Jackson Hole was abuzz last week as top economists rubbed shoulders with central bankers, but the stuffed bears in the lobby of the venue seemed symbolic of the angst permeating world markets.
In spite of this, the participants got down to business and I was not alone in thinking that today’s financial market turmoil and the anxiety over high unemployment in the United States and over European debt should be treated by the economics profession as an opportunity to think differently about solutions for kick-starting growth.
Today’s uncertainty should spur policymakers to take new economic ideas and build a social consensus for action. An ambitious, innovative approach is needed otherwise the crisis will likely be with us for some years. Indeed, the US and EU could face a Japan-style scenario, with prolonged recession and a high level of public debt.
‘Achieving Maximum Long-Run Growth,’ was this year’s theme at Jackson Hole – a seemingly upbeat topic during uncertain times.
What follows is a flavor of what I found memorable at Jackson Hole (besides bears in the hallways and lots of cowboy boots).
Dani Rodrik discussed how lagging economies catch up based on their ability to achieve structural transformation by absorbing ideas and knowledge from the technology frontier. In his paper on ‘The Future of Economic Convergence,’ Dani used the example of Asia to explain the role of unorthodox policies such as undervalued currencies, industrial policies, and significant state intervention to drive structural transformation. He also said that Asia’s orthodox policies – macro stability, investment in human capital, and an emphasis on exports was crucial to success in places like China and Korea.
I agree with Dani that industrial policy has a role to play in structural transformation (and it’s often been unfairly disparaged), but I am not so sure that undervalued currencies have been the key to convergence. Indeed, I think imports are at least as crucial as exports for growth, because imports often usher in new technology. Dani’s observed “undervaluation” may just be a result of the fact that ‘catching-up’ countries are in the process of converging from a dual economy to a unified modern economy and the Balassa-Samuelson theorem (that productivity improvements and expansion in the tradeables sector will raise wages and prices of non-tradeables goods, resulting in real appreciation) is not applicable in such a case.
Esther Duflo, meanwhile, posited that a long term strategy to balance growth with equity should entail policies that maximize the chance for the poor to fully participate in markets. Her paper describes market failures in finance, insurance, land, and education in developing countries, and discusses what is known, and not known, about how best to tackle them.
My view is that fixing all those market failures that are biased against poorer people might not be sufficient. Poor people’s income comes mostly from their labor earnings, while the rich people derive a large portion of their income from capital. If a developing country can follow its comparative advantage and starts its structural transformation by developing labor-intensive industries, the poor will have better employment opportunities, the economy will be competitive and dynamic, labor will turn from relatively abundant to relatively scarce, and the increase in wage rates will be much faster than the return to capital. In this way, the country may achieve growth with equity as Japan, Korea, Taiwan-China, and Singapore achieved during their catching up process.
The all-important issue of financial system operation and regulatory strategies were well explained in Ross Levine’s paper titled ‘Regulating Finance and Regulators to Promote Growth’. He argues that rules should be designed with incentives that allocate resources to entrepreneurs who will contribute most to growth. I fully agree with him about the importance of allocation. The firms that get the most ‘bang for the buck’ in terms of jobs and return on investment are actually small and medium sized enterprises. However, instead of changing the incentive structure of the existing financial institutions, the way to increase access to financial services -- especially in terms of making credit available to small and medium sized enterprises -- is to change the financial structure by developing small, local financial institutions, such as community banks.
The specter of negative debt dynamics was explored in a paper titled ‘The real effects of debt’ by Stephen Cecchetti, M. S. Mohanty and Fabrizio Zampolli. The paper does an excellent job of analyzing how the level of debt in an economy goes from good to bad. Also, it looks comprehensively at all forms of non-financial debt: household, corporate, and government. A key finding is that, once a certain ceiling is exceeded, debt hurts growth. According to the paper, for government debt, the number is in the range of 80-100% of GDP. For corporate debt, it’s around 90%, while household debt is around 85%, but the latter estimate is quite rough. While I applaud Cecchetti et al for highlighting the importance of post-crisis debt reduction, I think it’s vital to also unbundle how debt is used, since spending on things like smart infrastructure and targeted jobs programs can help stabilize the macroeconomy and re-start growth. Especially, under the current situation fiscal consolidation may not achieve its intended goal because the program may reduce growth and government revenues while increase unemployment and social expending.
In his paper, ‘Role Reversal in Global Finance’, Eswar Prasad floated one of the bigger ideas. He proposed a mechanism for global liquidity insurance that would meet the need for insuring against balance of payments crises. He argued that the reserve accumulation for self insurance was the cause of the global imbalance and the root of the global crisis. I agree with him that insurance during a financial crisis can be a ‘life saver’ in terms of averting a full meltdown and the buildup of reserves has the function of self insurance. However, the ensuing global imbalance was first and foremost a structural issue. Without addressing the root cause the crisis may repeat.
Last but not least, speeches by Ben Bernanke and Christine Lagarde telegraphed ‘get real’ messages. Bernanke wasn’t afraid to call for better designed tax policies and spending programs, even though it’s politically unpopular. Madame Lagarde was right to call for a common European vision and for policymakers there to accept that the most recent turmoil exposed some serious flaws in the architecture of the eurozone. Leadership and decisive action built around a common vision is essential. And, as she said, that requires “fiscal rules that actually work.”