Secular stagnation nothing more than a phoney rationale for more government waste
The current economic news from the US is encouraging
Stagnationists have been around for centuries. They have embraced many economic theories about what causes economic stagnation. That’s a situation in which total output, or output per capita, is constant, falling slightly, or rising sluggishly. Stagnation can also be characterised by a situation in which unemployment is chronic and growing.
Before we delve into the secular stagnation debate – a debate that has become a hot topic – a few words about current economic developments in the U.S. are in order. What was recently noticed was the Federal Reserve’s increase, for the first time in nearly a decade, of the fed funds interest rate by 0.25 per cent. What went unnoticed, but was perhaps more important, was that the money supply, broadly measured by the Centre for Financial Stability’s Divisia M4, jumped to a 4.6 per cent year-over-year growth rate. This was the largest increase since May 2013.
Since changes in the money supply, broadly determined, cause changes in nominal GDP, which contain real and inflation components, we can anticipate a pick-up in nominal aggregate demand in the US. Indeed, if M4 keeps growing at its current rate, nominal aggregate demand, measured by final sales to domestic purchasers, will probably reach its long-run average annual rate of 4.8 per cent by mid-2016. This rate of nominal aggregate demand growth was last reached in 2006, so the current economic news from the US is encouraging.
But what about the secular stagnation debate? The secular stagnation thesis in a Keynesian form was popularised by Harvard University economist Alvin Hansen. In 1938, he asserted that the US was a mature economy that was stuck in a rut that it could not escape from. Hansen reasoned that technological innovations had come to an end; that the great American frontier (read: natural resources) was closed; and that population growth was stagnating. So, according to Hansen, investment opportunities would be scarce, and there would be nothing ahead except secular economic stagnation; unless, fiscal policy was used to boost investment via public works projects.
Hansen’s economics were taken apart and discredited by many non-Keynesian economists. But, the scholarly death blow was dealt by George Terborgh in his 1945 classic The Bogey of Economic Maturity. In the real world, talk of stagnation in the US ended abruptly with the post-second world war boom.
Today, another Harvard University economist, Larry Summers, is beating the drums for secular stagnation. Summers, like Hansen before him, argues that the government must step up to the plate and invest more to fill the gap left by deficiencies in private investment, so that the economy can be pulled out of its stagnation rut.
It does appear that net private domestic investment as a per cent of GDP has trended downwards since 1960. This is due to the fact that private capital consumption allowances as a percentage of GDP have trended upward. This shouldn’t surprise us. With the increasingly rapid rate of innovation, obsolescence and, therefore, capital consumption have increased. On the surface, these facts appear to give the stagnationists a reed to lean on. But, it’s a weak one.
To understand the troubling net investment picture, we must ask why businesses are so reluctant to invest. After all, it’s investment that fuels productivity and real economic growth. Are the stagnationists on to something? Have we really run out of attractive investment opportunities that require the government to step in and fill the void?
A recent book by Robert Higgs, Taking a Stand: Reflections on Life, Liberty, and the Economy, helps answer these questions. In 1997, Higgs first introduced the concept of “regime uncertainty” to explain the extraordinary duration of the Great Depression of the 1930s. Higgs’ regime uncertainty is, in short, uncertainty about the course of economic policy – the rules of the game concerning taxes and regulations, for example. These rules of the game affect the net benefits and free cash flows investors derived from their property. Indeed, the rules affect the security of their property rights. So, when the degree of regime uncertainty increases, investors’ risk-adjusted discount rates increase and their appetites for making investments diminish.
There is a mountain of evidence that regime uncertainty has ratcheted up during the tenure of the George W. Bush and Barack Obama administrations. For example, a recent Pew Research Centre survey finds that the percentage of the public that trusts Washington to do the right thing has fallen to all-time lows of around 20 per cent.
So, contrary to the stagnationists’ assertions, the government is the problem, not the solution. Secular stagnation in the US is nothing more than a phoney rationale for more government waste.
Steve Hanke is professor of applied economics at Baltimore’s Johns Hopkins University