Stagnation anxiety

Secular stagnation is said to be present when economic growth is negligible or nonexistent over a considerable span of time. Today, secular stagnation has become a popular mantra of the chattering classes.

The idea is not new, however. Alvin Hansen, an early Keynesian economist at Harvard University, popularized the notion in the 1930s. In his presidential address to the American Economic Association in 1938, he asserted that the U.S. was a mature economy that was stuck in a rut. Hansen reasoned that technological innovations had come to an end; that the great American frontier (read: natural resources) was closed; and that population growth was stagnating. The only way out was more government spending, used to boost investment via public works projects.

Today, another Harvard economist, former U.S. Treasury secretary Larry Summers, is leading a secular stagnation bandwagon. Summers, like Hansen before him, argues that the government must invest in infrastructure to pull the economy out of its stagnation rut. The secular stagnation story has picked up a blue- ribbon array of establishment voices, including the Fed’s chairwoman, Janet Yellen and vice- chairman Stanley Fischer.

The adherents come from all sides of the political spectrum, including the two major candidates for the U.S. presidency: Hillary Clinton and Donald Trump. Clinton, for example, calls the need to upgrade the nation’s infrastructure a “nat i onal emergency”— her plans would probably run up a bill that would exceed President Obama’s proposed US$ 478 billion infrastructure program. And then there is Trump, who calls for the renewal of America’s aging infrastructure. When it comes to the issue of secular stagnation and its elixir, Clinton and Trump share common ground.

Now, let’s take a careful look at the story that has captured the imagination of so many influential members of the establishment. For evidence to support Summers’ secular stagnation argument, he points to anemic private domestic capital expenditures in the U.S.

Investment is what fuels productivity. So, with little fuel, we should expect weak productivity numbers in the U.S. Indeed, the U.S. is in the grips of the longest slide in productivity growth since the late 1970s. This is alarming because productivity is a key ingredient in determining wages, prices, and economic output.

As for aggregate demand in the economy, which is measured by final sales to domestic purchasers, it is clear that the U. S. is in the midst of a growth recession. Aggregate demand, measured in nominal terms, is growing (2.93 per cent), but it is growing at well below its trend rate of 4.75 per cent. And that below-trend growth in nominal aggregate demand has characterized the U. S. economy for a decade. To put this weak growth into context, there has only been one other recovery from a recession since 1870 that has been as weak as the current one: the Great Depression.

The three pillars of the secular stagnation story — weak private investment, productivity and aggregate demand — appear to support the narrative. But, under further scrutiny, does the secular stagnation story hold up?

To answer that question requires us to take a careful look at private investment, the fuel for productivity. During the Great Depression, private investment collapsed, causing the depression to drag on and on. Robert Higgs, a senior fellow at the Independent Institute, in a series of careful studies, was able to identify why private investment was kept underwater during the Great Depression. The source of the problem, according to Higgs, was regime uncertainty. As he explains:

“Roosevelt and Congress, especially during the congressional sessions of 1933 and 1935, embraced interventionist policies on a wide front. With its bewildering, incoherent mass of new expenditures, taxes, subsidies, regulations, and direct government participation in productive activities, the New Deal created so much confusion, fear, uncertainty, and hostility among businessmen and investors that private investment and hence overall private economic activ- ity never recovered enough to restore the high levels of production and employment enjoyed during the 1920s.

“In the face of the interventionist onslaught, the U.S. economy between 1930 and 1940 failed to add anything to its capital stock: net private investment for that elevenyear period totalled minus $3.1 billion. Without ongoing capital accumulation, no economy can grow.

“The government’s own greatly enlarged economic activity did not compensate for the private shortfall. Apart from the mere insufficiency of dollars spent, the government’s spending tended, as contemporary critics aptly noted, to purchase a high proportion of sheer boondoggle.” In short, investors were afraid to commit funds to new projects because they didn’t know what Roosevelt and the New Dealers would do next.

Moving from the Great Depression to our recent Great Recession, we find a mirror image. Obama, like Roosevelt, has created a great deal of regime uncertainty by generating a plethora of new regulations without congressional approval. In a long report earlier this month, The New York Times went so far as to hang the epithet of “Regulator in Chief ” around Obama’s neck. What a legacy.

Once regime uncertainty enters the picture, the secular stagnation story unravels. Private i nvestment, t he cornerstone of the story, is weak not because of market failure, but because of regime uncertainty created by the government. The government is not the solution. It is the source of the problem.

OBAMA, LIKE ROOSEVELT, WITH HIS PLETHORA OF NEW REGULATIONS HAS CREATED TOO MUCH UNCERTAINTY FOR PRIVATE INVESTMENT.