International Demand

How to create a sustainable economic recovery from Covid

Advanced economies are enjoying a stronger recovery than we expected a few months ago. This glimmer of hope stems from an improved health outlook, the power of government insurance that protected income during lockdowns, and central banks facilitating cheap government borrowing. But this is still only a recovery. Even the United States has yet to ramp up activity to pre-pandemic levels, let alone achieve expected results before the virus hits.

Until economies sustainably exceed gross domestic product levels predicted before Covid-19, no one should use the phrase ‘build back better’ as something that has been achieved. To be successful, advanced economies must increase the productivity of their workforce. Only with more efficient savings will we be able to improve wages, raise living standards and pay off coronavirus-related debts without additional strain.

But productivity has been the Achilles heel of every major economy this century. In the UK, the growth rate fell 1.76 percentage points after 2005, from an annual average of 2.21% in the previous decade to just 0.45%. The decline in the United States has been almost as steep, while Japan has the dubious honor of performing the best, while still registering an annual decline of 0.8 percentage points.

Much has been written to explain this poor performance, with little resolution. There has been an instinctive drive to blame the 2008-09 global financial crisis and few attempts to identify common causes.

A new study of the Oxford Martin School seeks to solve many of these problems by carefully using international evidence and accepting that there will never be a totally clear answer. He manages to rule out some possible causes, including a drop in the skill level of employees, which only seems to matter in Germany, or poor measurement of the data, which can only explain a fraction of the crisis.

Instead, the authors identify causes of significant size and common to all countries. It’s about weaker growth in investment in all forms of capital – digital, machinery, transportation equipment, and intangibles – and the deterioration of how capitalism works. Investment growth problems fall roughly in half between a cyclical component caused by a lack of demand after the financial crisis and structural forces such as the shift to intangible investment in which slower growth is detrimental. more to economic progress in the broad sense. Elsewhere, deeper system failures have reduced competitive pressure, allowing companies to increase profit margins without the normal improvements in efficiency.

This work is useful because it gives us a framework to judge the Covid-19 recovery policies that countries are putting in place. Simply aiming for a “high pressure” economy by increasing demand and hoping that productivity growth will follow is unlikely to succeed. This element, the paper estimates, represents a maximum of 0.4 percentage point decrease, therefore more demand and expenditure must be associated with an attempt to improve the functioning of economies, to make life less comfortable for companies, to increase competition and to re-engage in globalization.

They show that there are definitive steps countries can take to improve the lives of their citizens without having to expect new technologies to produce a surge of productivity that they can just ride. The Biden administration, for example, would score high for improving demand and seeking to increase investment, but still fails to deliver on its commitment to greater international competition with its Buy American trade policy.

The world of economics is too often divided between those who advocate strong demand and those who want supply policies to bring back the dynamism of past decades. The truth is that both are necessary and even then they still cannot guarantee success.

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