Stephen D. King may not be the author of "The Shining" or "Carrie," but that doesn't mean his new book doesn't offer a vision of a world with more, er, Misery. King, the chief economist of HSBC, argues in "When the Money Runs Out: The End of Western Affluence" that the rapid growth in the second half of the 20th century was an anomaly, and that with a return to a slower pace of growth citizens of leading Western nations need to re-adjust their expectations. We spoke recently on his trip to Washington; this transcript has been edited for length and clarity.
Neil Irwin: So explain your argument, in a nutshell.
Stephen D. King: Growth prospects in the advanced industrial nations are lower than people are used to. But the entitlements that we think we have will only be met by returns to growth of old. So if growth doesn't come back, we will have to reduce the entitlements, both physical and financial, that we’ve built up.
Policymakers typically assume that we can go back very easily to growth rates of old. But so far their forecasts have had an optimism bias. You can understand why. If you go back to those 3 or 4 or 5 percent growth rates, it will solve a lot of problems. But right now there is a growing gap between hope and economic reality.
N.I.: The standard assessment of all the developed economies other than maybe Canada, Australia and Nordic economies, is that they all have economic output right now that is well below potential. Do you agree with this premise that the economies of the U.S., UK, and Eurozone are still depressed relative to what might be plausible?
SDK: I think the room to grow is probably less than a lot of policymakers might believe. Part of the reason for saying that is output gaps are pretty unstable. They’re not very reliable.
The second is I suspect that before the financial crisis output was quite a long way above potential. The reason people didn’t think it was above potential is because inflation was mostly well-behaved. But there are lots of examples historically of countries that in hindsight had output well above potential even though inflation was well behaved. The first example is Japan in the late 1980s, which went through a huge bubble. Its activity was well above potential, but there was very little inflation. And it was the absence of inflation that gave people confidence that Japan was facing a new paradigm type story. A second example is the U.S. in the late 1920s. There was no inflation at all. You’d never guess from it that output was well above trend, but given what happened in the 1930s it’s evident that output was well ahead of trend.
Had we seen a very strong rebound in activity in the last few years, that would give credence to the idea that the output gap was very big. But the absence of a strong recovery suggests to me that what seemed a demand-side shock was actually a supply-side shock as well.
There are ways of justifying this. In the UK case, in the years before the financial crisis, the employment growth in the UK was really focused in only three areas. The first was financial services and the second was construction, which was in turn an outgrowth of financial services. And the third was the public sector. So if you’ve got a leveraged bubble in financial services, if that bursts, then a lot of other things happen at the same time and it’s difficult to claw back the growth you had.
In the U.S., I would argue before the financial crisis, there was already evidence that the U.S. economy was slowing down from the rate of the 1980s and 1990s. In that era it was around 3 percent a year. The average from 2000 to 2007 was only 2.5 percent, but that came about even though there was massive monetary and fiscal stimulus, even though there was a housing boom, even though there was lots of leverage. In many ways, it was a boom without cyclically strong growth. Perhaps the trend growth rate was significantly lower than it had been in earlier decades.
This comes back to a starting theme of the book, which is that the west went through a kind of golden age from the 1950s to the end of the 20th century, which included not just technology, but also a series of one-off effects that lift economic activity from this level to that level, and during that lift you have an unusually fast period of economic growth, but then when you get to that level the pace of growth comes back down. Those factors include the opening up of trade, particularly within the advanced nations in the 50s and 60s, then on an east-west basis in 1980s and 90s. I think there’s room for further opening of trade in the years ahead, but more focused on the south-south linkages, more between Asia, Latin America, Sub-Saharan Africa, the Middle East.
The second big change is women in the workforce. We went from very few women being employed productively to many women being employed productively. There is more change that can happen, but the majority of that benefit has already come through.
Third is education. If you were a graduate coming out of university in the 1950s, you were guaranteed to get a high paid job, because there were very few graduates. Nowadays people are finding that they can be educated very well and still struggle to find jobs that are commensurate with the education they have, which suggests a diminution of the marginal returns of education.
The fourth factor is consumer credit, which has seen a huge expansion, mostly for good reasons. But I think since the advent of the financial crisis it’s difficult to see how we can see that kind of growth in the future.
You take away those factors and you return to the growth rates that were more sustainable in the 19th century and first half of the 20th century. So perfectly good growth rates but not as good as you want them to be and in particular not good enough to meet the obligations we’ve built up.
NI: Seems like a key node in your argument is that keeping your eye on inflation as the measure of whether you are at or beyond economic potential gives you the wrong signal, gives you mistaken signals. Why is the fact that there was low inflation in the 2000s not a signal that we’re fine, there's plenty of room to grow?
SDK: Part of the reason is that if you go back to a very long period of time, hundreds of years, you don’t see much inflation. Inflation was a phenomenon of the postwar period. It really came to financial crises, economic upheavals, you still had them. You go back to the 19th century and think about countries under the gold standard, the gold standard was a tremendous monetary discipline in preventing inflation. But you still had periods of tremendously weak growth or periods of financial chaos.
I think low inflation is clearly desirable in itself. It may even be a necessary condition of lasting prosperity. But I don’t think it’s sufficient. I’d also argue that sometimes price stability actually creates economic instability, perversely. Prices are determined on an international basis rather than a local basis, and a lot of prices that have an impact on the economy are not really controlled by that particular economy’s central bank at all, they’re effects from abroad.
Prior to the financial crisis you had lots of price declines thanks to cheap imports coming from China, India, or wherever else. I think the sensible thing to do at the time would have been to let headline inflation to drop relative to wages. It would be to say as a central bank that we can’t control every aspect of inflation, so if the inflation we’re seeing is coming in lower than expected as a consequence of foreign developments, let’s just let that happen.
But there was a fear of course of deflation being bad, debt deflation, rather than good trade deflation. There was a desire to prevent inflation from falling too fast. The consequence was that policymakers left monetary policy too loose, which contributed to some of the bubble features of housing and leverage that came through over those few years.
The focus on inflation I think led to inflexibility with regard to shocks coming in from elsewhere in the world, and the consequence was that you were basically offsetting imported deflation with excessive domestic monetary stimulus, which contributed to some of the subsequent instability.
NI: So you're arguing that while perhaps central bankers have gotten pretty good at looking past commodity-driven inflationary or deflationary shocks, they have been less good at realizing there’s a whole world of things affecting domestic prices which they have no control over, and maybe you have to look past those things too?
A: Yes. But you have to look at why that is happening. If you believe energy prices are basically steady and there are occasional bumps in either direction, you can happily ignore them in setting monetary policy. But over the last 10 years, when energy prices move steadily up the whole time, it’s not as obvious that you should ignore them. Headline inflation was rising relative to core inflation. The first part of that period, the U.S. imported deflation, from the emerging economies, thanks to lower-priced imports. Then they imported inflation as demand for oil and other commodities from China took off. If you focus purely on core inflation, you wouldn't understand the full effects of both of those changes.
NI: On the fundamental drivers of rapid 20th century growth, your arguments are similar to those of Tyler Cowen in "The Great Stagnation", or to Robert Gordon. The counter-argument I suppose, is that, well, yes we got these one-time positive shocks, but by definition we don't know what those next positive shocks will be.
SDK: Yes, that’s certainly true. I agree with that. The difference between myself and Robert Gordon is I think technology will be important in the years ahead. I think his argument is that we have exhausted technological opportunities. I think that’s a difficult argument to sustain, because we really have no idea what will come next. Innovations are randomly distributed. My argument is there are specific events that happened that explain why the late 20th century was in many ways a golden age, and different from what happened in previous times.
My argument is not the Malthusian argument that we’re facing a disaster. Mine has much more to do with the idea that there is a difference between what we're actually achieving in income gains and what we hope to achieve given the recent experience. It’s a gap between realities and hopes and aspirations that is the problem. Reducing those hopes and aspirations is where the social questions arise.
NI: None of what you describe implies a single point of reckoning. Is this a grinding series of readjusting pension plans, social welfare programs to fit the new growth reality, or does this become a crisis point at some point?
SDK: It depends on the way you look at it, actually. I think for the U.S., the obvious thing is to raise the target age [for retirement benefits], change pension plans, and make it clearer to people over time that they’ll need to change their behavior, because we cannot meet the obligations we currently have. But it takes time and it’s potentially painful, and it also creates uncertainty that can actually corrode growth in the short term.
In the Eurozone it’s more tricky. You’ve got northern European creditors who lent to southern European debtors. Creditors are determined they should be repaid. But for them to be repaid it will mean year after year of austerity in the south, which is politically difficult to sustain. The question is what gives.
There are four options out there. First option is that you end up with the euro breaking up, which is unlikely in my view because the consensus to support the euro is very high, and partly because of the potential of financial chaos if it were to break up. The second possibility is a series of disorderly debt defaults in southern Europe. The third option is Europe tolerates higher inflation, which is fine for all the European countries except one, which is Germany which will never accept it. And the fourth is the idea of moving to full fiscal union. The problem is they all seem remarkably unlikely, but by process of elimination, one or more of them will have to happen.
N.I.: A logical implication of your argument seems to be that what the central banks are doing right now, with large-scale money-printing to try to achieve faster growth, will either be futile or dangerous or both. Is that the case?
SDK: I think [quantitative easing] started off in a welcome way as a powerful antibiotic designed to cure a really immediate threat, which was the possibility of a Great Depression. QE and fiscal stimulus were the right thing to do. The problem has been that policymakers have said they cannot only avoid the worst outcome, but can return us to the best outcome, and that’s something I’m not so sure about.
There’s dangerous conflation of two separate stories. There’s the Depression 1930s story, and the Japan Lost Decade story. I think we’ve avoided the 1930s story, but we may have already entered into a lost decade.
N.I.: By a lot of measures, we’ve already had one.
SDK: Yes, that's right. I should say that differently. We've already had one lost decade. The risk is that we’re going to have a second lost decade. So how do you avoid a second lost decade? The difficulty with QE is that it’s gone from this powerful antibiotic to become kind of an addictive painkiller that it’s nice to be on, but it may create distortions and doesn’t help longer-term growth
The first of the distortions is that it tends to have an impact on the distribution of income. If you’re a wage earner, you probably aren’t much affected by QE, where if you’re an owner of financial assets you’ve done pretty well. If you favor people who are asset-rich, those are wealthy people with a low marginal propensity to consume. That means the impact on growth is not as much as you might expect.
The second aspect has that persistent QE, by offering low interest rates, has made it easier for companies that aren't particularly efficient to survive, making it more difficult for new entrants to come in. The consequence there is that we’ve had an unusual period of weak productivity growth. The incumbents can keep shareholders happy by issuing debt, doing share buybacks and paying higher dividends, which rewards the financially asset-rich without adding much to the overall performance of the economy.
A third factor, most obvious of all is the issue of the possible creation of financial bubbles. By offering QE continuously you risk recreating the hunt for yield that we saw in the period before the financial crisis.
N.I. So how many people will buy your book expecting a horror novel? And how many sales are you counting on from people who are confused?
SDK: If they read the reviews, they may think it’s a horror novel anyway.
There was actually an occasion with my first book, back in 2010, I was doing some marketing for it in Vienna, and there was a car service to take me to the airport, and there was an announcement on the PA system for Stephen King to meet his driver at the information desk. So I went there, and the woman said, “Are you Stephen King the author?” I said well, yes, I am the author. She said ‘No you’re not,’ and I got my book out and showed her the picture of me on the back flap. She was terribly excited to meet Stephen King, and I didn’t want to disappoint her. But it’s quite handy for getting tables at restaurants.