the factors dragging at the economy could actually power a government spending-based recovery. Low interest rates make borrowing money historically cheap, meaning the U.S. would be able to upgrade its infrastructure for relatively bargain prices. If Summers’ plan works and growth rebounds, tax revenues would also increase, lowering America’s overall debt-to-GDP ratio.
Will politicians find the political will to follow such a program? Summers is optimistic, but only cautiously so. “Eventually policy makers get around to doing the right thing, but I think it’s a slow process,” he says. “It certainly doesn’t seem like it’s going to happen this year. I’m hopeful that with the next president it will.”
In the meantime, his only advice to Americans affected by stagnation is to accept the reality and plan for a long, slow recovery. “Major economic forces are like hurricanes or droughts,” Summers says. “They’re something to which individuals have to adapt, but which they can’t control.”