Turn away from pro­tec­tion­ism and growth will come

The Daily Telegraph - Business - - Business/Comment - KALLUM PICK­ER­ING An In­quiry into the Na­ture and Causes of the Wealth of Na­tions Kallum Pick­er­ing is se­nior econ­o­mist at Beren­berg

In one fun­da­men­tal re­spect, the field of eco­nom­ics has not changed much in the past three cen­turies. When Scot­tish-born Adam Smith pub­lished

in 1776 he asked what is still the most im­por­tant ques­tion: “What drives eco­nomic progress?”

Of course, in a world of hash­tags we now have to set­tle for the much more triv­ial-sound­ing “pro­duc­tiv­ity puz­zle”. But the essence of the prob­lem re­mains the same. Con­sider the fol­low­ing: liv­ing stan­dards that rise at 2pc per year will dou­ble roughly ev­ery 35 years. For liv­ing stan­dards that rise at 1pc per year, it will take 70 years.

In the West, the ex­pe­ri­ence of the post-war pe­riod is that growth bounces back strongly af­ter a down­turn. In a nor­mal cycli­cal re­cov­ery, strong in­vest­ment in­creases cap­i­tal per worker, and, in turn, pro­duc­tiv­ity.

Frus­trat­ingly, pro­duc­tiv­ity growth has un­der­per­formed enor­mously so far through­out the post-Lehman up­swing. While ma­jor ad­vanced economies, in­clud­ing the UK, cur­rently en­joy a record num­ber of jobs, the av­er­age worker does not pro­duce much more than a decade ago. Be­cause worker out­put has lan­guished, head­line GDP growth has been around a third lower than nor­mal. Real wages and rev­enues have in­creased more slowly. Con­fi­dence and the ap­petite for risk-tak­ing have been de­pressed. Mean­while, the growth im­pulse from eco­nomic poli­cies de­signed to speed up the re­cov­ery has dis­ap­pointed. Aus­ter­ity and bal­ance sheet re­pair has gone on longer than ex­pected.

The con­se­quences ex­tend well be­yond the mea­sur­able eco­nomic ef­fects. Much of the creep­ing po­lit­i­cal dis­en­fran­chise­ment of re­cent times can be at­trib­uted to stag­nat­ing liv­ing stan­dards and the risk that fu­ture gen­er­a­tions could find them­selves worse off than their par­ents.

Po­lit­i­cal and eco­nomic sys­tems that do not en­able peo­ple to get on will strug­gle to last. This is quite pos­si­bly the most press­ing eco­nomic and po­lit­i­cal is­sue of our time.

What is go­ing on? Are we col­lec­tively out of ideas that could push us for­ward? Anec­do­tal ev­i­dence sug­gests the op­po­site is true. Rates of in­no­va­tion in en­ergy, ar­ti­fi­cial in­tel­li­gence and robotics seem to be ac­cel­er­at­ing. Each on its own has the power to boost pro­duc­tiv­ity.

Peo­ple of­ten iden­tify the cur­rent pro­duc­tiv­ity weak­ness as a post­fi­nan­cial cri­sis phe­nom­e­non. This is wrong. Growth rates in worker out­put per hour had al­ready started to slow in the mid-2000s as West­ern economies, en­ticed by ex­cess short-run re­turns, started over-in­vest­ing in real estate with bor­rowed money. House­holds then took out ex­tra credit against their ris­ing home val­ues to fi­nance higher spend­ing. Ma­jor cap­i­tal mis­al­lo­ca­tion, dis­guised as proper growth, meant ma­jor economies un­der­in­vested in the es­sen­tial cap­i­tal and equip­ment that could have raised out­put and worker pro­duc­tiv­ity in a sus­tain­able way.

When the bub­ble fi­nally popped it had last­ing neg­a­tive ef­fects. Bur­dened with high debt and un­pro­duc­tive as­sets, ad­vanced economies had to go through a long pe­riod of bal­ance sheet re­pair that is not yet fully com­plete.

Weak pro­duc­tiv­ity growth dur­ing the last decade is the price we have paid. In the com­ing years things should im­prove mod­estly if the right poli­cies are fol­lowed and some cru­cial mis­takes are avoided.

Last year marked the par­tial re­turn to nor­mal cycli­cal dy­nam­ics. In the US, the UK and Ger­many, where the eco­nomic cy­cle is the most ad­vanced and un­em­ploy­ment is low, con­tin­ued strong de­mand will put in­creas­ing strain on avail­able re­sources. Firms will need to de­cide whether to raise pro­duc­tive ca­pac­i­ties through cap­i­tal in­vest­ment or sim­ply raise prices.

So far the signs are mostly good. US firms are re­spond­ing pos­i­tively to the Trump fis­cal stim­u­lus and tax re­form with higher in­vest­ment spend­ing. In Ger­many, firms are in­vest­ing more as they en­counter labour sup­ply con­straints. Even in the UK, where Brexit un­cer­tainty clouds the eco­nomic out­look, in­vest­ment is ex­pand­ing nicely. In a world where de­mand is grow­ing, UK firms seem more con­cerned about los­ing mar­ket share than a hard Brexit.

Mean­while, in­fla­tion across the ad­vanced world re­mains close to the 2pc rate that ma­jor cen­tral banks see as de­sir­able. Cen­tral banks can exit their stim­u­la­tive mon­e­tary poli­cies slowly, keep­ing the cost of cap­i­tal low. With luck, healthy de­mand growth should trans­late into a broad-based up­swing in in­vest­ment and pro­duc­tiv­ity in the com­ing years.

The risks to this op­ti­mistic out­look are ob­vi­ous. Con­fi­dence re­mains frag­ile. Firms and fi­nanciers re­mem­ber the pain of the fi­nan­cial cri­sis. In ad­di­tion, cen­tral banks and gov­ern­ments are not well pre­pared to deal with the next down­turn.

The ma­jor risk is a Trump-led trade war. While the cur­rent planned US and China tar­iffs will only have a small mea­sur­able ef­fect on global out­put and in­fla­tion, the risk that un­cer­tainty weighs on firms’ pro­duc­tion and in­vest­ment is sig­nif­i­cant.

Sen­ti­ment in Europe has al­ready soft­ened due to the trade skir­mishes. If the cur­rent tit-for-tat be­tween the US and China does not de-es­ca­late soon, the pick-up in in­vest­ment growth could be spoiled be­fore it builds any se­ri­ous mo­men­tum.

Af­ter much of the hard work in fix­ing the prob­lems that led to the cri­sis is done, it would be a pity if the long-awaited good times were spoilt by mis­guided eco­nomic poli­cies.

‘With luck, de­mand growth should trans­late into a broad-based up­swing in in­vest­ment and pro­duc­tiv­ity’

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