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Global Growth Slowdown: Permanent or Temporary?

It's now seven years, since the financial crisis hit the world economy – but global growth has still not moved back to pre-crisis levels. There are good reasons why this is not just a temporary phenomenon.

Seven years after the onset of the global financial crisis advanced economies, although accelerating slightly since 2012, have by no means yet returned to pre-crisis growth levels. Meanwhile, emerging economies appear to be still  shifting into a lower growth gear. This prolonged period of weak growth performance has sparked a heated debate on whether the slowdown is a temporary fall-out from the financial crisis itself, or whether slower global growth is in fact an extension of long-term trends that were already developing prior to the financial crisis. The debate over growth has intensified since Larry Summers, the former US Treasury Secretary and professor of economics at Harvard University, revived the notion of "secular stagnation", a term that was coined during the 1930s Depression.

Is the World Suffering From Secular Stagnation?

There are essentially two potential causes for secular stagnation. The first, put forward by Larry Summers himself in November 2013, suggests that the economy is suffering from a semi-permanent shortage of aggregate demand, and more specifically, insufficient investment spending to bring back the economy to full capacity. An alternative explanation of secular stagnation explains lower long-term growth as a consequence of a supply side deterioration, i.e. an unfavorable evolution of the productive inputs labor and capital as well as of productivity.

Demographics: a Significant Drag on Growth

Demographics are likely to play a central role in the evolution of economic growth, and already now are contributing to slower growth. An aging population can hold down growth through several channels. The most direct is through the supply of labor. The share of the working-age population has virtually peaked in the developed world and is now declining, with Japan, Germany and Southern Europe leading the way. Emerging markets will soon face demographic challenges too. The slowdown will be particularly pronounced in China, which is already suffering from the impact of the one-child-policy, in effect since 1979. Countries such as India, Indonesia or Mexico will remain on a more favorable, but still slowing trajectory. Only African countries, with the exception of South Africa, are expected to maintain an undiminished pace of population growth, with a continuing rise in the share of working-age population.

Aging Population Keeps Interest Rates Low

The drag stemming from an aging population and a shrinking labor force is also likely to depress investment demand. If the post-crisis investment weakness is primarily cyclical rather than structural, being in line with the sup-par pace of the overall recovery, demographics may lead to a lower investment level in a more permanent way in the years to come. On the one hand, declining population growth may lead to lower demand for goods and services. On the other hand, since firms need a given stock of capital per worker to produce a unit of output, a shrinking working-age population results in a decline of the marginal product of capital, which in turn reduces the entrepreneur's incentive to invest in capital stock. Demographically older economies may therefore imply lower investment. This is likely to keep interest rates low, as population aging will continue to boost savings. In fact, recent empirical evidence supports the view that population aging does not lead to dissaving; on the contrary, elderly people have high saving rates as they face longevity, and consequently, show strong demand for financial assets and for safety assets in particular. This development is reinforced by the fact that the prime savers population in emerging markets has not yet peaked.

Productivity Becomes Key for Future Development

Since the potential for expanding the labor force by other means (i.e. enhancing the participation rate of women and older individuals, raising the retirement age) is generally limited, albeit with considerable difference between countries, productivity becomes a crucial determinant of future growth. Recent experience, however, shows that productivity growth is trending lower in both advanced economies and emerging markets. Additionally to the prolonged cyclical investment weakness, which contributed negatively to productivity growth, there has been much discussion lately about a supposed stagnation in technological progress. Some economists reckon that the contribution of technology to growth may be weakening rather than strengthening and that it will not change the way the world works as much as the introduction of electricity or the telephone have in the past. Others are more optimistic regarding the potential for technology to keep boosting productivity growth in the future.

Efficiency Issues Are Slowing Down Productivity Growth

Even if the recent slowdown in productivity growth may persist for some time, it is not, in our view, due to an unusual slowdown of technological progress. We rather believe that the observed weakness in productivity growth is due to efficiency issues, which are slowing adoption and diffusion of new technology. The efficiency with which labor and capital are combined to generate output partly depends on the extent to which firms operate in an institutional, regulatory and legal environment that fosters competition, avoids unnecessary administrative burdens, provides modern infrastructure and access to capital. Conditioned by the financial crisis, market dynamism has weakened considerably, putting a drag on productivity growth.

Emerging Markets: Key Drivers for Global Growth

More and more productivity becomes a crucial issue also for the growth performance of emerging markets. Given the fading support from labor input and the likely slowdown in capital accumulation, these economies will need to enhance productivity growth, both across manufacturing and the rising service sector, depending on their specific developing path. A successful transition to higher productivity growth and efficiency will be crucial for the growth outlook in emerging markets. And given that their share in the global economy is now so much larger than some decades ago, this successful transition will also be key for the global growth outlook.