International Economic Week in Review: Why Are We Growing So Slowly? Edition

Why is the world economy growing below trend? That seems to be the central question economists are asking since the Chinese market intervention over the summer. At Pragmatic Capitalism, Cullen Roche argues that slow growth might simply be the new normal:

The slowing growth of the global economy has many people confused about what’s going on. There are all sorts of explanations out there including the “secular stagnation” theory, the “New Normal”, the “rise of the robots”, etc. But what if the “new normal” and “secular stagnation” are merely the normal?

He bases his argument on this central concept of Thomas Piketty’s Capital:

The inequality r > g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future.”

Essentially, the world economy is now at a point where capital (think liquid assets as well as physical assets) is growing faster than wages. That means the people who own capital continue to get richer at a faster pace than growth. Obviously, inequality adds to the problem. The Bank of Canada added to the slow growth literature on the topic a few weeks ago. After citing the major concepts advanced from the last few years (secular stagnation, the aging population, the global savings glut), they offer one of their own:

Another explanation for the slow growth is that a prolonged cyclical downturn can, itself, pull down potential growth (Congressional Budget Office 2014; Reifschneider, Wascher and Wilcox 2013; Hall 2014; IMF 2015). Potential output depends on the actual level of capital and trends in labour inputs as well as the state of technology.

A prolonged reduction in any of these components can have a negative effect on potential growth in the medium term.

The investment-to-output ratio in advanced economies fell to 19.5 per cent in 2009 from an average of around 24 per cent between 1980 and 2007 and has not yet returned to its pre-crisis levels. Decreased investment has reduced the amount of capital available for production, and when a reduction is persistent enough, it may pull down potential output. The effect of this decrease in capital stock can be magnified when firms have limited access to credit or when firms are less inclined to invest as a result of heightened uncertainty about expected returns on investment.

The economics world continues to grapple with the underlying reasons for the global malaise. It’s more than likely a combination of several theories will become the accepted explanation over the next few years.

The Reserve Bank of Australia maintained rates at 2%. Their policy announcement contained the following assessment of the domestic economy:

In Australia, the available information suggests that moderate expansion in the economy continues in the face of a large decline in capital spending in the mining sector. While GDP growth has been somewhat below longer-term averages for some time, business surveys suggest a gradual improvement in conditions in non-mining sectors over the past year. This has been accompanied by stronger growth in employment and a steady rate of unemployment.

Inflation is low and should remain so, with the economy likely to have a degree of spare capacity for some time yet. Inflation is forecast to be consistent with the target over the next one to two years.

The transition from raw material exports to a more balanced growth model remains Australia’s biggest challenge. It appears that change is occurring. The above reference to an increase in employment indicates the economy is absorbing some of the excess capacity created by the drop in mining investment. This week’s GDP release confirms the RBAs assessment of “moderate expansion:” GDP grew a stronger than expected 2.5% Y/Y. However, personal consumption expenditures are the primary source of growth, growing 2.9% Y/Y. In contrast, capital investment continues contracting, this time at a 4.9% Y/Y pace:

The Bank of Canada kept rates at 2%. Their announcement contained the following assessment of the Canadian economy:

In Canada, the dynamics of growth have been broadly in line with the Bank’s MPR outlook. The economy continues to undergo a complex and lengthy adjustment to the decline in Canada’s terms of trade. This adjustment is being aided by the ongoing US recovery, a lower Canadian dollar and the Bank’s monetary policy easing this year. The resource sector is still contending with lower prices for commodities.In non-resource sectors, exports are picking up, particularly in exchange rate-sensitive categories. However, business investment continues to be weighed down by cuts in resource-sector spending. The labour market has been resilient at the national level, although with significant job losses in resource-producing regions. The Bank expects GDP growth to moderate in the fourth quarter of 2015 before moving to a rate above potential in 2016. While bond yields are slightly higher, financial conditions remain accommodative in Canada.

Data released last week support the bank’s analysis. GDP increased 2.3% annually. However, household spending provided all the growth momentum. In contrast, capital spending contracted:

Final domestic demand was flat after edging up 0.1% in the previous quarter.Household final consumption expenditure rose 0.4%, and residential investment increased 0.6% after a flat second quarter.

Exports of goods advanced 2.7% after increasing 0.5% in the second quarter. Exports of services edged up 0.1%. Imports of goods and services decreased 0.7%, in tandem with weak domestic demand.


Business gross fixed capital formation fell 0.8%, the third consecutive quarterly decline. Investment in non-residential structures and machinery and equipment declined 1.5%.

The weak Canadian dollar is obviously helping; it’s near 5-year lows versus the dollar and pound:

However, manufacturing remains weak. RBA reported a manufacturing index of 48.6, continuing a string of 12 consecutive weak readings:

Finally, unemployment inched higher, rising .1% to 7.1%.

Research from the Markit Group dominated UK news this week. The organization reported a manufacturing composite number of 52.7, which marks more than 2½ years of continued expansion. There are potential issues, however:

“While the improvement in recent months is a welcome trend, scratching beneath the surface of the manufacturing numbers stills exposes a number of weaknesses.Growth remains heavily focussed on the domestic consumer, while the strong gains at large-scale producers have yet to filter through to SMEs. A broadening of the expansion is necessary if the nascent recovery is to be sustained.

The primary reason for the focus on the consumer is the strength of the pound, which is near a five-year high versus the euro:

Services are still growing, as shown by the 55.9 reading. But while new service business increased, backlogs and employment were down slightly. Finally, the construction number was 55.9. Overall, the UK economy continues to grow at a decent rate.

The ECB announced it lowered the deposit rate an additional .10% to -.30%, while also extending the duration of its asset purchase program (APP) to May 2017. Draghi offered the following assessment of the economy in his press conference:

Let me now explain our assessment in greater detail, starting with the economic analysis. Euro area real GDP increased by 0.3%, quarter on quarter, in the third quarter of 2015, following a rise of 0.4% in the previous quarter, most likely on account of a continued positive contribution from consumption alongside more muted developments in investment and exports. The most recent survey indicators point to ongoing real GDP growth in the final quarter of the year. Looking ahead, we expect the economic recovery to proceed. Domestic demand should be further supported by our monetary policy measures and their favourable impact on financial conditions, as well as by the earlier progress made with fiscal consolidation and structural reforms. Moreover, low oil prices should provide support for households’ real disposable income and corporate profitability and, therefore, private consumption and investment. In addition, government expenditure is likely to increase in some parts of the euro area, reflecting measures in support of refugees. However, the economic recovery in the euro area continues to be dampened by subdued growth prospects in emerging markets and moderate global trade, the necessary balance sheet adjustments in a number of sectors and the sluggish pace of implementation of structural reforms.

Recent news from the ECB on loans support some of Draghi’s hopefulness as loans to households continue to increase. But oil has been low for over year and it really hasn’t boosted PCEs by as much as hoped. As with most of his recent statements, this one is long on hope. Other economic releases were evenly split between positive and negative news. Retail sales were down .1% and inflation printed at a meager .1%. As these tables from their respective reports show, both series have been weak for the last six months:

But on the positive side, the unemployment rate continued lower, decreasing .1% to 10.7%. And Markit’s numbers continue pointing to a modest expansion: manufacturing was 52.8, services were 53.9 and the composite reading was 54.2.

Japanese news was mixed. On the positive side, the Markit manufacturing number was 52.8. The factory output and new orders figures were the best in 1 ½ years. However, industrial production decreased 1.4% Y/Y. And, as shown in this chart form the report, IP continues to meander sideways instead of making strong progress.

The Markit service number decreased from 52.2-51.6. Although slightly weaker, new order were positive. Employment, however, was weaker for the second consecutive month. Finally, retail sales increased 1.8% Y/Y, continuing a strong trend for the last year:

Ultimately, the post Great Recession economy will probably come to be known as the "slow growth" economy. While there are a number of theories floating around as to why we're growing slowly, the economic community has yet to coalesce around a unifying theory. Most likely, we'll see several concepts rise to the top. However, until we know why everything is so slow, we don't know what policies to implement. This means we can expect more of the same for the foreseeable future.

© Hale Stewart

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