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Looking Forward, Many Zeroes and Double-Zeroes on the Global Roulette Wheel

Project Syndicate: Looking Forward, Many Zeroes and Double-Zeroes on the Global Roulette Wheel

Four times in the past century, a large chunk of the industrial world economy has fallen into a depression of high unemployment that was both deep and long: the United States in the 1930s, industrialized western Europe in the 1930s, western Europe in the 1980s, and Japan in the 1990s. Two of those times the economic downturn has cast a long and black shadow on the particular region’s economic future: western Europe in the 1980s and Japan in the 1990s. In both, if they ever got or will get back to something like the pre-downturn trend of economic growth, it took decades before they did or will do so. One of these times we do not know what would have happened: at the end of the 1930s Europe became the battlefield as Adolf Hitler launched World War II. And one time the long-run growth trend was undisturbed: it is difficult to see any significant macroecnomic impact of the Great Depression on U.S. production and employment after World War II. Of course, in the absence of U.S. mobilization for World War II it is possible and even likely that the Great Depression would have cast a shadow on post-1940 U.S. economic growth: certainly that is how things looked, with signs of high levels of structural unemployment and a capital stock below trend, at the end of the 1930s before mobilization for World War II began in earnest.

In the United States we can already see signs that the downturn that started in 2008 is casting its shadow on the future. Reputable forecasters--both private and public--have been marking-down their estimates of U.S. potential GDP in the long run. Labor force participation, which usually stops falling and starts rising after the business-cycle trough, has been steadily declining over the past two and a half years. At least some monetary policymakers are seeing reductions in the unemployment rate that come from falling labor force participation as equally good reasons for shifting to more austere monetary policies as reductions in the unemployment rate that come from increases in employment. And much the same processes are at work with even stronger force in Europe.

Most important, however, has been what from today’s perspective looks to be a permanent collapse in the risk-bearing capacity of the private marketplace, and a permanent and large increase in the perceived riskiness of financial assets and of the businesses whose cash flows underpin them worldwide. In a world of aging industrial-core populations, large commitments from governments to social-insurance systems, and no clear plans for balancing government budgets in the long run, we would expect to see perhaps not substantial but clearly visible inflation and risk premiums priced into the Treasury debt of even the largest and richest economies. Sometime over the past generation the price levels of the U.S., Japan, and Germany might go up substantially as some government short-sightedly finds it plausible to attempt to finance some of its social-welfare expenditures via seigniorage. The price levels are unlikely to go down. Yet the desire to hold assets that avoid the medium-term risks associated with the business cycle has overwhelmed this long-run fundamental risk factor.

But this risk that the globe’s investors are currently rushing into U.S., Japanese, and German Treasury debt to avoid is not a “fundamental” risk. There is nothing in our psychological preferences, in the natural resources we have available, or in our growing technologies that makes investing in private enterprises riskier than it was five years ago. Rather, it is the demonstration that governments will not when push comes to shove perform their task of matching aggregate demand to aggregate supply to avoid mass unemployment that is the driver. It is the job of governments to manage aggregate demand so that even though Say’s law that supply creates its own demand is false in theory, it is nevertheless true enough in practice that enterpreneurs and enterprises can bet and bank on it.

“If”, John Maynard Keynes wrote 76 years ago, the government falls down on the job and “demand is deficient… the individual enterpriser... is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros.... the increment of the world’s wealth has fallen short of... savings... [because of] the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough…”

For sixty-two years, from 1945-2007, with some sharp but temporary and regionalized interruptions, entrepreneurs and enterprisers could bet that the demand would be there if they created the supply. This played a significant role in setting the stage for the fastest two generations of global economic growth the world has ever seen. Now the stage is no longer set.