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FD
EDITOR-IN-CHIEF: Camilla Lund Andersen
MANAGING EDITOR: Marina Primorac
SENIOR EDITORS
Gita Bhatt Natalie Ramirez-Djumena FINANCE & DEVELOPMENT A QUARTERLY PUBLICATION OF
Jacqueline Deslauriers Rani Vedurumudi THE INTERNATIONAL MONETARY FUND
James L. Rowe, Jr. Chris Wellisz March 2017 Volume 54 Number 1
ONLINE EDITOR: Marie Boursiquot
ASSISTANT EDITORS
Babar Ahmed Bruce Edwards FEATURES
Eszter Balzs Maria Jovanovi
Niccole Braynen-Kimani Nadya Saber GROWTH CONUNDRUM
Maureen Burke 2 Whither Economic Growth?
PRINT/WEB PRODUCTION SPECIALIST The global optimism at the turn of the century
Lijun Li
has been replaced by fear of long-term stagnation
EDITORIAL ASSISTANT: Robert Newman
Nicholas Crafts 2
COPY EDITOR: Lucy Morales
7 Cost of Aging
CREATIVE DIRECTOR: Luisa Menjivar As populations in richer nations get older, GDP growth slows, support costs
SENIOR GRAPHIC ARTIST: Michelle Martin rise, and government budgets feel pressure
ADVISORS TO THE EDITOR Ronald Lee and Andrew Mason
Bernardin Akitoby Laura Kodres
Celine Allard Tommaso Mancini Griffoli 10 Stuck in a Rut
Bas Bakker Gian Maria Milesi-Ferretti To revive global productivity, start by addressing the legacies of the
Steven Barnett Inci Otker-Robe financial crisis
Nicoletta Batini Laura Papi
Helge Berger Catriona Purfield
Gustavo Adler and Romain Duval
Paul Cashin Uma Ramakrishnan 14 Getting It Right
Adrienne Cheasty Abdelhak Senhadji Well-designed fiscal incentives can help spur
Luis Cubeddu Janet Stotsky
Alfredo Cuevas Alison Stuart innovation and ultimately growth
Thomas Helbling Ruud De Mooij
16 Rethinking GDP 14
2017 by the International Monetary It may be time to devise a new measure of
Fund. All rights reserved. For permission to
reproduce any F&D content, submit a request
economic welfare with fewer flaws
via online form (www.imf.org/external/ Diane Coyle
terms.htm) or by e-mail to copyright@imf.
20 Can Money Buy Happiness?
org. Permission for commercial purposes
also available from the Copyright Clearance People around the world share their thoughts on
Center (www.copyright.com) for a nominal what sparks this elusive feeling
fee.
24 Point-Counterpoint: Secular Stagnation
Opinions expressed in articles and other Sluggish Future 20
materials are those of the authors; they do J. Bradford DeLong
not necessarily reflect IMF policy. Policy Is the Problem
Subscriber services, Changes of address, John B. Taylor
and Advertising inquiries
IMF Publication Services 26 Straight Talk: The Case for Inclusive Growth
Finance & Development Emerging economies should share the fruits of their growth
PO Box 92780 more equitably
Washington, DC, 20090, USA
Telephone: (202) 623-7430
Tao Zhang
Fax: (202) 623-7201
E-mail: publications@imf.org ALSO IN THIS ISSUE
Finance & Development 30 A Middle Ground
is published quarterly by the International The renminbi is rising, but will not rule
Monetary Fund, 700 19th Street NW, Eswar Prasad
Washington DC 20431, in English, Arabic,
34 A Broader Reach 30
Chinese, French, Russian, and Spanish.
English edition ISSN 0145-1707 When more people and more firms have access to financial services, the
Postmaster: send changes of address to whole society can benefit
Finance & Development, International Adolfo Barajas, Martin ihk, and Ratna Sahay
Monetary Fund, PO Box 92780, Washington,
DC, 20090, USA. Periodicals postage 37 In Equality We Trust
is paid at Washington, DC, and at Inequality in the United States and Europe erodes trust among peopleand
additional mailing offices. can stifle economic growth
The English edition is printed at Dartmouth
Printing Company, Hanover, NH. Eric D. Gould and Alexander Hijzen
D
stability; Brazil has shown protecting
EEP unease about rising inequality and stagnating
them is compatible with development
living standards in advanced economies was at the
Frances Seymour and Jonah Busch 40 heart of the 2016 political upheaval. Globalization
43 Risky Mix and trade have been blamed, but entrenched slow
If financial institutions combine banking and growthwhat economists call secular stagnationmay be
nonbanking business there is potential for danger the real culprit. Parents who took for granted that their chil-
Ralph Chami, Connel Fullenkamp, Thomas dren would enjoy a brighter future had their dreams dashed
Cosimano, and Cline Rochon by the global financial crisis of 2008. Nine years later, rising
46 Unburnable Wealth of Nations populism and a return to nationalist, inward-looking poli-
Successful action to address climate change would cies threaten to unravel the postwar economic order.
diminish the value of fossil fuel resources in many As Nicholas Crafts of the University of Warwick argues
in our overview story, declining productivity growththe
of the worlds poorest countries
main reason for slow growth and falling incomeswas evi-
James Cust, David Manley, and Giorgia Cecchinato
dent long before the crisis struck. This issue of F&D looks
at why and asks whether the worlds advanced economies
DEPARTMENTS should resign themselves to secular stagnation or hope that
28 Picture This the right policies can revive productivity and lasting eco-
nomic growth.
Girl Power 28 Diving into the causes of slow productivity growth, IMF
Policies that help integrate women into the economists Gustavo Adler and Romain Duval find roots
workforce benefit everyone in the global financial crisistight credit undermined
Maria Jovanovi not only firms productivity but also the economys ability
50 Currency Notes to redirect capital. Other factors were also in play, espe-
cially aging populations. Ronald Lee of the University of
Fifty Marks the Spot 50
California, Berkeley, and Andrew Mason of the University
Trinidad and Tobagos new of Hawaii, Manoa, argue convincingly that slower popula-
$50 bill is dressed for a celebration tion growth will almost certainly mean slower national
Marie Boursiquot income and GDP growth. But they also show that the effect
52 People in Economics on individualsin per capita income and consumption
will depend on economic policies.
Parallel Paths
We wonder what to do. Can policy choices calm fears
Atish Rex Ghosh profiles Kristin
about redistribution and fairness without shutting down
Forbes, who straddles academia
trade, the main engine of postwar economic growth?
and policymaking What drives higher productivity and innovation? How can
55 Book Reviews 52 advanced economies adapt to an aging workforce?
The Man Who Knew: The Life and Times of Alan First we must measure the right thing. Diane Coyle of
Greenspan, Sebastian Mallaby the University of Manchester discusses the pros and cons of
The Vanishing Middle Class: Prejudice and Power GDP to measure economic welfare.
in a Dual Economy, Peter Temin Second, we should not forget that two-thirds of the worlds
populationnamely, those in developing and emerging market
A Culture of Growth: The Origins of the Modern
economiesface a different reality. Younger populations and
Economy, Joel Mokyr
still-vibrant productivity in many of these countries are driving
higher economic growth at home and in the global economy.
Illustration: cover: Michael Glenwood; pp. 2829, David Hunt, ThinkStock, Freepik;
Third, we shouldnt go overboard. Global trade has been
pp. 30, 32, iStock via Getty Images.
a leading force behind productivity growth, and barriers
Photography: pp. 23, Christof Stache/Getty Images; p. 5, Michael H/Getty against it would hurt all economies, large and small. Instead
Images; p. 7, Tuul & Bruno Morandi/Getty Images; p. 10, Orjan F. Ellingvag/
of reaching for easy answers, economists and policymakers
Corbis via Getty Images; p. 14, Toru Yamanaka/Getty Images; p. 16, Christopher
must probe their own economies challenges. As Berkeley
Jue/Getty Images; p. 24, courtesy of University of California, Berkeley; p. 25,
courtesy of Stanford University; p. 26, IMF photo; p. 34, Money Sharma/AFP/
economist Bradford DeLong argues, Only if we do some-
Getty Images; p. 37, Mike Kemp/In Pictures Ltd./Corbis via Getty Images; thing about it, is it likely that in nine years we will no longer
p. 40, Ricardo Siqueira/Brazil Photos/LightRocket via Getty Images, ThinkStock; be talking about secular stagnation.
p. 42, ThinkStock; p. 43, Ryan McVay/Getty Images; p. 46, Andrey Rudakov/
Bloomberg via Getty Images; pp. 5051, Central Bank of Trinidad and Tobago; Camilla Lund Andersen
Carole Ann Ferris; p. 52, IMF photo; pp. 5557, IMF photo. Editor-in-Chief
Read o n lin e a t w w w.im f.o r g /fa n d d
V isit F& Ds Fa c e b o o k p a g e :
www.facebook.c o m /F in a n c e a n d D eve lo p m e n t Finance & Development March 20171
Whither
ECONOMIC GROWTH?
The global optimism at the turn of the century
has been replaced by fear of long-term stagnation
I
T seems like only yesterday that the so-called new per hour worked) is expected. Compared with the
economy was ascendant and growth expectations golden age of the 1950s and 1960s, the slowdown is
were buoyant. But today there is a widespread fear even more pronounced, especially for Europe.
of a future of secular stagnation, in which very Slower growth in Europe and the United States has
slow growth will be the new normalespecially in mixed implications for growth prospects in develop-
advanced economies. While it is clear that the turn- ing economies. Most obviously, on the negative side,
of-the-century optimism was not justified, it is also it means less demand for these countries exports, so
possible that todays pessimism is excessive. models of development based on export-led growth
Current mainstream growth projections for the may need to be rethought. The slowdown may also
United States and the European Union over the reduce the availability of new technology across the
medium term represent a marked slowdown from world. On the other hand, it may imply a lengthy
growth rates in the decades prior to the global finan- period of low real interest rates and redirection of
cial crisis that began in 2008 (see table). Compared capital flows away from advanced economies toward
with 1995 to 2007, future US and European growth emerging markets with more promising investment
of real (after-inflation) GDP per person is expected opportunities. That could mean a continuation of
to diminish by half, or worse. In each case, a serious rapid catch-up growth and a faster rise in their share
weakening of growth in labor productivity (output of world GDP.
deal about
the world
Cost of Aging
A
N aging population and slower rate of GDP and aggregate consumption. Many
labor force growth affect economies advanced economies already have a declining
in many waysthe growth of GDP working-age populationin Europe it will fall As populations
slows, working-age people pay more more than 20 percent between 2015 and 2055, in richer nations
to support the elderly, and public budgets strain with an attendant decline in GDP growth.
under the burden of the higher total cost of get older,
health and retirement programs for old people. Per capita output matters GDP growth
Yet an aging population may raise the But individual well-being depends not
amount of capital per worker, which would on aggregate, but on per capita, growth. slows, support
boost wages and output per hour worked Standard growth models predict that slower costs rise, and
(productivity) and reduce interest rates as population growth also leads to rising output
higher wages lower the return on capital. and wages per worker. The underlying ques- government
Alternatively, population aging and slowing tion is whether this higher output per worker budgets feel
labor force growth could lead to secular stag- will translate into higher per capita income.
nation if firms are discouraged from investing That will depend on how much, as the popu-
pressure
abundant loanable funds. lation ages, increased productivity offsets the
Economic growth is slowing in advanced rise in the number of dependents (old and
economies at least in part because the end young) per worker.
of the baby boom led to a decline in popula- To answer that question, we look more
tion and labor force growthdespite immi- closely at how economic activity varies by
gration. Many empirical studies have found age, drawing on national transfer accounts,
that GDP growth slows roughly one to one which measure how people at various ages
with declines in labor force and population produce, consume, and save resources
growtha disquieting prospect for both the (NTAccounts.org; Lee and Mason 2011;
United States and Europe. United Nations 2013).
In the United States, during the 40 years from Children consume more than they pro-
1975 to 2015, the 20- to 64-year-old population duce, and the same is true on average for
grew 1.24 percent a year, but is projected at only the elderly. Consumption by children and to
0.29 percent for the next 40 years. That should some degree by the old is covered by prime-
lead to a corresponding decline in the growth age adultsthose roughly 25 to 59who
The lower the support ratio, the fewer workers there are to
Chart 1
finance consumers, so either consumption must be reduced
Earning and eating or labor supply increasedfor example, through later retire-
Prime-age adults, ages 25 to 59, earn more than they consume, ment. Between 2015 and 2050 the support ratio will drop
while the young and elderly do the opposite. 0.26 percent a year in the United States, 0.40 percent in
(average per capita value, index, 1 = average labor income of ages 3049) other high-income nations, and 0.82 percent in China (see
1.2 Chart 2). This means that by 2050, unless the labor supply
1.0
increases, consumption must drop by 25 percent in China,
9 percent in the United States, and 13 percent in other high-
0.8
income countries. The age patterns of consumption and
0.6 earning, like those shown in Chart 1, will have to be adjusted
0.4 to accommodate new demographic realities.
Labor income
0.2 Consumption Paying for elderly consumption
0
0 10 20 30 40 50 60 70 80 90 100 The elderly pay for consumption in a variety of ways. Besides
Age what they may earn from continuing to work, older consumers
Lee, corrected 2/10/2017
Source: Mason, Lee, and others, forthcoming. rely in part on their assetsincluding farms and businesses,
Note: The data cover the 24 countries classified as high income by the World Bank. Labor housing, and savings and investments. Another part comes
income includes earnings, benefits, labor income of the self-employed, and an estimate of the
value of labor supplied by unpaid family workers. Consumption is based on household from the government in the form of cash such as pensions
expenditures imputed to individuals plus in-kind public transfers received by people at each age.
and in-kind public transfers such as health care and long-
term care. These public transfers are paid for by taxes, mostly
those paid by the prime-age adult population. Some consump-
Chart 2 tion may come through net support (support received minus
Burden sharing support given) from younger family members. The elderly in
The number of workers supporting consumers (young, prime age, east Asia get more support from their families than they give.
and elderly) will decline between now and 2050. But in much of the rest of Asia (including Japan and Korea),
(support ratio, 2015 = 100) Europe, and the Americas, older people on average give more
120 to their younger family members than they receive.
China US Other high income
110
100 An aging population puts
90
80 budgetary pressure on society
70
60
as a whole.
1980 90 2000 10 20 30 40 50
In general, the higher the proportion of consumption the
Source: Mason, Lee, and others, forthcoming. elderly pay for themselves, the less cost falls on prime-age
Note: Other high income = the 24 countries classified as high income by the World Bank,
excluding the United States. The support ratio is the number of workers divided by the total adults as higher taxes (see Chart 3). Europe stands out for its
number of consumers (that is, everyone).
heavy reliance on public sector transfers to pay for elder con-
sumption. When older people contribute little to their own
produce more than they consume (see Chart 1). As a popu- consumptioneither through asset income or continuing to
lation ages, the proportion of workers declines, while the workit is a recipe for heavy costs as the population ages.
proportion of high-consuming elderly rises. In some coun- The reverse is true in the United States, where people gener-
tries, such as Japan, Sweden, and the United States, relative ally retire later and rely more on their own assets in old age.
consumption by old people is much higher than the average Latin America is between the two, and Asia resembles the
depicted in Chart 1; in others, such as Austria and Spain, United States.
the relative increase is much smaller. Greater consumption Public sector transfers for pensions, health care, and
by the elderly may be partially offset by a smaller propor- long-term care are a particular problem as populations age,
tion of children in the population. But if fertility rates begin because these payments, even after subtracting the portion
to recover from current low levels, the proportion of chil- funded by tax payments from the elderly, absorb a large por-
dren and old people in the population may increase, boost- tion of public budgets. Projections indicate that typically
ing pressure on prime-age workers. these programs will be unsustainable unless taxes are raised
An aging population puts budgetary pressure on society as or benefits reduced or both.
a whole because the number of workers declines relative to Fiscal support ratios are a way to look at the problem. They
the number of consumers. This phenomenon is quantified by are constructed like support ratios, except they relate taxpay-
the support ratio of the total number of workers to consumers ers to beneficiaries rather than workers to consumers. In the
(which includes everyoneyoung, prime age, and elderly). United States, the fiscal support ratio will drop 11 percent
T
To revive ECHNOLOGICAL change seems well (see Chart 1).
to be happening faster than ever. Of course, productivity is inherently diffi-
global The prospect of such inventions as cult to measure, but there is no good reason to
productivity, driverless cars, robot lawyers, and suspect that measurement error has increased
3D-printed human organs becoming com- over the past decadeand even if it has, it
start by monplace suggests a new wave of technologi- would hardly account for the bulk of the slow-
addressing the cal progress. These advances should raise our down, as recent studies show (Svyerson 2016).
standard of living by allowing us to produce If sustained, sluggish productivity growth
legacies of the more goods and services with less capital will seriously threaten progress in raising
financial crisis and fewer hours of workthat is, to be more global living standards, the sustainability of
productive. But, to paraphrase Nobel laure- private and public debt, the viability of social
ate Robert Solow, we can see it everywhere protection systems, and economic policys
but in the productivity statistics. ability to respond to future shocks. It would
The vexing truth is that output per worker be unwise to sit around and wait for artificial
and total factor productivitywhich mea- intelligence and other cutting-edge technolo-
sures the overall productivity of both labor gies to spawn a hypothetical productivity
and capital and reflects such elements as revival. But, to cure the affliction, we must
technologyhave slowed sharply over the first diagnose its root causes.
past decade, and especially since the 200809
global financial crisis. This phenomenon is Lasting scars
evident in advanced economies and seems Productivity growth comes from technologi-
to extend to many developing economies as cal innovation and diffusion, and there is no
Workers wait to be called for jobs at Local 13 Longshore Workers Dispatch Hall,
10 Finance & Development March 2017 Los Angeles, California, United States.
Adler, corrected 2/10/2017
GROWTH
persistent declines in output. Such
Chart 1
output losses reflect not only con-
Easing off tinuing declines in employment and
Productivity growth has slowed dramatically around the world in recent years, especially since
investment but also a permanent
the global financial crisis.
drop in productivity (see Chart 2).
(five-year average productivity growth rate, percent)
Advanced Economies Emerging Market Economies Low-Income Economies
The dynamics following the global
3 financial crisis were no different.
200809 All
2 global
How could a majorbut seem-
1 financial ingly temporaryfinancial shock
crisis
have such large and persistent effects
0
Excluding China on productivity?
1 Much can be attributed to the
2 interplay of weak corporate balance
3 sheets, along with tight credit condi-
Adler,95corrected
20002/10/2017
1990 05 10 15 1990 95 2000 05 10 15 1990 95 2000 05 10 15 tions, weak aggregate demand, and
Sources: Penn World Tables 9.0; IMF, World Economic Outlook; and IMF staff calculations. the economic and policy uncertainty
Note: Group averages are weighted using gross domestic product (purchasing power parity).
that characterize the postcrisis envi-
ronment. These factors appear to
have fed a vicious circle between weak investment, total fac-
Chart 2 tor productivity, and potential growth. We focused primarily
Lasting effects on advanced economies, and although some of our findings
The output decline seen during deep recessions, such as apply to developing economies, factors behind their produc-
the global financial crisis, reflects a long-lasting drop in tivity slowdown are less clear and warrant more research.
total factor productivity. In advanced economies, firms with weaker balance sheets
(TFP response to deep recessions, percent) that is, those with high debt or substantial expiring loans
2
before the crisis experienced a more abrupt productivity drop
0 than their counterparts with stronger balance sheets (Chart 3).
TFP total (global financial crisis)
TFP total (past episodes)
This was not good news. If these firms had been doing badly
2 before the crisis, their downsizing or outright market exit
4
would have led to higher aggregate productivityallowing
the so-called cleansing effect of recessions to play out. But this
6 was not the case. Firms with more vulnerable balance sheets
enjoyed productivity dynamics similar to those with lower vul-
8
1 0 1 2 3 4 5 nerability until 2008, which suggests that the persistent slug-
Years gish performance of more vulnerable firms after 2008 resulted
Sources: Blanchard, Cerutti, and Summers 2015; Penn World Tables 9.0; KLEMS; and
IMF staff calculations.
from the crisis shock, not from intrinsically poor performance.
Note: TFP = total factor productivity (deviation from pre-recession trend) in advanced Balance sheet vulnerabilities were compounded by hard-
economies. TFP is the portion of economic growth not explained by increased inputs of
capital and labor. ening financial conditions. In fact, the sharp drying up of
credit that followed the Lehman Brothers failure, and later
the euro area crisis, sets the global financial crisis apart
shortage of explanations for why either or both may have from past recessions. The combination of two factors vis-
slowed. Some blame a fading information and communica- ibly affected productivityparticularly in countries where
tion technology boom (Fernald 2015; Gordon 2016); lethar- financial conditions tightened the most. In those economies,
gic businesses and insufficient labor and product market the postcrisis divergence in productivity between firms that
reforms (Andrews, Criscuolo, and Gal 2015; Cette, Fernald, entered the crisis with sizable maturing loans and those with
and Mojon 2016); the rise of specific-knowledge-based capi- low refinancing needs was most striking. A simple calcula-
tal and winner-take-all market dynamics; mismatched and tion suggests that the interplay between preexisting firm-
deficient skills; demographic factors such as aging popula- level vulnerability and tighter credit may account, on average,
tions; or slowing global trade integration (IMF 2016). for up to a third of the total slowdown in productivity after
Many of these factors have played a significant role and the crisis in advanced economy firms.
may well remain a drag on productivity. But the abruptness, Why did the credit crunch wreak such enduring harm on
magnitude, and persistence of the productivity slowdown in productivity of existing firms? Our evidence suggests that
the aftermath of the global financial crisis suggest that these the sudden liquidity squeeze and the associated difficulty in
slow-moving forces are not the only, or even the main, cul- financing working capital may have forced distressed firms
prits. The crisis itself is a first-order factor. into asset fire sales, layoffs, intangible investment cuts, or
Unlike typical economic slowdowns, deep recessions bankruptcy, with lingering adverse effects on productivity.
often associated with financial crisesinvolve large and Immediately following the Lehman failure, firms with pre-
Chart 3
1990s and early 2000s, for example, technological change
such as Internet use was embodied in new and increasingly
Divergent paths
powerful computers. Estimates suggest that falling invest-
Firms that were highly indebted or had substantial expiring loans
ment may have lowered total factor productivity growth in
before the crisis saw a bigger drop in productivity than those with
advanced economies by nearly 0.2 percentage point a year
stronger balance sheets.
following the crisis.
(total factor productivity index, 2005 = 100)
Elevated policy uncertainty since the crisis also appears
100 TFP by firm leverage 100 TFP by firm rollover risk to have played a significant role in driving down investment
and productivity in important economies. Higher uncer-
96 96
tainty leads firms, especially those dependent on external
92 92 financing, not only to cut investment but also to concen-
trate what it does invest on shorter-term, lower-risk, lower-
88 88
return projects. According to new IMF findings, greater
84 84 uncertainty weakened productivity disproportionately in
industries (for example, construction) that relied more on
80 80
2005 07 09 11 13 2005 07 09 11 13 external financing. Weaker investment in information and
Low High communication technology were a contributing factor.
Source: Duval, Hong, and Timmer, forthcoming. Higher uncertainty overall may have aggravated the post-
Note: High/low leverage and high/low rollover risk correspond to the 75th and 25th percentiles crisis productivity slowdown by as much as 0.2 percent a
of the cross-country cross-firm distribution of leverage and rollover risk in a large sample of firms
in advanced economies. Rollover risk is measured as debt maturing within a year in 2007, as a year, on average, in Europe, 0.1 percent in Japan, and 0.07
percent of total sales. Leverage is measured as total debt to total assets.
percent in the United States.
T
Well-designed HERE is considerable debate over anything away, so they will not spend enough
how countries can increase their po- on research and development.
fiscal incentives tential economic growth in the com- This underinvestment can be addressed by
can help spur ing years. Many will rely on produc- fiscal incentives such as tax credits and direct
tivity growth, driven by innovation. subsidies, which lower the cost of innovation
innovation Just as inventions such as electricity and the and encourage firms to invest more. Empirical
and ultimately internal combustion engine in the late 19th studies suggest that fiscal incentives must
century laid the foundation for high growth reduce a firms research and development
growth in the mid-20th century, so too could three- costs by approximately 50 percent to factor in
dimensional printing, driverless cars, and the spillover benefits that others gain.
artificial intelligence pave the way for growth During the past decade, fiscal support
during the coming decades. Some observers, for private research and development has
such as Erik Brynjolfsson and Andrew McAfee increased in most countries. Yet differ-
of the Massachusetts Institute of Technology, ences remain large, and support is generally
believe a major growth surge is in the offing. well below the 50 percent desirable level. If
Others, such as Northwestern Universitys advanced economies were to increase their
Robert Gordon, are less optimistic. support in the form of tax credits or other
Whatever your view of the future, one incentives to meet this target level, esti-
thing is clear: policy matters. Governments mates suggest that research and develop-
generally pursue a wide variety of policies to ment would increase by approximately 40
make a welcoming environment for innova- percent. Such expansion could lift GDP in
tionthrough the protection of intellectual these economies by as much as 5 to 8 per-
property rights, competition policies, labor cent over the long term.
market regulation, and effective bankruptcy But it is not just the size of fiscal incentives
laws. Tax and spending policies do much to that matters: good design and implementation
stimulate innovation and growthprovided are also critical. Countries vary widely in this
they are well designed. regard. In Australia and Korea, for instance,
relatively generous tax credits effectively
Inspiration, perspiration, incentives reduce the cost of extra research and develop-
Research and development help drive innova- ment investment by nearly 50 percentthat is,
tion. Governments play an important role in they approach the theoretical ideal. Germany
funding higher education and basic research offers targeted subsidies to encourage collabo-
at universities and public laboratories, which ration between universities and private firms.
helps advance innovation at private compa- Other countries grant tax relief for the wages
nies. But fiscal policies can also play a direct of researchers. Most of these fiscal incentives
role in fostering innovation by businesses. have worked well, studies suggest, when they
Private firms typically do not invest enough were implemented effectively.
in research and development, in part because However, not all fiscal incentive policies
they lack adequate incentives. These invest- are equally effective at nurturing innovation.
ments tend to benefit the broader economy Take, for example, the so-called patent
in addition to what the firm itself can appro- box regimes many European countries have
priate. Others may imitate the technology in introduced recently. These programs signifi-
new products, which often inspires follow-up cantly reduce the corporate tax burden on
innovations. As a result, research by one firm income from innovation (such as from pat-
usually ends up being beneficial to others. ents), but they have not worked. Although
Private companies are not interested in giving they reward success, they do not reduce the
Diane Coyle
W
HY does economic growth matter? The an- term measure. Economic policies aimed at delivering growth
swer for economists is that it measures an im- have demonstrated the validity of the famous comment of their
portant component of social progressname- intellectual architect, John Maynard Keynes: In the long run
ly, economic welfare, or how much benefit we are all dead.
members of society get from the way resources are used and Seventy years on, the long run is upon us. A broad measure
allocated. A look at GDP per capita over the long haul tells of the sustainability of economic growth, and thus long-term
the story of innovation and escape from the Malthusian trap economic welfare, would take account of economic assets as
of improvement in living standards that is inevitably limited well as the flows counted in GDP: the need to maintain infra-
by population growth. structure or record its depreciation as bridges crumble and
GDP growth is instrumentally important as well. It is roads develop potholes. A true national balance sheet would
closely correlated with the availability of jobs and income, account for future financial liabilities, such as state pensions. It
which are in themselves vital to peoples standard of living would also include increases in human capital as more people
and underpin their ability to achieve the kind of life they attain greater education and skill. Economic welfare must be
value (Sen 1999). calculated net of such changes in the value of national assets.
However, GDP is not a natural object, although it is now
everyday shorthand for economic performance. It cannot be Household work
measured in any precise way, unlike phenomena in the physi- A long-standing criticism of reliance on GDP as the mea-
cal world. Economists and statisticians understand, when sure of economic success is that it excludes much unpaid
they stop to think about it, that it is an imperfect measure work by households. There must be an accepted definition of
of economic welfare, with well-known drawbacks. Indeed, what is part of the economy and measurable and what is not.
early pioneers of national accounting, such as Simon Kuznets Economists call this a production boundary. What is within
and Colin Clark, would have preferred to measure economic that boundary and what is not inevitably involve matters of
welfare. But GDP prevailed because the demands of wartime judgment. One early debate was whether government spend-
called for a measure of total activity. So from the very start, ing should be includedon the grounds that it is collective
the concept of GDP has long had its critics. But coming up consumptionor excludedon the grounds that the gov-
with a better gauge of welfare is easier said than done. ernment is paying for things like roads and security that are
inputs into the economy (just like a business expense) rather
Short-term measure than consumption or investment goods.
GDP measures the monetary value of final goods and ser- Another key debate concerned how to define goods and
vicesthat is, those that are bought by the final userpro- services producedand often also consumedby house-
duced and consumed in a country in a given period of time. holds. Home-produced goods such as food were included,
The limit of GDP as a measure of economic welfare is that because in many countries these can just as easily be bought
it records, largely, monetary transactions at their market and sold in the market, but home-provided services such as
prices. This measure does not include, for example, environ- cleaning and child care were not. Not surprisingly, feminist
mental externalities such as pollution or damage to species, scholars have always decried the fact that work done mainly
since nobody pays a price for them. Nor does it incorpo- by women is literally not valued. Many economists agreed in
rate changes in the value of assets, such as the depletion of principle, but the line was drawn partly for reasons of practi-
resources or loss of biodiversity: GDP does not net these off cality: surveying household services was a daunting task, and
the flow of transactions during the period it covers. these services were seldom purchased in the marketplace.
The environmental price of economic growth is becoming This of course has changed dramatically in the econo-
clearerand higher. The smog over Beijing or New Delhi, the mies of the Organisation for Economic Co-operation and
impact of pollution on public health and productivity in any Development (OECD) since the 1940s and 50s, when the pro-
major city, and the costs of more frequent flooding for which duction boundary decisions were made. As more women work
countries are still ill-prepared are all illustrations of the gap for pay, the market for services such as cleaning and child care
between GDP growth and economic welfare. This is why econo- has grown, and households can and often do switch between
mists and statisticians have been working to introduce estimates performing and buying these services. There is no logical rea-
of natural capital and its rate of loss (World Bank 2016). When son not to treat household work like any other work.
they do, it will be clear that sustainable GDP growth (that enables The evolution of the digital economy has reignited this old
future generations to consume at least as much as people today) debate, as it is starting to change the way many people work.
is lower than GDP growth recorded over many years. Getting National accountants have treated government and business as
these new measurements into the mainstream policy debate and the productive part of the economy and households as non-
reflected in political choices, however, is another matter. productive, but the previously relatively clear border between
Indeed, GDP ignores capital assets of all kinds, including home and work is eroding. More and more people are self-
infrastructure and human capital; it is an inherently short- employed or freelance through digital platforms. Their hours
may be flexible, and work can overlap with other activities. the price of such innovations as solar energy and genome
In many cases they are using household assets, from comput- sequencing has been falling rapidly. Could it be that the sta-
ers and smartphones to their homes and cars, for paid work. tistics are not properly adjusting for quality improvements
Many people contribute free digital work such as writing open- arising from technology and therefore overstate inflation and
source software that can substitute for marketed equivalents, understate productivity and growth in real terms?
and it clearly has great economic value despite a price of zero. Official figures in practice incorporate very little qual-
These developments underline the need for a much better ity adjustment to calculate hedonic price indicesthat
statistical understanding of household activity, yet few coun- is, those that take into account quality improvements.
tries collect any suitable information on household assets. Researchers who have tried to extend hedonic adjustment to
a broader range of prices in the information and communica-
Ever-evolving technology tion technology sector in the United States have concluded
The blurring of boundaries between home and work is not that it makes little difference to the picture of slow productiv-
the only way in which technology is making GDP calculation ity growth, in part because there is little US-based informa-
difficult. Many in the technology sector argue that conven- tion and communications technology manufacturing (Byrne,
tional GDP statistics understate the importance of the digital Fernald, and Reinsdorf 2016).
revolution. The pace of innovation has not slowed in areas However, this research has not been extended to the far
such as telecommunications, biotechnology, materials, and wider range of goods and services affected by digital transfor-
green energy, they rightly point outmaking the lackluster mation, and there are some conceptual questions that need to
growth and productivity performance of so many advanced be resolved. For example, is a streamed music service equiva-
economies even more of a puzzle. lent to a digital download or buying compact discs, or is it a
For instance, compression technology allows wireless net- new good? In other words, is the consumer buying a specific
works to carry more data faster than ever at high quality, and format or simply the ability to listen to music? If the former,
JASPREET SETHI
Independent Financial Consultant
New Delhi, India
harder, I believe.
ADAM HASSAN
Self-employed, Abuja, Nigeria
MOHAMMAD ADNAN
Automobile Mechanic, New Delhi, India
You can have lots of money, but if you dont have happi-
ness in your heart, you wont be able to share it.
If I suddenly found myself with lots of money, I
would invest it and try to help people, because thats
the way to become happy. I would help the displaced
in our country, single mothers, and children who have
been subject to violence and war. Id help people try to
achieve a different type of happiness, a happiness that
has nothing to do with material things.
Reporting/photos by Feature Story News: Abuja, Kunie Babs; Bogot, Fernando Ramos; New Delhi, Kshitij Nagar; London, Natalie Powell; Moscow, Andrei
Kharchenko.
Sluggish Future
J. Bradford DeLong
Y
OU are reading 8. Increasing technology- and rent-seeking-driven obsta-
this because of the cles to competition, which make investment unprofitable for
long, steady de- entrants, and market cannibalization possible for incumbents.
cline in nominal The result is that with rates so close to zero, central banks
and real interest rates on all can no longer easily and effectively act to maintain full
kinds of safe investments, employment by cutting interest rates in recessions. Central
such as US Treasury securi- banks typicallyand powerfullyoperate by buying and sell-
ties. The decline has created ing bonds for cash to encourage investment spending by lead-
a world in which, as econo- ing the value of assets in the future to be higher and encourage
mist Alvin Hansen put it consumption spending by making people feel richer. But when
when he saw a similar situa- there is little room for cutting rates central banks are reduced
tion in 1938, we see sick re- to using novel, uncertain, and much weaker tools to try to
J. Bradford DeLong is Professor
coveries die in their infan- guide the economy.
of Economics at the University
cy and depressions feed on The magnitude of this decline in safe rates since 1990 is
of California, Berkeley.
themselves and leave a hard demonstrated by US Treasury securities. The short-term
and seemingly immovable annual interest rate has fallen from 4 percent to 1.2 percent
core of unemployment In other words, a world of secular in real (inflation-adjusted) terms and from 8 to 0.5 percent in
stagnation. Harvard Professor Kenneth Rogoff thinks this is nominal terms, with long-term rates following them down.
a passing phasethat nobody will talk about secular stagna-
tion in nine years. Perhaps. But the balance of probabilities is
the other way. Financial markets do not expect this problem
We should adopt appropriate
to go away for at least a generation. fiscal policies that provide for
Eight reinforcing factors have driven and continue to drive
this long-term reduction in safe interest rates: expansionary investment.
1. Higher income inequality, which boosts saving too
much because the rich cant think of other things to do with The natural response to this secular stagnation is for
their money; governments to adopt much more expansionary tax and
2. Technological and demographic stagnation that low- spending (fiscal) policies. When interest rates are low and
ers the return on investment and pushes desired investment expected to remain low, all kinds of government invest-
spending down too far; mentsfrom bridges to basic researchbecome extraor-
3. Nonmarket actors whose strong demand for safe, liq- dinarily attractive in benefit-cost terms, and government
uid assets is driven not by assessments of market risk and debt levels should rise to take advantage of low borrowing
return, but by political factors; costs and provide investors the safe saving vehicles (gov-
4. A collapse of risk-bearing capacity as a broken finan- ernment bonds) they value. Harvards Lawrence Summers
cial sector finds itself overleveraged and failing to mobilize argues that interest rates are so low that the inability of cen-
savings, thus driving a large wedge between the returns on tral banks to conduct effective monetary policy has become
risky investments and the returns on safe government debt; a chronic condition. He says that there is no sign we will
5. Very low actual and expected inflation, which means emerge from this state for a generation, and so we should
that even a zero safe nominal rate of interest is too high to bal- adopt appropriate fiscal policies that provide for expansion-
ance desired investment and planned saving at full employment; ary investment the private sector is reluctant to undertake.
6. Limited demand for investment goods, coupled with Critics of Summerss secular stagnation thesis miss the
rapid declines in the prices of those goods, which puts too point. Each seems to focus on one of the eight factors driving
much downward pressure on the potential profitability of the decline in interest rates and then say that factor either will
the investment-goods sector; end soon or is healthy for some contrarian reason.
7. Market failure in the information economywhich Since the turn of the century, the North Atlantic economies
means markets cannot properly reward those who invest in new have lost a decade of what we used to think of as normal eco-
technologies, even when the technologies have enormous social nomic growth, with secular stagnation the major contributor.
returnswhich lowers the private rate of return on investment Only if we do something about it is it likely that in nine years
and pushes desired investment spending down too far; we will no longer be talking about secular stagnation.
24 Finance & Development March 2017
GROWTH
S
ECULAR stagna- These shifts are closely related to changes in economic
tion has been the policymainly supply-side or structural policies: in other
subject of much de- words, those that raise the economys productive potential
bate ever since 2013, and its ability to produce. During the 1980s and 1990s, tax
when Lawrence Summers reform, regulatory reform, monetary reform, and budget
proposed the hypothesis that reform proved successful at boosting productivity growth
the economy as currently in the United States. In contrast, the stagnation of the
structured is not capable of 1970s and recent years is associated with a departure from
achieving satisfactory growth tax reform principles, such as low marginal tax rates with
and stable financial condi- a broad base, and with increased regulations, as well as
tions simultaneously. with erratic fiscal and monetary policy. During the past
Speaking at a recent con- 50 years, structural policy and economic performance
John B. Taylor is the Mary
ference, Summers posited have swung back and forth together in a marked policy-
and Robert Raymond
that for the past decade and performance cycle.
Professor of Economics at
a half, the economy had been To see the great potential for a change in policy now, con-
Stanford University.
constrained by a substantial sider the most recent swing in productivity growth: from
increase in the propensity to 2011 to 2015 productivity grew only 0.4 percent a year com-
save and a substantial reduc- pared with 3.0 percent from 1996 to 2005.
tion in the propensity to spend and invest, which were keep- Why the recent slowdown? Growth accounting points
ing equilibrium interest rates and economic growth low. to insufficient investmentamazingly, capital per worker
Few dispute that the economy has grown slowly in recent declined at a 0.2 percent a year clip from 2011 to 2015
years, especially when the financial crisis is taken into compared with a 1.2 percent a year increase from 1996 to
account. But secular stagnation as an explanation for this 2005and to a decline in the application of new ideas, or
phenomenon raises inconsistencies and doubts. total factor productivity, which was only 0.6 percent during
Low policy interest rates set by monetary authorities, 201115 compared with 1.8 percent during 19962005.
such as the US Federal Reserve, before the financial cri-
sis were associated with a boom characterized by rising
inflation and declining unemploymentnot by the slack Productivity growth is
economic conditions and high unemployment of secular
stagnation. The evidence runs contrary to the view that the depressingly low nowactually
equilibrium real interest ratethat is, the real rate of return
required to keep the economys output equal to poten-
negativebut there is nothing
tial outputwas low prior to the crisis. And the fact that
central banks have chosen low policy rates since the crisis
secular about this.
casts doubt on the notion that the equilibrium real inter-
est rate just happened to be low. Indeed, in recent months, To reverse this trend and reap the benefits of a large boost
long-term interest rates have increased with expectations to growth, the United States needs another dose of struc-
of normalization of monetary policy. tural reformincluding regulatory, tax, budget, and mon-
For a number of years going back to the financial cri- etaryto provide incentives to increase capital investment
sis, I and others have seen a more plausible reason for the and bring new ideas into practice. Such reforms would
poor economic growthnamely, the recent shift in govern- also help increase labor force participation and thus raise
ment economic policy. Consider the growth in productivity employment, further boosting economic growth.
(output per hour worked), which along with employment While the view that policy is the problem stands up to
growth is the driver of economic growth. Productivity the secular stagnation view, the ongoing debate suggests a
growth is depressingly low nowactually negative for the need for more empirical work. The recent US election has
past four quarters. But there is nothing secular about this. raised the chances for tax, regulatory, monetary, and per-
Indeed, there have been huge swings in productivity in the haps even budget reform, so there is hope for yet another
convincing swing in the policy-performance cycle to add
past: the slump of the 1970s, the rebound of the 1980s and
1990s, and the current decline. to the empirical database.
Toward
Inclusive Growth
Emerging markets should share the fruits
of their growth more equitably
Tao Zhang
G
ROWTH rates in emerging mar- markets need to achieve high-income status.
ket countries have significantly Addressing these issues today is all the more
outpaced those of more developed important in light of the prospect of less
economies in recent years. Pov- favorable global economic conditions.
erty has fallen; standards of living have im-
proved. But with this rapid expansion comes More progress needed
the danger that the gap between the rich and Over the past few years, emerging markets
the poor in those countries will widen. Pew have made progress in fostering inclusive
Research polls show that most people are op- growththanks, in part, to favorable global
timistic about the future in emerging markets conditions, such as low interest rates and
such as India, Nigeria, and other countries rebounding international trade. Growth in
Tao Zhang is Deputy that are progressing toward advanced econ- these countries has averaged about 4 per-
Managing Director at omy status. But we must ensure that growth cent a year since the early 2000s, accounting
the IMF. remains inclusive in these economies so that for over half of global growth. And income
this optimism is justified. inequality has declined, with the Gini coef-
By inclusive growth, I mean a more equi- ficientthe most common indicator of
table sharing of the benefits of increased pros- inequalityfalling to about .40 from .45.
perity, decent-paying jobs, equal employment (The Gini coefficient ranges from zero, when
and education opportunities, and improved everyone has the same income, to 1, when
access to and provision of health care and a single individual receives all the income.)
financial services. In comparison to advanced Poverty has also fallen, employment has
economies, emerging markets experience risen, education levels have gone up, and
greater income disparity and higher poverty, access to financial services and health care
and lag behind in access to key social services has improved.
like health care and finance. But sustaining this progress can be chal-
We need to make growth inclusive not lenging. To begin with, we cannot be com-
only because it is the morally right thing to placent. In many emerging markets, income
do, but also because it is critical for achieving inequality remains high and too many people
sustainable strong growth. Research inside still live in absolute poverty. More important,
and outside the IMF has shown that high lev- these countries are facing a new global eco-
els of inequality tend to reduce the pace and nomic landscape, with increasing uncertain-
durability of growth and that policymakers ties. As emerging markets strive to attain the
should not be afraid to adopt measures that same level of development as advanced econ-
ensure shared prosperity, including ones that omiesa process that entails accumulating
redistribute wealth. capital and raising productivitythese chal-
So it will be important for policymakers to lenges will tend to worsen.
ensure that growths benefits are shared equi- I see five priority areas where IMF policy
tably. Failure to do so risks increasing politi- advice can support country authorities in
cal and social instability, stifling investment addressing these challenges.
in human and physical capital, and eroding Productivity: A rising tide lifts all boats,
support for structural reformswhich would the saying goes. Raising productivity (out-
impede the sustained growth that emerging put per hour worked) will help create the
GIRL POWER
Policies that help integrate women into the workforce
benefit everyone
E
QUALITY between men and women is important for shrinking workforces because of an aging population can
both moral and economic reasons. If half of the worlds expand their labor force by including women.
population cannot reach its full potential, the whole global In most countries, however, at least one legal hurdle pre-
economy suffers. Despite much progress in recent decades, ineq- vents women from finding work. In addition to reforming
uity across gender lines persists in the workforce. Female labor institutions, regulations, and laws that promote discrimina-
force participation continues to be lower than that of men due to tion against women, governments can implement family-
many factors, including wage gaps, unequal access to opportu- friendly policies like parental leave and affordable child care.
nity, health and education disparities, and legal obstacles. Especially in low-income countries and emerging markets,
Equal access to jobs and economic opportunities benefits additional investments in infrastructure, health, and educa-
all peoplenot just women. For example, countries facing tion would help women join the workforce.
Globally, women
make up 40% of In the Middle
the labor force. East & North
Africa it's 21%
40%
63%
In sub-Saharan
Africa, that
number is
90%
and outcomes, and is closely linked with
overall income inequality. OF COUNTRIES
Reducing HAVE AT
inequality
by 0.1 on the LEAST ONE
GENDER-BASED
GII leads to a
1% increase
in economic
LEGAL RESTRICTION
growth.
+ =
positions are held by
women. Increasing that 38%
number to 3 out of 10 PROFITS
would result in a 38%
increase in a company's
return on assets.
100
9%
MILLION
JAPAN
12%
UAE
27%
INDIA JOBS FOR WOMEN
0 10 % 20 % 30 %
Prepared by Maria Jovanovi. Text and charts are based on the IMF's ongoing gender research, available at imf.org/gender
and drawing on other institutions knowledge and data.
Finance & Development March 201729
A Middle Ground
The renminbi is rising,
but will not rule
Eswar Prasad
I
N November 2015, the IMF made an announcement that scenarios now predicting a plunge in the renminbis value
was symbolically momentous in the annals of internation- and prominence as financial capital surges out of China.
al finance. It decided to anoint the Chinese renminbi an Reality likely lies somewhere between these two extremes.
elite global reserve currency. The renminbi was to join the In the long run, what the renminbis ascendance means for
select basket of currencies (previously comprising the US dol- the global financial system depends, to a large extent, on how
lar, euro, Japanese yen, and British pound sterling) that con- Chinas economy itself changes in the process of elevating its
stitute the IMFs artificial currency unit, the special drawing currency. Transforming the domestic economy may in fact
right (SDR). The renminbi appeared to be on its way to taking have been a hidden agenda behind Chinas aggressive promo-
the world by storm and reshaping global finance. tion of its currency.
Since then, much has changed. The renminbi has lost value
relative to the dollar, and China is dealing with a spate of cap- Size counts but not for all
ital outflows, partly reflecting loss of confidence in the econ- Chinas economy is now the second largest in the world
omy and the currency. The renminbis inclusion in the SDR (based on market exchange rates). In 2016, its annual GDP
basket, which took effect in October 2016, has not stanched was $11 trillion, accounting for 15 percent of world GDP, sec-
this erosion of confidence. ond only to the United States, whose annual GDP is $19 tril-
The earlier hype predicting the renminbis inevitable rise lion. China is also an important player in international trade,
to dominance, perhaps even rivaling the dollar, has proved accounting for 13 percent of global trade in goods. Chinas
overblown. But the same is likely to be true for doomsday impact on the world economy is even greater when measured
although this will take many years and will hardly be a lin- Eswar Prasad is a professor in the Dyson School at Cornell
ear process. If China plays its cards right, with suitable finan- University and senior fellow at the Brookings Institution. This
cial sector and other market-oriented reforms, the renminbi article is based on his new book, Gaining Currency: The Rise
could one day be an important reserve currency and could of the Renminbi.
M
When more ANY households and small- In other words, people who have lim-
scale entrepreneursmainly in ited or no access to financial services
people and developing and emerging mar- could be better off if they did. So might
more firms ket economiesfind that lack society. The benefits of financial services
of access to financial services prevents them could lift many people out of poverty,
have access from saving for a rainy day, borrowing funds reduce inequality, and encourage entre-
to financial to expand their businesses, or purchasing preneurship and investment. Furthermore,
a house, a refrigerator, or other consumer if it makes credit available to previously
services, the durable goods. Their financial transactions, excluded individuals with entrepreneurial
whole society whether for personal or business purposes, talent, broader access to financial services
can be costly and sometimes dangerous, be- might help productivity and economic
can benefit cause they almost always involve cash. With growth. Promoting financial inclusion, as
limited ability to save or to buy insurance, the process of broadening access to and use
their financial condition is vulnerable to an of financial services is called, has become a
extended illness or a natural disaster. mantra of many central banks and finance
The lives of a vast number of people, ministries, particularly in developing econ-
including many poor in advanced economies, omies and emerging markets. In almost 60
might be improved if they had access to and countries, there are national strategies and
used a secure and affordable formal finan- even explicit quantitative targets for finan-
cial system and did not, for example, have to cial inclusion.
rely on extended family for emergency funds.
Similarly, their savings would increase if they Several aspects
could deposit any funds they can accumulate The notion of financial inclusion has sev-
in an interest-earning bank account rather eral dimensions, but key is access to finan-
than having to hide the money in their homes cial services such as banking and insurance
and if they learned how to assess and buy the at an affordable costparticularly for the
products and services that banks, insurance poorestand effective and responsible use of
companies, and even securities firms offer. these services.
It has been clear for a while that financial inclusion is good for 15
Average quality of
individuals and firmswhat economists call the micro level: 10 banking supervision
Poor people benefit from basic payment services, such 5
T
RUST meits a common Our research examines whether the down- Inequality in
phrase that often arouses ward trend in trust and social capital is a
suspicion. Trust is a com- response to increased income inequality. the United
modity thats in short sup-
Social glue
States and
ply lately, in the United States and around
the world, with potentially serious implica- Trust is a key component of the social capi- Europe erodes
tions. Take the example of the three-card tal that enables participants to act together trust among
monte or shell game played on streets around more effectively to pursue shared objectives
the world. Most people are reluctant to take (Putnam 1995). In survey data, trust is mea- peopleand
part because they dont trust the fairness of sured by so-called generalized trusthow can stifle
the game or the person playing it. Similarly, much a person trusts unspecified people
when conventional economic and political rather than friends or family. Typically, this economic
activities are perceived as unfair or their ac- is gauged by a question such as Generally growth
tors as untrustworthy, people want extra re- speaking, would you say that most people
assurance before they participate. Rising eco- can be trusted or that you cant be too careful
nomic inequality is one reason people may be when dealing with others?
less likely to perceive economic and political During the past 40 years, generalized
activity as fair. trust in the United States has declined
Who cares? This article is based on the authors 2016 IMF Working Paper, No.
The decline in trust and social capital is troubling not only 16/176, Growing Apart, Losing Trust? The Impact of Inequality on
because of its effects on social cohesion; it may also have eco- Social Capital. It does not necessarily reflect the views of the OECD or
nomic implications. A substantial body of literature in cul- its member states.
tural economics shows that trust is a key ingredient for good
economic performance. References:
This literature highlights two key ways trust influences Alesina A., and E. La Ferrara. 2002. Who Trusts Others? Journal of
the economy. First, it smooths the way for economic inter- Public Economics 85: 20734.
action in the private sphere by replacing transaction costs, Cingano, Federico. 2014. Trends in Income Inequality and Its Impact
such as legal and insurance fees, with less expensive, infor- on Economic Growth. OECD Social, Employment and Migration Working
mal ways of forming and maintaining agreements. In addi- Paper 163, Organisation for Economic Co-operation and Development,
tion, greater trust can mean fewer problems and costs when Paris.
it comes to monitoring employees and determining appro- Coleman, James S. 1990. Foundations of Social Theory. Cambridge,
priate rewards. MA: Harvard University Press.
Second, trust can promote cooperation in the public Dabla-Norris, Era, Kalpana Kochhar, Nujin Suphaphiphat, Frantisek
sphere by reducing collective-action problems related to Ricka, and Evridiki Tsounta. 2015. Causes and Consequences of Income
the provision of public goods and by enhancing the over- Inequality: A Global Perspective. IMF Staff Discussion Note 15/13,
all quality of public institutions. Governments may not International Monetary Fund, Washington, DC.
be able to solve pressing socioeconomic challenges in a Ostry, Jonathan D., Andrew Berg, and Charalambos G. Tsangarides.
society that is distrustful, intolerant, and dividedespe- 2014. Redistribution, Inequality, and Growth. IMF Staff Discussion Note
cially when it comes to constitutional reforms and inter- 14/02, International Monetary Fund, Washington, DC.
national treaties, which often require healthy popular Putnam, R. D. 1995. Tuning In, Tuning Out: The Strange
support. Distrust also reduces the credibility of public Disappearance of Social Capital in America. Political Science and
policy, which undermines its ability to effectively change Politics 28 (4): 66465.
economic incentives and shape the economic behavior of . 2015. Our Kids: The American Dream in Crisis. New York:
citizens and business. In this case, distrust prevents poli- Simon & Schuster.
cies from being effectively implemented. Rothstein, B., and E. M. Uslaner. 2005. All for All: Equality,
There is also growing empirical evidence that trust pro- Corruption, and Social Trust. World Politics 58: 4172.
motes economic growth generally, via specific drivers such Zak, P. J., and S. Knack. 2001. Trust and Growth. Economic Journal
as international trade, financial development, innovation, 111 (470): 291321.
GROWTH
has shown protecting
them is compatible
with development
Atlantic Forest, Brazil.
Frances Seymour and Jonah Busch
T
ROPICAL forests are places of won- While everyone knows that burning fossil
der and beauty in the popular imagi- fuels generates the emissions that cause cli-
nation, rich in cultural and biological mate change, deforestations role is less well
diversity. Development planners view known, and forest protection is an under-
them more practicallyas a source of timber valued solution to the problem. Every time
revenue or a land bank for agricultural expan- an area of forest is cleared or burned, the
sion. But evidence to support a third view is carbon stored in tree trunks, branches, and
growing rapidlytropical forests provide es- leaves is released to the atmosphere. The
sential services that underpin both global cli- total contribution of emissions from defor-
mate stability and development goals. estation exceeds that of the European Union,
Protecting tropical forests need not be a trailing only China and the United States.
drag on development, nor a zero-sum trade- Halting tropical deforestationwhich cur-
off with growth and poverty reduction. Brazil rently denudes an area the size of Austria
has demonstrated that many of the steps to every yearwould make a significant dent in
protect forests are feasible, affordable, no global annual emissions.
regrets measures in tune with more equi- And because forests recapture carbon as
table and inclusive growth. Paying developing they grow back, they can also mitigate emis-
economies to keep carbon, a major sions from other sources. In other words, as
source of global warming, in forests a natural carbon-capture-and-storage tech-
can help overcome incentives for nology, forests can produce net negative
deforestation as usual. emissions, essential to the long-term goal of
the 2015 Paris Agreement on mitigating cli-
From problem to solution mate change for balance between emissions
Climate change is increasingly rec- and removals. Stopping tropical deforesta-
ognized as a key threat to global economic tion and allowing damaged forests to recover
growth and development, especially to poor could deliver reductions of up to 30 percent
households and countries. Exposure to a of current emissions (see Chart 1).
single major natural disaster such as a hur- The potential of forests to contribute
ricaneexpected to be more frequent and to mitigation was one reason the Paris
severe on a warming planetcan knock a Agreement singled out forest conservation
country off its economic growth trajectory as an important opportunity for interna-
for decades (Hsiang and Jina 2014). tional cooperation. The Agreement endorses
T
HE biggest banks in the world are not just banks proprietary trading (using their own money rather than trad-
theyre financial supermarkets that can underwrite ing for a client), was enacted as part of the Dodd-Frank Act
securities, manage mutual funds, and act as brokers in 2010. In Europe, regulators in both the United Kingdom
in addition to lending money. Offering many differ- and the European Union have proposed various types of
ent kinds of financial services increases the profits of these ring-fencingseparating banks traditional functions from
institutionswhether they are universal banks, in which the the rest of their operations.
functions are all part of the bank, or are holding companies These actions, however, are based more on a fear that
that own separate bank and nonbank providers. something bad could happen than on experience. Poor lend-
But when all these activities are under one roof, many reg- ing decisions by banks and many nonbank lenders appear to
ulators believe that new risks are added that could endanger have been the main cause of the crisis, rather than nontradi-
both the institution and the financial system. After the global tional activities such as proprietary trading. Nonetheless, it
financial crisis of 2008, regulators in a number of countries may be necessary to protect traditional banking from poten-
proposed rules to insulate traditional banking (taking depos- tial damage caused by banks other financial activities. This
its and making loans) from the risks associated with other decision should be based on careful consideration of the risks
financial services. For example, in the United States, the so- involved in combining banking with other financial services
called Volcker Rule, which prohibits banks from engaging in in a single company.
Differing risks
We found an important distinction between
the risks involved in traditional banking and
the risks of other financial activities that helps
explain why nontraditional activities may be
dangerous for banks based on two categories
of financial risk: slow moving and fast moving.
Slow-moving financial risks take time to
build up and cause losses over long peri-
ods, possibly months or even years. Because
they accumulate relatively slowly, these risks
often give advance warning that a future loss
may occur. Credit, or default, risk is the lead-
ing example of a slow-moving financial risk.
Often, borrowers go through periods of declin-
ing sales or other income that indicate they will
have trouble repaying their loans. This longish
process gives a bank time to take steps to miti-
gate or even prevent damage from default. For
example, banks can work with their custom-
ers to prevent default by temporarily reducing
T
O achieve climate change goals, the world must cut ability to diversify their economies and sources of govern-
consumption of fossil fuels dramatically. But climate ment revenuesand it would take them longer to do so than
change success may put developing countries rich in countries less dependent on fossil fuel deposits.
fossil fuels in an almost no-win situation. Last, economic and political forces in many of these coun-
If there is no progress in combating climate change, poor tries create pressure to invest in industries, national compa-
countries are likely to be disproportionately harmed by nies, and projects based on fossil fuelsin essence doubling
the floods, droughts, and other weather-related problems down on the risk and exacerbating the ultimate consequences
spawned by a warming planet. But if there are successful of a decline in demand for their natural resources (see map).
global actions to address climate change, poorer countries
that are rich in fossil fuels will likely face a precipitous fall Carbon risk
in the value of their coal, gas, and oil deposits. If the world What seems clear to virtually all scientists who study the issue
makes a permanent move away from using fossil fuels, the is that the world cannot consume all of its oil, gas, and coal
likely result will be a huge reduction in the value of their reserves without catastrophic climate consequences. To limit
national and natural wealth. the increase in global temperature to 2 degrees Celsiusthe
These nations face three special challenges. First, they have more conservative of the goals agreed to by governments at
a higher proportion of their national wealth at risk than do the 2015 climate change talks in Parismore than two-thirds
wealthier countries and on average more years of reserves of current known reserves, let alone those yet to be discov-
than major oil and gas companies. Second, they have limited ered (see Table 1), must remain in the ground (IEA 2012).
T
RINIDAD AND TOBAGO got its first national
currency in 1964, two years after obtaining inde-
pendence from Great Britain. In denominations of
$1, $5, $10, and $20, each a different color, the bills
featured Queen Elizabeth II, Trinidad and Tobagos coat of
arms, its central bank, and an illustration representing a local
industryan offshore oil rig, for example.
An oil rig was featured on the 1964 $1 note.
Introducing the fifty
In 1977, a year after becoming a republic, the countrys coat
of arms took center stage on the notes, replacing Queen
Elizabeth, and $50 and $100 notes entered the scene. But the
fifty was pulled from circulation just two years later, after a
shipment of unissued bills was stolen.
To mark Trinidad and Tobagos 50th year of independence
in 2012, the central bank reintroduced the $50 bill. But it
wasnt readily accepted by the public. Senior citizens had
Front of the 2012 commemorative $50 note.
Crowning glory
In December 2014 the new note debuted. It was
produced by the central bank of Trinidad and
Tobago and UK currency printer De La Rue.
Part of the reason for problems with the $50
note issued in 2012 was insufficient consulta-
tion with stakeholders; the central bank in 2014
engaged in strong consultation with such key
Back of the newest $50 note.
stakeholders as banks, businesses, and experts
in history and art. and handling of the polymer notes, so that citizens would
The new $50 note is rich in color and highlights the coun- be able to withdraw the new $50 bill from ATMs.
trys natural beauty and cultural heritage. The bills golden In November 2015, the central bank issued an updated
color celebrates the central banks 50-year jubilee. Its dra- $50 polymer note that removed the commemorative text
matic design includes a red hibiscus flower, a young woman Celebrating 50 years of Trinidad and Tobagos Central
in carnival attire, and a red-capped cardinal. The bird, whose Bank,19622012 and added raised dots to help those who are
colors are those of the countrys flag, is poised for flight visually impaired. And a red banner was added across the tail
against a transparent polymer plastic window. of the red-capped cardinal as an additional security feature.
The $50 also has enhanced security features. A small gold- The $50 bill has a checkered history, much like the small
green iridescent hibiscus flower changes color as you move industrial and high-income economy, which has been colo-
the bill around, and the micro text of the number 50 can be nized by the Spanish, British, French, Dutch, and even the
seen only under a magnifier. tiny Duchy of Courland. But the country is now leading
The design won the country the International Bank Note the way with an ultramodern currency that is striking in its
Societys Banknote of the Year award. Because many older beauty, welcoming to those who cannot see it, and protected
cash-counting machines werent prepared to handle the
new polymer notes, the central bank teamed up with com-
from those who would dare compromise it.
mercial banks to upgrade technology vital to the processing Marie Boursiquot is F&Ds Online Editor.
PARALLEL
PATHS
Atish Rex Ghosh profiles Kristin Forbes,
who straddles academia and policymaking
D
EWORMING children seems an unlikely interest
for economist Kristin Forbes, who has spent most
of her professional career straddling academia and
policymaking. But the professor at the Massachu-
setts Institute of Technologys (MITs) Sloan School of Man-
agement has been willing to tread unlikely paths as well.
Forbes, who is also an external member of the Bank of
Englands Monetary Policy Committee, has focused on such
international issues as financial contagionthat is, how eco-
nomic problems spread from country to countrycross-bor-
der capital flows, capital controls, and how economic policies
in one country have spillover effects in others.
But when presented with evidence by colleagues that one
of the most cost-effective ways to keep children in develop-
ing economies in school was to rid them of parasitic worms,
she helped form a charity aimed at deworming kids.
Still, academic research and policymaking absorb most
of Forbess timewhether at MIT, the World Bank, the
Bank of England, or the US Treasury Department, among
other places.
Yet her path was not predestinedand more than once, luck
or coincidence played a crucial role. Growing up in Concord,
New Hampshire, she developed a passion for the outdoors and
attended a public high school. Though it was hardly a low-
performing school (about half of the class would go on to col-
lege), most of her classmates set their sights on the University
of New Hampshire. Forbess counselors were bemused when
she aspired to more prestigious colleges, such as Amherst or
Williams. But in an early instance of forging her own path,
Forbes did indeed end up going to Williams College. After graduation, Forbes pondered what to do nextvac-
illating between law or following in her fathers footsteps
A wealth of choices and becoming a doctorbut ended up in Morgan Stanleys
At Williams, Forbes was confronted by a wealth of choices investment banking program. Though she learned about
and wound up in courses on astrophysics, religion, psychol- markets (knowledge that would later come in handy for her
ogyand economics. She credits her Econ 101 professor, economics research), Forbes soon realized that investment
Morton (Marty) Schapiro (later, president of Williams banking was not for her. And then she caught a lucky break
College) with inspiring her interest in the subjectmostly by Richard Sabot, one of her professors at Williams, put her in
applying basic economic concepts to everyday life. He spoke touch with Nancy Birdsall, who was finishing up the World
of the diminishing, and eventually negative, marginal utility Banks 1993 study of how nations in East Asia achieved eco-
of consuming too much beer (not an irrelevant example on nomic success and was looking for a researcher to help apply
college campuses). Still, she dithered between economics, its insights to Latin America.
history, and political science (enjoying the interplay between So Forbes went to the World Bank for a yearand got her
the subjects), but finally majored in economics and gradu- first taste of policy-oriented research. Working with Birdsall
ated summa cum laude. and Sabot inspired Forbes to become a career economist like
Judging Greenspan
todays economic problems. For one, as potentially damaging as she
economics should move toward the thought they might be, but also that
empirical. Greenspan had what was it would be too politically tricky to
arguably his biggest insight when push through regulation. He made
he was deep in the weeds, tallying sideways references to irrational
numbers rather than relying on exuberance by the late 1990s,
ivory tower models. In the summer but backed off on curbing it when
of 1996, there was a debate at the the markets stabilized. Like most
Fed about whether interest rates finance-friendly regulators, Greens-
should be hiked to ward off over- pan didnt want the music to stop.
heating in the economy. Wages were When it did, to his great credit, he
rising, and the stock market was up issued a mea culpa, admitting there
45 percent over the course of a year. had been a flaw in his thinking.
Yet productivity figures seemed Mallabywho wrote this book over
oddly weak, given the efficiency five years with Greenspans coop-
gains that businesses were seeing eration while working as a senior
from globalization and new tech- fellow at the Council on Foreign
nologies. Solving the conundrum Relationsbelieves it was mistake
Sebastian Mallaby was crucialif productivity was for him to do so, since ideologically,
actually rising, then there was no he had never bought totally into
The Man Who Knew
reason to hike interest rates, since rational markets.
The Life and Times of Alan workers making more widgets could
Greenspan also be paid more without trigger-
Penguin Press, 2016, 800 pp., $40.00
ing inflation. Nearly every eco-
(hardcover)
nomic guru at the timefrom Larry The man who
T
oo much success can be a Summers to Janet Yellenworried
dangerous thing. That is about inflation. But Greenspan in- knew didnt know
perhaps the key takeaway sisted that Fed researchers go back
from Sebastian Mallabys epic new and re-tally the numbers across 155 everything.
biography of former US Federal industries and four decades. The
Reserve chair Alan Greenspan, The result? The maestro was right; low
Man Who Knew. The central and productivity in services was artifi- I disagree. Actions matter, and
(to this reviewer at least) somewhat cially lowering the overall rate. Greenspan took responsibility for
shocking revelation of the book is The times that Greenspanand as his. While his flaw was less an
that far from being a blind follower a result, the economyfaltered were intellectual one than a moral one,
of markets know best efficiency usually when there was too little the fact that he admitted to mak-
theory, Greenspan was well aware data and too much ego in the room. ing a mistake of any kind is one of
that easy monetary policy and stock The praise and political power that the things that redeems him. Many
prices could create bubbles in the came with his many lucky hunch- others who played a part in the
marketterribly damaging ones (he esand some well-deserved policy events leading up to the 2008 crisis
did a seminal paper on the topic in home runsmade him less willing and Great Recession failed to do so.
1959). And yet he allowed them to to rock the boat and raise interest Whats more, Greenspans admis-
inflate anyway, believing this prefer- rates, even when it was clear that sion marked an important departure
able to more dramatic government this really was what was needed to from the fiction of the omniscient
interference in the market. The derail a potential crash and reces- central banker (one that he helped
great irony is that thanks in large sion. Once a staunch opponent of craft). The world has come to
part to Greenspan, central bankers government bailouts he later sup- depend far too much on central
themselves have become the major ported bailouts of emerging markets bankers being those who know.
player in global marketssome- like Mexico (whose debt was held Its time to demand more from the
thing that has introduced huge, by big US banksa crucial fact that politicians we elect to run the real
unknown risks into our economy. the book underplays). He dismissed economy itself.
Clearly, the man who knew didnt warnings by US Commodity Futures
know everything. Trading Commission chair Brook- Rana Foroohar
Despite this, many lessons in sley Born on derivatives, believ- Assistant Managing Editor
Greenspans legacy are relevant to ing incorrectly that they werent Time magazine
A
mericans tend to assume that that the vanishing middle class has that the US economy is on a trend
history marches forward and left behind a dual economy. His more like that of a developing econ-
that their children will do bet- dual sectors are finance, technol- omy than of a rich, developed nation
ter than they did. This is a fundamen- ogy, and electronics, or FTEakin may seem jarring, but that is exactly
tal tenet of the American Dream and to Lewiss capitalist sectorand the nature of the distributional struc-
a core deliverable of the economy over low-skill work, akin to the subsis- ture of the worlds richest economy.
most of the course of the 20th century. tence sector, whose workers bear the The steps that brought the United
Sometimes, though, there are brunt of the vagaries of globaliza- States more equality in the middle of
detours. tion. The book lays out how mem- the 20th century certainly included
Even though over the past 40 years, bers of the FTE sector seek to keep attention to educationthe United
the United States grew ever richer, their own taxes low and suppress the States was among the first to provide
the gains from this growth have not wages they pay so as to maximize universal access to primary education
been shared. The US economy pro- their profits. Mass incarceration, nationwide, and the GI bill after World
duced $18 trillion worth of goods housing segregation, and disenfran- War II opened college doors to genera-
and services in 2016, more than any chisement all serveamong other tions of studentsbut that was not the
other country that yearor any year thingsto keep the low-skill sector only policy. Among other things, the
on record. Data show that between in a subservient labor market posi- middle decades of that century also
1980 and 2014 pretax income grew, tion. These developments play out boasted high taxation on estates and top
on average, by 61 percent, yet most of along racial lines set by the nations incomesmoney that could be invested
these gains went to those at the very history of slavery. in broader economic growthyet both
top. For the bottom 50 percent of the The bridge between these two sides have been seriously eroded over the past
US population incomes grew only of the economy is education. There are four decades. If we want to revive our
1 percent; those in the top 1 percent paths for children of low-wage fami- vanishing middle class, which Temin
snagged 205 percent income growth. lies to get into the richer FTE capital- so eloquently describes, well need to do
This is not the way the American ist group, but Temin argues that there more to undermine the dual economy
Dream was expected to play out. are many more obstacles, especially structures he so accurately details.
Explaining rising inequality in the for children from African-American Heather Boushey
United States is the aim of Peter Temins families. This is why Temins top policy Executive Director and
new book, The Vanishing Middle recommendation is universal access Chief Economist,
Class. Temin argues that the distribu- to high-quality preschool and greater Washington Center for
tion of gains from economic growth financial support for public universities. Equitable Growth
J
oel Mokyrs A Culture of ideas to be distributed and shared, areas of Chinese culture but did
Growth: The Origins of the and hence challenged, corrected and not stimulate the ideas and actions
Modern Economy gives culture supplemented, says Mokyr. associated with an industrial revo-
center stage in the rapid economic But how did these cultural changes lution. Mokyr concludes, It seems
growth and industrialization brought come about and spread in the period wrong to dub the Chinese experi-
about by the first Industrial Revolu- of fundamental change in Europe? ence a failure. What is exceptional,
tion and ongoing and self-reinforcing How did the Enlightenment turn indeed unique, is what happened in
in Western Europe ever since. It is into the Industrial Revolution, which eighteenth-century Europe.
a certain type of culture that is the in turn was the starting point of
reason growth-inducing change sustained growth? Mokyr paints a
occurred in Europe and not, say, in backdrop of improved navigation and These developments
China, the author insists. What this
culture means, and what made it dif-
shipbuilding that opened Europe to
new products and new ideas (early
reduced attachment
ferent in Europe, is the topic of this
provocative analysis.
globalization), and the printing press,
which lowered the cost of communi-
to old ideas.
Mokyr proposes that the cation and increased the benefits of
Enlightenment and the Industrial literacy. These developments opened This book is the latest example of
Revolution were not exogenous minds to new ideas and new ways Mokyrs ability to explicate complex
developments, but were a conse- of thinking elsewhere and reduced issues, illustrating his big-picture
quence of a change in attitudes attachment to old ideas. These changes thesis with a myriad of fascinating
(which he sums up as culture) in were also helped by the absence of details. He writes with clarity
Western Europe. This occurred over a single central authority in Europe, enjoyable for the general reader as
roughly two centuries, between 1500 individual freedom, the enforcement well as for the specialist in economic
and 1700, a period that brought about of property rights, and competition history. A Culture of Growth is a
a change in beliefs about peoples abil- in the marketplace for both material must-read for anyone interested in
ity to use science to control their des- goods and ideas. Among other things, how Western society got where it is
tiny and, especially, the natural world. the new ideas led to advances in sci- today and what this implies for the
The Enlightenment, taking off ence and technology that we now call spread of technology in the global
in the late 17th century and lasting the Industrial Revolution. And all of economy of the future.
through the 18th, encouraged a quest that led to sustained economic growth. Barry R. Chiswick
for useful knowledgethat is, sci- Mokyr then shows that although Professor of Economics and
ence and technologythat resulted in looking at why something hap- International Affairs, The George
permanent and sustained command pened is useful, so is analyzing why Washington University
Visit bookstore.imf.org/fd3117
Finance & Development, March 2017