What's wrong with the world economy?

While earlier it was China and other Asian economies that were contributing to a 'global savings glut', it seems Germany is now sitting on a mountain of savings, point out Abheek Barua & Bidisha Ganguly.

The global economic situation looks just as grim as ever.

The International Monetary Fund (IMF)'s World Economic Outlook, the agency's quarterly monitor, now suggests a sustained moderation in potential output growth (in lay terms an economy's capacity to grow without breeding serious inflation pressures) across both advanced and emerging economies.

This is mainly due to a decline in productivity growth compared to the period before the crisis. 

Why the dip in productivity growth? The IMF suggests that unlike the pre-2008 period when innovations in information technology had led to a period of exceptional growth, the developed world is stuck in the dipping phase of a technology cycle.

For emerging economies, the integration into regional and global value chains had, in the pre-crisis period, led to a rise in trade and direct investment from the developed world that brought in its wake sizeable transfers of knowledge and technology. This seems to be petering out. 

Heavyweight economists are also weighing in on the vexing question of what's wrong with the world economy.

The IMF's rather pessimistic prognosis, in fact, fits in with the hypothesis of "secular stagnation" that former Harvard professor and US Treasury secretary Larry Summers has been championing.

Summers has essentially resurrected an idea that had been floated by John Keynes' acolyte Alvin Hansen in the late 1930s. It highlights the concern that slower population growth and moderation in technological advance will have a fundamental impact on capital investment and growth. This seems to be the perfect description for the state of the world today. 

If the notion of secular stagnation is indeed the correct description of the state of play, it has major implications for the choice of appropriate policy.

For one thing, this makes it very difficult for monetary policy alone to work, as interest rates need to be exceptionally low (or even negative) in order to achieve full employment.

This is what the advanced countries had done in response to the post crisis slowdown culminating in the quantitative easing programmes of pumping in loads of money when policy interest rates had reached zero.

Summers advocates that fiscal policy should also be eased, so that greater investment is possible in public infrastructure that would set off a virtuous cycle ultimately drawing in private investments that, in turn, could boost innovation. 

Where there are two economists, there are bound to be two conflicting opinions. Former US Federal Reserve Chairman Ben Bernanke, points out that fiscal expansion might be a good idea for the near term while it cannot be a sustainable solution in the longer run.

Predictably, Bernanke disagrees with the hypothesis of secular stagnation and proposes an alternative theory. He explains the prevalence of low growth, low inflation and low interest rates by reviving his favoured theory of a "global savings glut".

While earlier it was largely China and other Asian economies that were responsible for excess savings, he now points to Germany as the world's largest net exporter of both goods and financial capital - that is, it is sitting on a mountain of savings.

To put it simplistically, Germany is the new China. 

His solution lies, therefore, not in fiscal policy but in the realm of trade and exchange rate policy.

A sharply weakening euro both against the dollar and other currencies is not helping since it ends up enhancing Germany's trade competitiveness and bloats its savings base. 

However, all is not lost if we go by Bernanke's view of the world. Germany might be shoring up its savings but other big contributors to the glut are seeing a moderation in excess savings.

First, China is focusing more on domestic demand, particularly consumption, than on exports and that would reduce domestic savings. Lower oil prices are reducing the surplus generated by oil exporters. 

Tailpiece: The Indian Budget seems to have taken the prescription of a public infrastructure-led growth seriously. Wonder if it reflects the fact that two former IMF-wallahs are our economic czars. 

Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is Principal Economist, CII.