DELHI – In a recent exchange between former US Federal Reserve Chairman Ben Bernanke and former US Treasury Secretary Larry Summers on the plausibility of secular stagnation, one point of agreement was the need for a global perspective. But from that perspective, the hypothesis of secular stagnation in the period leading up to the 2008 global financial crisis is at odds with a central fact: global growth averaged more than 4% – the highest rate on record.
The same problem haunts Bernanke’s hypothesis that slow growth reflected a “global savings glut.” From a Keynesian perspective, an increase in savings cannot explain the surge in activity that the world witnessed in the early 2000s.
Supporters of the secular-stagnation hypothesis, it seems, have identified the wrong problem. From a truly secular and global perspective, the difficulty lies in explaining the pre-crisis boom. More precisely, it lies in explaining the conjunction of three major global developments: a surge in growth (not stagnation), a decline in inflation, and a reduction in real (inflation-adjusted) interest rates. Any persuasive explanation of these three developments must de-emphasize a pure aggregate-demand framework and focus on the rise of emerging markets, especially China.
Essentially, the world witnessed a large positive productivity shock emanating from the emerging markets, which accelerated world growth while reinforcing disinflationary pressures that had already been set in motion by the so-called Great Moderation in business-cycle volatility. This key development helps to reconcile two of the three major global developments: faster growth and lower inflation.
The real puzzle, then, is to square rising global productivity growth with declining real interest rates. Bernanke correctly emphasized that long-term real interest rates are determined by real growth. So the positive productivity shock should have raised the return to capital and, hence, equilibrium real interest rates. Moreover, this tendency should have been accentuated by the fact that the productivity shock reflected a decline in the global capital-to-labor ratio implied by the integration of Chinese and Indian workers into the global economy. But this did not happen: instead, global real interest rates declined.
Central to understanding this puzzle are two distinctive features of the emerging-market productivity shock: it was resource-intensive and mercantilist in origin and consequence. Both features increased global savings.
For starters, because relatively poor but large countries – India and especially China – were the engines of global growth, and were resource-hungry, world oil prices soared. This redistributed global income toward countries with a higher propensity to save: the oil-exporting countries.
Even more important were mercantilist policies. China and other emerging-market countries pursued an economic strategy that defied the standard tenets of growth and development theory. Mercantilist growth was based on – and to some extent required – pushing capital out rather than attracting it. By limiting foreign inflows and keeping domestic interest rates low, China was able to maintain a relatively weaker currency, which served to sustain its export-led growth model. This led to massive current-account surpluses (more than 10% of GDP at one point), which sent capital flowing to the rest of the world.
Recognizing the significance of this strategy exposes a common fallacy whereby the global savings glut is attributed to emerging-market countries’ desire to insure themselves against financial turmoil by acquiring dollar reserves. That may have been true in the immediate aftermath of the Asian financial crisis of the late 1990s, but it was quickly overtaken by the growth imperative. In other words, the self-insurance motive might explain China’s first trillion dollars of reserve holdings, but it has nothing to do with the subsequent three trillion.
Further contributing to the savings glut was growth itself. As incomes rose, already-prudent Asians became even more prudent, and profitable companies became even more profitable. This endogenous response to rapid productivity growth was a key factor contributing to the savings glut. Old development verities that savings drive growth had to be re-assessed, because, to some extent, emerging-market growth drove savings.
Here lies the explanation of the interest-rate puzzle. As savings (and hence the global supply of loanable funds) increased, real rates came under downward pressure. Low rates, in turn, provided the lubrication needed to finance the asset bubble in the US and elsewhere. According to Summers, high savings caused weak growth; under the alternative explanation offered here, it was primarily rapid growth – and its distinctive features – that drove high savings.
Today, as world growth decelerates, secular stagnation seems plausible once again. But secular stagnation is an ailment of countries at the economic frontier. For the rest of the developing world, the real worry is not a shortfall of demand; it is the need to sustain high rates of productivity growth so that they can catch up with the advanced economies. As policymakers gather in Washington for their ritual conversations this week, they should not lose sight of that key distinction.
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