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How to wean the world off monetary stimulus

Robert B. Zoellick

(Financial Times) – After seven years of extraordinary governmental stimulus, the world needs a shift from exceptional monetary policies to private sector-­led growth. The US Federal Reserve’s increase in interest rates sounded the clarion call. China’s market tribulations highlight deepening global uncertainties and the need for new approaches. Three possible ways to generate growth stand out for 2016.

First, Lawrence Summers warns of the threat of “secular stagnation” posed by a world lacking demand, and grafts decades of globalisation on to a theory developed in the late 1930s. The former US Treasury secretary fears emerging markets face sluggish global demand, capital outflows, weaker investment prospects and depreciating exchange rates. Without new demand, emerging markets will weigh down developed ones, which will in turn further depress developing countries.

According to this theory China, long the rising source of growth, faces a difficult conversion from a heavy industrial to a services economy. In circumscribed global economic conditions, policy-makers will weaken currencies to lure limited demand, provoking protectionist countermoves. The solution is big government spending, especially on infrastructure, financed by borrowing at extremely low interest rates.

Kenneth Rogoff, who argues the global economy is in the later stages of a debt “supercycle”, offers a second perspective. Professor Rogoff’s history lessons suggest growth will recover, albeit slowly, as time erodes the burdens of financial excess. Systemic market crises – a worldwide whirlwind fed by the collapse of housing in the US and elsewhere, debt dangers in the eurozone and financial tremors in China and emerging markets – have penalised the global economy with a long probationary period.

If Prof Rogoff is correct, Prof Summers’ surge in government spending would just prolong the debt disease. Prof Rogoff would instead seek to ease debtors’ plights by keeping rates low or even negative, and by restructuring debt, while setting the stage for productive investment. He too sees the benefit of infrastructure investment, although he is wary of wasteful state projects.

The third growth solution would re-focus policy on boosting productivity and potential, especially in the private sector. Supply-siders such as Michael Spense, a Nobel laureate in economics, and Kevin Warsh, a former US Federal Reserve Board governor, are concerned that extraordinary policies distort private sector expectations about investments, profits, taxes, valuations and future governmental actions. They emphasise that the demand that will drive private capital investment, which should support higher wages and profits, is expected future demand. In contrast, policies intended to boost demand in the near term can actually discourage business confidence in the future; they are unlikely to rely on mergers, acquisitions and stock buybacks rather than big long-term commitments.

Similarly, others call for tax and regulatory policies to encourage private-sector investment and employment. Open trade policies, encouragement of increased labour force participation (including for women and disabled people), legal immigration, and more effective education and training could also boost potential growth. The creation of scientific, educational and entrepreneurial conditions that encourage technological progress would create opportunities. The problem is that such structural growth reforms have proved politically difficult. With leaders shaken by the rise of populists and nativists, it is easier to rely on state spending or central banks.

The critical question for 2016 is whether countries will face up to vital structural reforms. For China and many other emerging markets, they are necessary to overcome the middle-income trap. Shinzo Abe, Japan’s prime minister, needs to implement his “third arrow”, comprising increased competition, corporate governance and encouraging more women into the work force. For the eurozone, labour market flexibility, incentives to work and invest, and more efficient systems of social protection are vital. For the US, the question is whether the public will elect a president and congress that will work together to rekindle private dynamism.

If in 2016 there is no shift from monetary to growth policies, the future envisioned by Profs Summers and Rogoff could prove more likely: sluggish growth; currency conflicts; and populist politics and fights over distribution – punctuated by mini-crises as struggling economies falter. Political leaders can either try to shape their countries’ destinies now or risk a future reckoning from the decade’s economic experiments.

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