Krugman on Bubbles and Secular Stagnation

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Thursday, 26 September 2013 04:49

Paul Krugman has some interesting thoughts on the possibility that the U.S. economy might have a serious problem with secular stagnation that has been remedied in large part over the last two decades by bubble generated demand. This is old hat to some of us, but it's great to see Krugman pursuing this line of thought.

There are two points worth adding on the topic. One important component of demand that has been big-time in the negative category in the last 15 years is net exports. This represents a serious failure of the international financial system. The old textbook story is that capital is supposed to flow from slow growing rich countries to fast growing poor countries where it can receive a higher rate of return and assist these countries in their development. 

The textbook story has never fit the data very well (net capital flows have often been in the opposite direction), but the flows from poor to rich have been especially large in the years following the East Asian financial crisis. The harsh treatment by the I.M.F. of the countries in the region (yes, this was the bailout led by the Committee to Save the World) led to a sharp increase in the accumulation of foreign exchange reserves (i.e. dollars) by developing countries. Countries in Latin America, Asia, and Africa suddenly began to accumulate as much reserves as possible with the idea that this would protect them against ever being in the situation of the East Asian countries.

That led to a large rise in the value of the dollar and a big increase in the size of the U.S. trade deficit. The trade deficit in turn led to a big gap in demand that was filled at the end of the 1990s by the stock bubble and in the last decade by the housing bubble. (A trade deficit means that income generated in the United States is being spent in other countries instead of the United States.) There may well be a problem of secular stagnation even if trade were closer to balanced, but the huge expansion of the trade deficit in the last 15 years clearly aggravated the problem considerably.

The other factor that should be kept in mind is that potential GDP or full employment is not exactly a fixed point in space. One of the big factors that determines the potential level of output is the average number of hours worked per worker. In places like Germany, the Netherlands, and France, the average work year has roughly 20 percent fewer hours than in the United States. This means that to produce the same output, these countries would need  20 percent more workers. (That assumes equal productivity per hour, which is pretty close to being the case.) 

There is both a short-term and long-term story here. In the short-term we can employ more workers to produce the same amount of output by promoting work sharing type policies to encourage companies to reduce work hours rather than lay off workers in response to a decline in demand. Such policies have been pursued aggressively by Germany which is the main reason that its unemployment rate has fallen by 2.5 percentage points since the beginning of the downturn while the U.S. unemployment rate has risen by almost 3.0 percentage points even though growth in the two countries has been almost identical. (Germany has slower labor force growth, which is another big factor.) 

The United States has a work sharing option in the unemployment insurance system in more than half of the states, but the take-up rate is very low, largely because employers don't know about it. This is unfortunate, especially since the federal government will pick up the tab for state work sharing programs through 2014.

While the short-term story can be thought of as redistributing unemployment, the longer term picture is more interesting. Over the last three decades, workers in most European countries have taken much of the gains of productivity growth in the form of more leisure. This means 4-6 weeks a year of paid vacation, paid family leave and sick days, and in at least one country, 35 hour work weeks.

These forms of leisure have been integrated into these countries' social structures in the same way as the weekend is taken for granted in the United States. People in Europe do not think of themselves as being partially unemployed because they work less than 1500 hours a year. In addition to creating a situation where more people are employed at the same levels of output, these types of leisure also allow for better work-family balances and more environmental-friendly life styles.

In principle, secular stagnation is a story of wealth, not poverty. It means that we are capable of producing more goods and services than we are actually using. It is an incredible indictment of our economic system that it can lead to the sort of suffering we saw in the Great Depression and are seeing again today.