With the world’s industrial democracies in crisis,
two competing narratives of its sources and
appropriate remedies are emerging. The first,
better-known diagnosis is that demand has collapsed
because of high debt accumulated prior to the
crisis. Households and countries that were most
prone to spend cannot borrow any more.
To revive growth, others must be encouraged to
spend. Governments that can still borrow should run
larger deficits, and rock-bottom interest rates
should discourage thrifty households from saving.
Under these circumstances, budgetary recklessness is
a virtue, at least in the short-term. In the
medium-term, once growth revives, debt can be paid
down and the financial sector curbed so that it does
not inflict another crisis on the world. This
narrative, a standard line modified for debt crisis,
is the one to which most government officials
subscribe to and needs little elaboration.
Its virtue is that it gives policymakers something
clear to do, with promised returns that match the
political cycle. Unfortunately, despite past
stimulus, global growth is still tepid, and it is
increasingly difficult to find sensible new spending
which can pay off in the short run.
Attention is therefore shifting to a second
narrative. The fundamental capacity of developed
economies to grow by making useful things has been
declining for decades, a trend that was masked by
debt-fuelled spending, this narrative suggests. More
such spending will not return them to a sustainable
growth path. Instead, the advanced countries must
improve the environment for growth.
The narrative starts with the 1950s and 1960s, an
era of rapid growth in the West and Japan. Several
factors, including post-war reconstruction, the
resurgence of trade after decades of protectionism,
the introduction of new technologies in power,
transport, and communications across countries, and
expansion of educational attainment, underpinned the
long boom. But, when these low-hanging fruits were
plucked, it became much harder to propel growth.
In the interim, democratic governments were quick to
expand the welfare state in the face of the
seemingly endless vista of innovation and growth.
However, when growth faltered, this meant that
government spending expanded, even as its resources
For a while, central banks accommodated that
spending. The resulting high inflation created
widespread discontent, especially because little
growth resulted. Faith in stimulus diminished,
though high inflation did reduce public debt levels.
Central banks then began to focus on low and stable
inflation as their primary objective, and became
more independent from their political masters. But,
deficit spending by governments continued apace, and
public debt as a share of gross domestic product
(GDP) climbed steadily without inflation to reduce
its real value.
Recognising the need to find new sources of growth,
nations rushed to deregulate industry and the
financial sector. Productivity growth increased
substantially in some of these countries over time.
This persuaded more countries to adopt reforms of
Yet, even this growth was not enough, given rising
promises of social security. Public debt continued
growing. Incomes of the moderately educated global
middleclass failed to benefit from deregulation-led
growth, though it improved their lot as consumers.
The most recent phase of the search for growth took
different forms. In some countries, a private-sector
credit boom created jobs in low-skilled industries
like construction, and precipitated a consumption
boom as people borrowed against overvalued houses.
In others, a government-led hiring spree created
secure jobs for the moderately educated.
Under this narrative, the pre-crisis GDP of most
countries was unsustainable, bolstered by borrowing
and unproductive make-work jobs.
More borrowed growth may create the illusion of
normalcy and may be useful in the immediate
aftermath of a deep crisis to calm a panic, but it
is not the solution to a fundamental growth problem.
If this diagnosis is correct, economies need to
focus on reviving innovation and productivity growth
over the medium term and on realigning welfare
promises with revenue capacity, while alleviating
the pain of the truly destitute in the short run.
For overregulated countries, growth potentials may
consist in deregulating service sectors to spur
creation of more private sector jobs for retrenched
government workers and unemployed youth.
For most economies, however, the imperative is to
improve the match between potential jobs and worker
skills. People understand better than the government
what they need and are acting accordingly. Only a
little of the government’s attention has been
focused on grassroots issues, partly because payoffs
occur beyond election-induced horizons, and partly
because government programmes have been of mixed
Tax reform can, however, provide incentives for
retraining while maintaining incentives to work,
even while fixing gaping fiscal holes.
Hopefully, three powerful forces will help create
more productive jobs in the future: better use of
information and communications technology (ICT) and
new ways to make it pay; harnessing lower-cost
energy as alternative sources; and sharply rising
demand in emerging markets for higher value-added
Countries have choices. They can act as if the world
is well, except that their consumers are in a funk
and that “animal spirits” must be revived through
public investment. Else, they can treat the
prevailing global economic crisis as a wake-up call
to fix all that has been papered over in the last
few decades. For better or for worse, the narrative
that persuades governments and the public will
determine the future of the global economy.