THE BLOG
02/04/2016 04:01 pm ET Updated Feb 04, 2017

The Grim Future of a Stagnant Economy

Last week, two events made it clear that the U.S. and world economy are still plagued by stagnation. The consequences could not be more ominous. Countries that experience protracted periods of below average growth are more likely to elect extremist right-wing politicians. This is especially true in nations with existing extremist parties--like Tea Party Republicans in the United States, the British National Party, the National Front in France, and the National Democratic Party in Germany--along with minimal barriers to entry in the election arena, which have been fortified by the Citizens United ruling and the rise of independently wealthy candidates such as Donald Trump. We are now witnessing the frightening political manifestation of economic stagnation.

The first event was the fourth quarter GDP release for the United States. Gross Domestic Product--the broadest measure of economic production--only grew at an annual rate of 0.7 percent in the last quarter of 2015. In the past year, GDP has only grown 1.8 percent, down from 2.1 percent since the end of the recession in 2009. And this is lower than the historical growth rate of 3 percent. Furthermore, since 2008, the U.S. economy has been producing less than its potential, averaging $652 billion per year, costing every American over $16,000 in lost income.

The second event was a radical policy change from the Bank of Japan, who lowered interest rates to -0.1 percent on central bank deposits to stimulate lending and growth. In other words, the Bank of Japan now charges banks to hold their money, making it the fourth economy after the Eurozone, Denmark, and Sweden to dip below the zero lower bound. The logic is that banks will pass on interest rate savings to consumers and businesses in the form of cheaper loans.

The United States, the Eurozone, and Japan--three of the world's four largest economies--have engaged in unprecedented monetary stimulus since 2008 by slashing interest rates, and flooding their economies with credit. And yet growth in each of these economies is anemic. Why hasn't the multi-trillion dollar monetary stimulus boosted growth?

The answer is that the current stagnation needs both monetary stimulus, which has mainly boosted the prices of assets disproportionately owned by the wealthy, and, more importantly, fiscal stimulus. But due to political opposition from the right, government spending, and thus economic growth, has been crippled by economic austerity. Austerity is argued to reduce budget deficits, which will lower interest rates and inspire business and consumer confidence. But austerity has a demonstrably weak track record, as the world's largest economies continue to stagnate even after cuts to government spending.

Without spending on programs that directly create jobs, there will be no demand for the loans incentivized by central banks. With weak demand and still-damaged business and consumer balance sheets, flooding the economy with credit will have minimal effects on growth. What needs to happen to stimulate a worldwide recovery is increased government spending on a scale similar to that provided by the world's central banks. Industrial policy that targets strategic investments such as infrastructure, green energy, and public transportation can boost growth by directly providing funds for investment and hiring.

Governments could also guarantee employment to unemployed workers. Instead of paying workers not to work through unemployment insurance, governments could directly hire workers in economically and socially productive sectors. If this sounds infeasible, consider that during the Great Depression, the U.S. government largely solved the unemployment problem while improving the country's infrastructure by funding programs such as the Civilian Conservation Corps and the Works Progress Administration. In addition, the government became a de facto employer of last resort during World War II, lowering unemployment under 2 percent and generating massive growth, not only during the war, but in subsequent years as well. By lowering unemployment and increasing incomes, fiscal policy could generate massive increases in spending and growth.

Governments could also costlessly change laws that would boost growth, such as making it easier for workers to unionize. Higher union membership would increase wages, allowing for greater consumption and growth. Currently, 1 out of every 8 workers belong to a union, and most of these are concentrated in the public sector. But in the 1950s and 1960s, 1 out of every 3 workers belonged to a union. During this period, economic growth exceeded 4 percent, compared to the 2.6 percent growth since 1980.

But why do politicians continue to insist on more austerity and anti-worker policies? These policies would tilt the balance of power from the wealthy to workers. And since the wealthy dominate the campaign finance landscape, essentially buying politicians to implement their will, politicians will only support policies that will increase their chances of receiving more money and getting re-elected.

Although pro-wealthy policies increase capital gains, dividends, and profits in the short-term, they ultimately destroy broad-based purchasing power, which will lower growth for everyone else in the long-term. The elite are only concerned with their own gains and their wealth under business- and finance-friendly policies would be greater than otherwise.

This greed has set the stage for a protracted period of below-normal growth and secular stagnation. Such policies are inimical to not only a sustainable economic future, but also an inclusive political future. Some economists even think we might be returning to the era of patrimonial capitalism of the late 19th century.

The costs of prolonged stagnation are serious and stretch beyond economics. Citizens of slow growing economies with wide inequality become less trustful, more xenophobic, and politics become more reactionary and extreme. History is a useful guide in showing us where this can lead. The rise of fascist governments in the 1930s, especially the Nazi's in Germany, came in response to a protracted economic depression and a weak recovery.

A new world order will emerge in the next decade. Whether it is one of inclusive, broad-based growth for all or exclusive, unequal growth for a few will be determined by the policies implemented today. It does not look like the world's dominant policy makers are capable or willing to see the consequences of their misguided actions.