News Stephen Kinsella

Thursday 18 September 2014

Demography, debt and inequality will decide our future

Published 19/08/2014 | 00:00

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Further rises in Ireland's productivity have to come from increases in funding to early childhood education and third-level research

Fads drive our culture more than we would like to admit. Economics is no different. Once a big idea gets established, it is hard to shift the majority of the profession from focusing on it.

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The fad du jour is "secular stagnation". Standard economics tells us that long-term growth comes from increases in productivity, meaning people take the resources they have and rearrange them in more valuable ways.

Imagine trying to dig a hole in a road. You can use 20 guys with shovels and hammers, or three guys with one JCB. Both arrangements of resources get the hole dug, but the second team uses more capital (the JCB) and less labour, and gets the hole dug in a tenth of the time. There is less employment in construction, but also less shovel breastfeeding. The road gets dug faster and the economy grows.

Growth comes from increases in the value of goods and services we produce every year. When that value goes up, we have a good, though imperfect, measure of how well the economy is doing.

Secular stagnation comes from the interplay of a number of factors including demography, inequality, education and debt.

The economy doesn't grow as much as it should because there aren't enough working-age people generating increases in productivity because the work force is ageing. Growth is hampered when there aren't any measurable increases in productivity from education because most people have high-school or university educations. The level of inequality retards growth because the rich spend a smaller fraction of their income than the middle class and especially the poor.

Rising inequality may reduce consumer demand among the poor and investment over time as the middle classes are deprived of incomes to invest with. Extremely high debt levels relative to taxable incomes in advanced countries mean governments can't spend their way out of recessions as easily as they could in the past. So that source of growth, the "pump-priming" beloved of Keynesian economists, just can't be done.

The economy "stagnates" because economic growth is compounding. The bridge you build today contributes to growth this year, but also to next year, too, as people drive places more easily. Economists have a rule of thumb called 'the rule of 72'.

If the economy grows by 5pc on average, then because 72/5=14, roughly speaking, incomes double every 14 years. Now drop the growth level to an average of 2pc per year. Incomes double in 36 years. These aren't just numbers. The most important thing to remember when studying economics is the human story behind the numbers. Doubling incomes means people live longer, healthier lives while enjoying better services from their better-funded government.

So secular stagnation matters because depressing growth levels for longer than necessary following the Great Recession which began in 2008 means longer durations of unemployment, lower levels of services from the State, higher levels of inequality, and a longer period of time paying down debt levels.

A recent book by VoxEu brought some of the world's leading thinkers on secular stagnation together. They agreed (I know, a miracle! Economists agreeing!) on a few principles: Europe is in much more danger of secular stagnation than the US. That's bad for Ireland, as we sell Europe a lot of stuff. Our growth is dependent on Europe's. The economists agreed that real interest rates have to be kept very, very low or even negative for a very long period of time to help keep employment levels up, but even then it's going to be hard to attain full employment. Finally, they agreed that every major policy decision has to take the dangers of secular stagnation into account.

In the Irish case, demographic factors are not our problem. Europe's workforce is ageing. Ours isn't ageing nearly as fast. Our economy is one of the most educated in Europe, meaning further increases in productivity have to come from increases in funding to early childhood education in the long run, and increases in funding to third-level research in particular in the short term. Inequality is a problem in Ireland, but we won't know just how unequal we are in wealth and income until the autumn, when the household finance and consumption survey data are released.

I suspect Ireland won't be that unequal relative to, say, France, and certainly not as unequal as Brazil. And debt? Ireland is stuffed to the gills with the stuff. The best way to deal with that debt is growth, which we desperately need, and which the data are telling us is more likely by the day.

Stephen Kinsella

Irish Independent

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