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Why is the world decelerating and what consequences will that have? | Finance Talks

Why is the world decelerating and what consequences will that have?

By Ignacio de la Torre

“We were saying yesterday” that a world that decelerates translates to an increase in the number of years that the next generation needs to live to do better than their parents, and also that the growth of the world’s economy in 2019 will be very low, less than 3%– the second worst since the 2007 crisis. That contrasts negatively with the average growth of 3.7% in the last decade.

At the expense of the more critical considerations of this lower growth (China, India, euro zone…), it is important to reflect upon the structural factors associated with the lower growth rates, and the consequences this may have.

If we stick to the first point (structural issues), the economy grows due to two factors: the increase in the number of worked hours and the growth of productivity.  The hours, depends on the hours we decide to spend working in a year and also on the demographic increase or decrease (of the active population specifically) since workers account more or less for the total hours that impact on GDP.

The number of hours we decide to work has reduced considerably since World War II. Thus, a French person would work 2.200 hours a year on average towards 1950 compared to the 1.300 that we work nowadays.  The tendency to work fewer hours is more or less accentuated depending on the productivity of the workers. The more productivity there is, the more income, which allows people to decide to work fewer hours. In any case, once the work shifts are established (partly because productivity grows less and less, as we will see shortly) the first growth factor is explained by the changes in the population that is willing to work (active). If this grew stronger since the mid-20th century until its end, the reality is that we’ve had several years now in the 21st century in which the active population of developed countries has dropped to negative numbers, something that also happens in China, the world’s second largest economy.  The consequence is that if demography explained 40% of the world’s GDP growth in Western countries since World War II (and this despite the decline of the working shift), from now on we will not only not have this additional factor, but it will drain the population, which will mathematically lead to lower economic expansion rhythms (the case of Japan, a country that loses less than a million workers a year is paradigmatic).  Globally, the drop in fertility is an undeniable fact to the point that today we have 2.4 children per woman, with marked falls in developed and emerging countries, which could lead– if this rate continues– to the end of population growth and even begin a decline in two decades.

At the same time productivity has explained the other 60% of the world’s growth. This had been going up in western countries with rhythms of 2% since World War II up to the mid-60s. Since then the increases have been slimmer, closer to 1%, except the gap between 1996 and 2004 (due to massive adoption of the internet). Today productivity in certain geographical zones like the euro zone barely grows 0%. It can seem paradoxical that at the height of the fourth industrial revolution (particularly artificial intelligence) productivity barely is growing. The reality is that every scientific innovation takes years and sometimes decades to hatch productivity, partly because the process of “creative destruction” that the inventions generate can also cause business decline in companies and negatively affected sectors, that see their productivity go down until it disappears.

Again paradoxically the policy of central banks to keep low structural interest rates could be helping these “zombie” companies survive longer than normal, which aggravates the low productivity problem and also translates to less growth and less inflation, which perpetuates lax monetary policies.

The consequences will be lower growth, which will mean– as I expressed earlier– that our children will take many more years to improve their standard of living. However, there are other more worrisome consequences. The first is world debt. If it represented 2.1 times the worlds GDP when the crisis started, it now is 2.4 times the GDP. Debt worries us when it decelerates, due to the fact that it becomes more difficult to pay back. We would then have a structural problem between the elevated debt and low growth that would create financial crises. That should worry us more than small economic ups and downs, since financial instability could cause a small economic bump to become a formidable hurdle, as we learned ten years ago.

On the other hand, the more people that retire and aren’t replaced by new workers, the more difficult it will be for the social state to confront its level of expenses, mostly for pensions and hospital costs, all while addressing the huge public debt. This will force us to rethink the structure of the social state, and perhaps also consider changes in taxation, which could change in the medium-term from work (since there will be fewer workers) to consumption and wealth. Finally, the political consequences are also considerable, as the population ages, they will vote to protect their interests (pensions) at the expense of the increasingly lower percentage of young people, which will cause significant social scars (the percentage of young people that believe that democracy is essential has reduced in the last decades).

Therefore, the only “miraculous” recipe to avoid this “dystopia” is to accelerate the growth of productivity, something that, as we will see, might not be so “miraculous”.

This article was originally published in Spanish in El Confidencial on October 3, 2019