Below is a brief summary of the structural stagnation argument. It’s a condensed argument meant for economists. In my textbook (Chapter 28 of Colander, Economics, 9th edition) I spell out the issues step-by-step in a way that students can understand organizing the discussion around a globally modified AS/AD model.
The story begins in the mid 1990s with the rise of large-scale globalization, which changed the operating features of the U.S. economy. Globalization wasn’t new; what was new is that the two new players on the scene—China and India—had a huge available pool of labor. Instead of a wave of globalization the U.S. economy experienced in the 1970s, it was a tsunami.
The natural international adjustment to the massive globalization would have been for the value of the dollar to fall, which would have equalized comparative wages and prices. That didn’t happen anywhere near as much as was needed to bring about equilibrium because the United States was able to run trade deficits and the United States had a significant resource with comparative advantage—international traders—those involved in organizing and facilitating trade. Expanded globalization significantly increased the income of these international traders, changing the nature of our trade balance to one that focused on services and profits, not production.
This structure created the American version of the Dutch Disease, which benefited a small group (in this case international traders) while hurting those businesses and workers that lacked a comparative advantage in globally competitive activities (largely manufacturing). Combined with the trade deficit made possible by large international capital flows into the United States, pressure was put on lower wage jobs even as high-income individuals were prospering. In terms of jobs, the high exchange rate and trade deficits increased the natural rate of unemployment in globally competitive activities and constrained U.S. potential output. Put another way, just as China boomed because of export-led growth, the U. S. economy slowed because of import-led stagnation. That slowdown in growth of potential output started in the mid-1990s, but it was hidden by macro policies designed to hold the economy at a higher growth rate than was sustainable in the long run.
For more than a decade it worked. Expansionary monetary and fiscal policy achieved not only 3% annual growth, but even higher growth rates, and unemployment remained low because workers displaced in globally competitive activities found jobs in protected activities such as health care, education, and construction. The expansionary policy that held the economy above its sustainable long-run potential did not result in goods inflation because of the changed institutional structure: wages of U.S. workers in globally competitive activities could not rise, and the United States’ ability to run large trade deficits meant that the exchange rate did not have to adjust.
The downward pressure on tradable goods prices more than offset the increase in prices in those activities that were less globally competitive. So, the result was little to no goods inflation, even as the economy exceeded its potential. The result was two Americas—one with globally competitive sectors that were suffering and another with non-globally competitive sectors that were doing great. Unemployment remained low (at least lower than what it would have been) without causing goods inflation. But the two-Americas reflected a structurally imbalanced unemployment, which is unsustainable in the long run, especially since many of the non-globally competitive activities depended on government spending and expanding credit. But there was a limit to how much government spending could rise since the unwillingness of people to pay their full cost through taxes was leading to higher and higher deficits.
These structural problems—an unsustainably high exchange rate, high unemployment and lowering of potential output—were also hidden through the first decade and a half of the 2000s by loose monetary policy, which pushed up asset prices, creating a positive nominal wealth effect, even as sustainable real wealth did not rise. This wealth effect added to the feeling that the United States had reached a wonderful equilibrium. Unfortunately, as we now know, rising asset prices were creating a bubble that burst in 2008. The bursting of the bubble showed, with painful consequences, that the equilibrium was unsustainable— unemployment rose and growth fell as government attempted to retrench into a sustainable equilibrium not based upon an asset bubble. In the standard view, this was seen as a recession. In the structural stagnation view, this was seen as suppressed depression that would last much longer than the typical post war recession, and not be solved by demand side policies alone. Dealing with it would require difficult structural changes that made U.S production more globally competitive.
If the structural stagnation view is correct, policymakers face a dilemma—implement austerity measures that would allow the structural problems to unwind with its attendant pain or continue expansionary measures to keep those problems at bay as much as possible, putting the pain off to another day. If the root of today’s economic problems are structural, there is no easy answer. The real policy question is: When do we want to face the structural problems? Now or in the future?
No one wants austerity for austerity’s sake, which is often the way calls for spending restraint and less expansionary monetary policy are portrayed. Austerity is in many ways simply facing up to our structural problems. If structural stagnationists are right, at some point the United States is going to have to face up to the problems. Currently, on average, the U.S. cost structure at the current exchange rate is not globally competitive. This means that when global firms ask, “Should we expand production in the United States?” on average they answer, “No,” and funds for investment go abroad. Until these structural problems are met, the slower growth that the United States is currently experiencing is as good as it gets, and even a little bit better than is sustainable, because we still have nominal asset prices/nominal GDP above its long-run steady state ratio, and we are keeping the economy growing only with highly expansionary monetary and fiscal policy that maintains and increases the current asset price bubble. In the long run that is a policy that is asking for another crash.
As I stated above, in the text I don’t take a position about whether the structural stagnation view is the correct view—that is not the job of a text. I present it because it raises precisely the type issues that I think we should be raising in the macro course, and which the former structure of texts did not allow us to do. This has meant moving international issues up earlier in the text—to give students an understanding of globalization and exchange rates, and changing the discussions of inflation to distinguish goods inflation from asset inflation to better allow a discussion of asset bubbles. But I think discussing the structural stagnation view allows precisely the type debate that we should be teaching our students to understand.
First Published : June 29, 2014