How to grow A special report on the world economy October 9th 2010 worldeconomy.indd 1 28/09/2010 12:52 The Economist October 9th 2010 A special report on the world economy 1 How to grow Also in this section Withdrawal symptoms After the stimulus, the hangover. Page 3 The cost of repair A battered nance sector means slower growth. Page 6 From hoarding to hiring Some countries have successfully preserved jobs. Now they must create new ones. Page 9 Pass and move Spain o ers a test case for labour•market reform in Europe. Page 12 Smart work Faster productivity growth will be an important part of rich economies’ revival. Without faster growth the rich world’s economies will be stuck. But what Page 13 can be done to achieve it? Our economics team sets out the options A better way HAT will tomorrow’s historians see The next few years could be dened as as the dening economic trend of the much by the stagnation of the West as by The rich world should worry about growth• W early 21st century? There are plenty of po• the emergence of the rest, for three main promoting reforms more than short•term tential candidates, from the remaking of • reasons. The rst is the sheer scale of the re• scal austerity. Page 16 nance in the wake of the crash of 2008 to cession of 2008•09 and the weakness of the explosion of sovereign debt. But the list the subsequent recovery. For the advanced will almost certainly be topped by the dra• economies as a whole, the slump that fol• matic shift in global economic heft. lowed the global nancial crisis was by far Ten years ago rich countries dominated the deepest since the 1930s. It has left an un• the world economy, contributing around precedented degree of unemployed work• two•thirds of global GDP after allowing for ers and underused factories in its wake. Al• di erences in purchasing power. Since though output stopped shrinking in most then that share has fallen to just over half. countries a year ago, the recovery is prov• In another decade it could be down to 40%. ing too weak to put that idle capacity back The bulk of global output will be produced to work quickly (see chart 1, next page). The in the emerging world. OECD, the Paris•based organisation that The pace of the shift testies to these tracks advanced economies, does not ex• countries’ success. Thanks to globalisation pect this output gap to close until 2015. and good policies, virtually all developing The second reason to worry about stag• countries are catching up with their richer nation has to do with slowing supply. The peers. In 2002•08 more than 85% of devel• level of demand determines whether oping economies grew faster than Ameri• economies run above or below their ca’s, compared with less than a third be• trend rate of growth, but that trend rate tween 1960 and 2000, and virtually none itself depends on the supply of workers in the century before that. and their productivity. That productivity in This rise of the rest is a remarkable turn depends on the rate of capital invest• achievement, bringing with it unprece• ment and the pace of innovation. Across dented improvements in living standards the rich world the supply of workers is for the majority of people on the planet. about to slow as the number of pensioners But there is another, less happy, explana• rises. In western Europe the change will be A list of acknowledgments and sources is at tion for the rapid shift in the global centre especially marked. Over the coming de• Economist.com/specialreports of economic gravity: the lack of growth in cade the region’s working•age population, the big rich economies of America, west• which until now has been rising slowly, An audio interview with the authors is at ern Europe and Japan. That will be the fo• will shrink by some 0.3% a year. In Japan, Economist.com/audiovideo/specialreports cus of this special report. where the pool of potential workers is al• 1 2 A special report on the world economy The Economist October 9th 2010 2 ready shrinking, the pace of decline will now reckons that the fallout from the • more than double, to around 0.7% a year. Onwards, ever upwards 2 nancial crisis will, on average, knock some America’s demography is far more favour• US real GDP per person, 2009 $’000 Log 3% o rich countries’ potential output. able, but the growth in its working•age scale Most of that decline has already occurred. population, at some 0.3% a year over the 60 The longer that demand remains weak, coming two decades, will be less than a 40 the greater the damage is likely to be. Ja• third of the post•war average. pan’s experience over the past two de• With millions of workers unemployed, 20 cades is a cautionary example, especially an impending slowdown in the labour 10 to fast•ageing European economies. The supply might not seem much of a problem. 8 country’s nancial crash in the early 1990s But these demographic shifts set the 6 contributed to a slump in productivity boundaries for rich countries’ medium• 4 growth. Soon afterwards the working•age term future, including their ability to ser• population began to shrink. A series of vice their public debt. Unless more immi• 2 policy mistakes caused the hangover from grants are allowed in, or a larger propor• 1 the nancial crisis to linger. The economy tion of the working•age population joins 1869 901900 1910 20 30 40 50 60 70 80 90 2009 failed to recover and deation set in. The the labour force, or people retire later, or result was a persistent combination of Sources: US Department of Commerce; BLS; The Economist their productivity accelerates, the ageing weak demand and slowing supply. population will translate into perma• To avoid Japan’s fate, rich countries nently slower potential growth. world. Growth in output per worker in need to foster growth in two ways, by sup• Calculations by Dale Jorgenson of Har• America, which had risen sharply in the porting short•term demand and by boost• vard University and Khuong Vu of the Na• late 1990s thanks to increased output of in• ing long•term supply. Unfortunately, to• tional University of Singapore make the formation technology, and again in the ear• day’s policymakers often see these two point starkly. They show that the average ly part of this decade as the gains from IT strategies as alternatives rather than com• underlying annual growth rate of the G7 spread throughout the economy, began to plements. Many of the Keynesian econo• group of big rich economies between 1998 ag after 2004. It revived during the reces• mists who fret about the lack of private de• and 2008 was 2.1%. On current demo• sion as rms slashed their labour force, but mand think that concerns about econo• graphic trends, and assuming that produc• that boost may not last. Japan’s productivi• mies’ medium•term potential are beside tivity improves at the same rate as in the ty slumped after its bubble burst in the ear• the point at the moment. They include Paul past ten years, that potential rate of growth ly 1990s. Western Europe’s, overall, has Krugman, a Nobel laureate and commen• will come down to 1.45% a year over the also weakened since the mid•1990s. tator in the New York Times, and many of next ten years, its slowest pace since the The third reason to fret about the rich President Barack Obama’s economic team. second world war. world’s stagnation is that the hangover Faster productivity growth could help from the nancial crisis and the feebleness Stimulus v austerity to mitigate the slowdown, but it does not of the recovery could themselves dent European economists put more emphasis seem to be forthcoming. Before the nan• economies’ potential. Long periods of high on boosting medium•term growth, favour• cial crisis hit, the trend in productivity unemployment tend to reduce rather than ing reforms such as making labour markets growth was at or slowing in many rich augment the pool of potential workers. more exible. They tend to reject further countries even as it soared in the emerging The unemployed lose their skills, and disil• scal stimulus to prop up demand. Jean• lusioned workers drop out of the work• Claude Trichet, the president of the Euro• force. The shrinking of banks’ balance• pean Central Bank, is a strong advocate of Yawning 1 sheets that follows a nancial bust makes structural reforms in Europe. But he is also Output gap* as % of potential GDP, forecast credit more costly and harder to come by. one of the most ardent champions of the 2010 2011 Optimists point to America’s experi• idea that cutting budget decits will itself 7 6 5 4 3 2 1– 0 ence over the past century as evidence that boost growth. All this has led to a passion•1 Japan recessions, even severe ones, need not do lasting damage. After every downturn the 3 Germany economy eventually bounced back so that All right for some for the period as a whole America’s under• GDP per person employed* France lying growth rate per person remained re• % increase on previous year United markably stable (see chart 2). Despite a lack 5 States of demand, America’s underlying produc• OECD tivity grew faster in the 1930s than in any 4 other decade of the 20th century.