How Could the South Respond to Secular Stagnation in the North?

• Date: 01 February 2017
• Author: Joerg Mayer
• DOI: http://doi.org/10.1111/twec.12389
• Published date: 01 February 2017

How Could the South Respond to Secular

Stagnation in the North?

Joerg Mayer

DGDS, UNCTAD, Geneva, Switzerland

1. INTRODUCTION

SEVEN years after the onset of the global financial crisis, world economic growth

remains significantly slower than before the crisis. Many developed countries continue

to lack robust demand growth and experience inflation significantly below targeted rates,

despite several years of accommodative monetary policy, improved financial conditions and

some relaxation of fiscal consolidation. Developing countries maintained rapid growth up to

2010–11 through the adoption of countercyclical policies, which raised domestic demand and

mitigated declining growth stimuli from the external economic environment. However, these

policies have been gradually unwound as many developing countries have experienced pres-

sure on domestic prices or trade balances that could be contained only by accepting lower

domestic-demand growth. The emphasis of the development literature on the importance of

developed-country growth for developing-country growth indicates that developing countries

may experience a progressive downward slide of growth if the lack of aggregate demand in

developed countries persists.

Concerns that economic growth in developed countries will remain weak for a protracted

period of time have been summarised as ‘secular stagnation’, that is an extended period of

low growth reflecting persistently weak demand that could turn into stagnation because

weak actual output growth reinforces the erosion of potential output growth. There is no

agreement as to whether the current economic situation in developed countries actually

reflects secular stagnation (for discussion see, e.g. Teulings and Baldwin, 2014), because

considerable unevenness across countries’ growth performance has emerged. Yet, the mere

risk of protracted subdued demand growth in developed countries and the spillover effects

of policies that they may adopt to address this phenomenon provide enough reason for

developing countries to consider a response to diminished prospects for export-led growth.

The paper’s main contributions are its focus on the impact that secular stagnation may

have on developing countries’ growth prospects and its use of a unified framework focused

on an integrated treatment of trade, finance, investment and innovation and based on two tra-

ditions that emphasise the role of exports in economic growth. These are the growth model

based on the balance-of-payments constraint (Thirlwall, 1979), which underlines the relat ion-

ship between imports and exports in the growth process, and the model of cumulative causa-

tion (Myrdal, 1957; Kaldor, 1970), which emphasises the positive association betwee n growth

of a country’s GDP and that of its manufacturing sector.

The paper’s main argument is that concerns raised by models emphasising the balance-of-

payments constraint on developing countries’ growth prospects are well founded, albeit less

serious than the simplest versions of the model would imply. Changing assumptions to allow

for cumulative-causation forces from domestic-demand growth and relative price effects indi-

cate that developing countries can maintain rapid growth by compensating for lower export

growth by faster domestic-demand growth, provided that they can also reduce the income

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The World Economy (2017)

doi: 10.1111/twec.12389

The World Economy

elasticity of import demand. Achieving this requires changing policies towards a focus on

investment that moves the composition of domestic production closer to the emerging

composition of domestic demand and emphasises sectors that are sufficiently large to enjoy

cumulative-causation effects. Such investment should be accompanied by incomes policy and

capital-account management, as well as supply-side policies to strengthen innovation capacity.

Drawing down excessive foreign-exchange reserves or obtaining concessionary loans from

development banks could provide the financing for capital-goods imports that some develop-

ing countries may require. Resource-based economies will find growth rebalancing more

challenging than those that have developed manufacturing during periods of export-led

growth. Small countries may require further growth support from enhanced South–South inte-

gration. Rebalancing developing countries’ growth strategies will be complicated if developed

countries continue addressing the risk of secular stagnation by relying on monetary expansion

and/or if their policies involve shifting the composition of their aggregate demand towards a

greater importance of external demand.

The next section discusses the risk of secular stagnation in developed countries, its poten-

tial reasons and attendant policy options. Section 3 examines the relationship between devel-

oped-country and developing-country growth from the perspective of growth models and

combines two demand-oriented models to consider the channels through which this relation-

ship works. Section 4 discusses policy responses by developing countries, and Section 5

concludes.

2. THE RISK OF SECULAR STAGNATION IN DEVELOPED COUNTRIES

The hypothesis of ‘secular stagnation’ describes the risk that very sluggish economic

growth becomes the new norm in developed countries because their traditional macroecon-

omic toolkit, and especially monetary policy, becomes ineffective (Krugman, 2014a;

Summers, 2014a, 2014b).

1

It asserts that the financial crisis of 2007–08 was a second-order

event and that the main culprit for the slow recovery from the crisis has been a decade-long

tendency of inadequate aggregate demand growth.

2

The United States has addressed the

resulting adverse effects on output growth by successive waves of accommodative monetary

1

The term ‘secular stagnation’ was coined by Hansen (1939) who worried that the United States was

facing slowing demographic and labour-force growth combined with constraints on farmland expansion

that would generate under-investment and aggregate demand deficiency that would cause economic

growth to decline to very slow rates. While fiscal expansion related to the Second World War and accel-

erated population growth during the 1950s prevented Hansen’s concern to materialise, the hypothesis

that global economic recovery over the past seven years has been held back by deficient aggregate

demand has revived interest in this issue. For a review on the diagnosis, causes and possible remedies of

secular stagnation, see, for example, Teulings and Baldwin (2014).

2

IMF (2014) considers the period of secular stagnation to have begun in the mid-1980s, when real

interest rates in developed countries started to decline following the adoption of disinflationary policies

in these countries. However, the mid-1980s also mark the beginning of the long-run decline of the wage

share in developed countries (ILO, 2015). Disinflationary policies may be at the origin of this decline as

they became theoretically justifiable following the growing attention given during the 1970s and 1980s

to new classical macroeconomics that, as opposed to Keynesian economics, asserts that only the aggre-

gate price level and labour market flexibility, and not aggregate demand, have an impact on output and

employment growth.

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