Lower potential output, higher total and long-term unemployment, vast public and private debt, and volatile capital markets are just some features of the new reality policymakers face. Income inequality has widened further too, which is not helpful for long-term growth, while there is the rising cost of addressing climate change to take on board. These challenges are daunting.
If advanced countries are to avoid permanently lower growth and welfare, returning to business-as-usual must be ruled out. Today’s “new normal” of lower growth and tighter public finances makes it hard to maintain welfare and meet higher social costs. Policymakers need to take decisive policy action, but for long-term growth, they will need more than that.
Advanced economies that are close to the so-called “technological frontier” will only grow to the extent that they can move that frontier forward, and this requires tapping into new sources of growth.
In contrast, emerging economies are still in the process of catching up with developed ones, and should continue to grow as a result. But while the process of shifting wealth, with a recalibration of world GDP towards Asia and other major emerging economies more generally, is an opportunity, it is also a serious global challenge.
The crisis has proven that instability is an inherent characteristic of market economies. The “great moderation”–that promised era in which business cycles would be less volatile– proved to be illusory and dangerously misleading. A host of misguided policies in financial markets, distorted incentives and insufficient systems of control contributed to an environment in which excessive risk taking and a (mis)allocation of resources towards unsustainable investment became all too widespread.
International imbalances, between surplus and deficit countries in particular, reflected skewed savings and investment choices, but also ill-adapted policies on reserve accumulation and exchange rates. As globalisation and inter-connectedness affect every dimension of our economic and social lives, these nationally oriented policies proved to be not only ineffective, but made the global imbalances worse. All the more reason why this era of shifting wealth calls for more international co-operation between developed and emerging economies, particularly as we must try to avoid unbalanced global growth in the years ahead.
Understanding why imbalances, whether at global, national or business levels, grow and persist is essential to identifying market failures. Redressing them will demand new policy thinking, advice and design on all fronts.
Take also the problem of public debt, which has risen sharply since the crisis started. To be sure, domestic policies are partly to blame. Some OECD countries are paying a high price for not having done more to balance their budgets during the good times. In other countries public finances seemed in good shape before the crisis, but the cost of lax policies that encouraged property bubbles and a swelling in private debt is now being sorely felt.
More attention must be paid to the relationship between public finances and growth. There is now clear evidence that if debt becomes too high, growth will suffer on a permanent basis. A better allocation of spending and taxation can help address this problem. Likewise, more attention must now be devoted to how public goods such as education, health, environmental protection, etc, will be provided and what roles the state and markets can play.
Towards a new growth vision
Ultimately, the pre-crisis paradigm was unsustainable, economically, socially and environmentally, and we need a new vision of well-being for both advanced and emerging economies that recognises new challenges, new opportunities and new sources of growth. The vision would promote green growth and innovation, as well as skills, inventiveness and other value-adding “intangible assets”. It would address some of the causes of the crisis, by financial market reforms, for instance, to promote stability and growth, discourage reckless investment and safeguard wider public interests. Growth in our new model would be more inclusive than before the crisis, since exclusion and widening inequalities can damage long-term welfare. Moreover, improving the quality of life would be recognised as a distinct, desirable and measurable outcome of policy.
Advancing towards this new vision of inclusive growth would demand a good understanding of the relationships and trade-offs between myriad factors, and the likely side-effects and spillovers of different policy options.
Consider inequality, which has widened in many OECD countries in recent decades. The proverbial “rising tide” has not lifted all boats, as a small portion of top earners captured a large share of the overall income gains in some countries, while other incomes have risen only a little, if at all. Would growth-enhancing policy reforms have positive or negative side effects on income inequality? Which redistributional policies might also be beneficial for long-term growth? What are the complementarities and trade-offs? Some policies could produce a double dividend by boosting long-run GDP per capita and reducing inequality. Investing in education and skills, promoting the integration of immigrants and helping more women into decent employment, are just a few examples.
But other policies entail trade-offs. For instance, shifting the tax mix away from labour and corporate income taxes towards consumption and real estate taxes could improve incentives to work, save and invest, but could undermine equity if regressive tax instruments are not offset by measures such as cash transfers for lower earners.
Green growth offers the promise of boosting welfare via several channels, including human capital, technology and innovation, while also helping to deal with rising fossil fuel costs and climate change. Strategies for green growth must be centred on the mutually reinforcing aspects of economic and environmental policy, and seeing the full value of natural capital as a factor of production in its own right.
We know that with existing production technology and consumer behaviour, there is a frontier, a limit beyond which further depletion of natural capital will undermine overall growth. We do not know precisely where that limit lies but we do know that we must promote growth that relies far less on depleting natural capital. We also know innovation will be needed to push the technological frontiers outwards and help us achieve this decoupling. As focusing on GDP as a measure of economic progress generally overlooks the contribution natural assets make to wealth and well-being, the new growth model would have to overcome this by using measurements that encompass the quality and composition of growth.
Green growth raises several policy questions which must be addressed. For instance, to what extent would introducing a carbon tax to tackle climate change, affect jobs or cause carbon intensive industries to move to other countries? Understanding such distributional impacts of environmental policies is important for competitiveness, for instance.
Assessing future impacts is also key, so our approach must also incorporate a long time horizon: environmental impacts are cumulative and some may be irreversible. Though policies are not irreversible, growth and technological change tend to build on one another, creating dependencies and lock-in. One only has to think of today’s energy and transport sectors to understand this inertia. Action taken now can prevent any such lock-in from occurring, and help anticipate unfavourable or even catastrophic outcomes in such a way as to avoid significant economic costs in the future.
Nor should our new vision be narrowed down to a few economic factors. A classical, pre-crisis model that privileged pure efficiency and output can no longer be relied on for designing and evaluating new broader policies, or for measuring a country’s overall performance. Rather, a multi-dimensional welfare function is needed that can allow for the fact that society may wish to sacrifice short-term economic growth in favour of other wellbeing priorities, such as healthcare or more leisurely work-life balance.
With this multi-dimensional framework we would be able to paint a coherent picture of the linkages and identify the different variables that affect imbalances and cause potential market failures. We would then shape the long-run policies and response strategies accordingly.
The OECD has built up half a century of cross-cutting experience scrutinising and advising on the causes of growth. We know, in light of the crisis, that our growth model must now be reviewed and revamped for the challenges ahead. Our new model will be a means to helping us better understand how economic, structural and institutional policy choices might shape global growth prospects in 50 years time. Above all, it will help us devise better policies for better lives.
OECD/The World Bank (2012), Promoting Inclusive Growth: Challenges and Policies, Paris.
Padoan, Pier Carlo, “The evolving paradigm”, OECD Yearbook 2012, Paris.
Padoan, Pier Carlo (2010), “Beyond the crisis: Shifting gears”, OECD Observer No 278.
“World economy: Crisis over? Chief Economist Pier Carlo Padoan explains”, oecdobserver.org.
Love, Patrick (2012), "The arithmetick of green growth", OECD Insights.
©OECD Observer No 290-291, Q1-Q2 2012