Lawrence Summers is a professor at and past president of Harvard University. He was treasury secretary from 1999 to 2001 and economic adviser to President Obama from 2009 through 2010.
The most challenging economic issue ahead of us involves a group that will barely be represented at this week’s annual Davos summit: the middle classes of the world’s industrial countries. As the Center for American Progress’s Inclusive Prosperity Commission, which I co-chaired with Ed Balls, the top economic official in Britain’s Labor Party, concludes in a new report, nothing is more important to the success of industrial democracies than sustained increases in wages and living standards for working families.
Amid the focus on global finance, geopolitics and the moral imperative to help the world’s poor, no one should lose sight of the fact that without substantial changes in policy, the prospects for the middle class globally are at best highly problematic.
First, the economic growth that is a necessary condition for rising incomes is threatened by the specter of secular stagnation and deflation. In the United States, 2014 was expected to be one of rising interest rates along with acceleration of growth, the end of quantitative easing and the approach of tightened monetary policy. In Japan, prices were to start rising again. In Europe, the year was to bring continued economic reform and normalization.
In fact, 10-year Treasury rates have fallen by more than 1 percentage point in the United States and are only half as high in Germany and Japan as they were a year ago. In a number of major countries, including Germany, France and Japan, short-term interest rates are now negative, with lenders to governments forced to pay for the privilege. Such low interest rates suggest a chronic excess of saving over investment and the likely persistence of conditions that make monetary policy ineffective in Europe and Japan, along with their possible reemergence in the United States. Market indicators almost everywhere suggest that inflation is expected to be well below the target rate for a decade.
The world has largely exhausted the scope for central bank improvisation as a growth strategy. Excess demand, inflation, excessive credit and the need for monetary tightening are the least of our concerns. Central banks still have to do their part, but it is time for concerted and substantial measures to raise both public and private investment.
Second, the capacity of our economies to sustain increasing growth and provide for rising living standards is not assured on the current policy path. The United States is often held out as a model, and indeed its performance has been strong by global standards. The United States has enjoyed growth of about 11 percent over the past five years. Of this, standard economic calculations suggest that about 8 percent can be regarded as cyclical, resulting from the decline in the unemployment rate. That leaves just 3 percent over five years as attributable to growth in the economy’s capacity. Even after our recovery, the share of American men age 25 to 54 who are out of work exceeds that in Japan, France, Germany and Britain.
Demand issues aside, growth prospects are worse in Europe and Japan, where adult populations are shrinking and ageing and economic dynamism is subsiding. A significant part of the sharp downward revisions in the estimated potential of industrial economies is a consequence of the recession conditions of recent years. In many ways, strong growth is itself the best structural policy for promoting growth as investment rises, workers gain experience and so forth. But more must be done.
Third, if it is to benefit the middle class, prosperity must be inclusive, and in the current environment this is far from assured. If the United States had the same income distribution it had in 1979, the bottom 80 percent of the population would have $1 trillion — or $11,000 per family — more. The top 1 percent would have $1 trillion — or $750,000 — less. There is little prospect for maintaining international integration and cooperation if it continues to be seen as leading to local disintegration while benefiting a mobile global elite.
The focus of international cooperative efforts in the economic sphere must shift. Considerable progress has been made in trade and investment. Less has been made in preventing races to the bottom in areas such as taxation and regulation. Only with enhanced international cooperation will the maintenance of progressive taxation and adequate regulatory protection be possible. And only if ordinary citizens see benefit in an ever more open global economy will it come about.
These three concerns — secular stagnation and deflation, slow underlying economic growth and rising inequality — are real. But they are not grounds for fatalism. The experience of many countries, including Canada and Australia in this century, and many eras shows that sustained growth in middle-class living standards is attainable. But it requires elites to recognize its importance and commit themselves to its achievement. That must be the focus of this year’s Davos.
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