The International Monetary Fund has got some bad news for us — the slower rate of economic growth could be here to stay.
In its latest World Economic Outlook, the IMF says a combination of slower catch-up growth by emerging economies and ageing societies in the developed world are set to hold back global growth despite signs of a recovery setting in.
In the aftermath of the financial crisis, potential growth in advanced economies has slowed from an average of over 2% per year to around 1.6%. Here’s what that looks like:
As you can see from the chart, most of the fall in potential growth is coming from the squeezing of that middle brown section — employment growth. That represents the potential growth in the number of employees in an economy and it is falling as Western societies get older.
This process, according to the IMF, is likely to hold back growth in future. As the Fund puts it:
Working-age population growth is likely to decline significantly in most advanced economies, particularly Germany and Japan, where it will reach about — 0.2 per cent a year by 2020. At the same time, rapid ageing is expected to further decrease average trend labour force participation rates, offsetting the positive effect of continued population increases on overall labour supply.
Meanwhile emerging economies have also seen growth rates slipping since the crisis, albeit from higher starting points. This is largely due to slower catch-up growth as the technological improvements and increases in educational achievement over the past few decades that have helped to narrow the gap with their advanced peers are unlikely to be repeated.
What does this all mean? Well, firstly it means that living standards are going to struggle to rise in future at the same pace as they have done. Workers experiencing sluggish wage growth since the crisis may find that it becomes the norm rather than the exception in future.
Unfortunately, slower potential growth also has worrying implications for public finances. Governments can lower the burden of public debt in two ways, either by cutting spending to reduce borrowing or through the economy growing faster than debt costs.
Slower growth means that cutting debt is likely to rely more heavily on spending cuts than simply allowing growth to erode the problem. Yet the very factor holding back growth — ageing societies — is also likely to make such cuts harder to achieve as older people use state services such as healthcare more intensively than their younger peers.
As it says in the WEO (emphasis added):
Reduced prospects for potential growth in the medium term have important implications for policy. In advanced economies, lower potential growth makes it more difficult to reduce still-high public and private debt…In emerging market economies, lower potential growth makes it more challenging to rebuild fiscal buffers.
Despite the gloom, there are ways in which countries can act to ameliorate some of the consequences of this growth squeeze. In particular, the IMF suggests state support for innovation and further education should be policy goals as well as providing an environment that promotes increased labour force participation by those of working age, especially for women.
More controversially, perhaps, the IMF also says providing support for demand through accommodative central bank policies and also, where possible, government spending may also be needed to boost investment.
One subject that the Fund elects not to discuss in any detail is the potential growth benefits of higher immigration. For example, Britain’s Office for Budget Responsibility, the government’s budget watchdog, recently noted that higher than forecast immigration over the past few years had “raised potential output growth by 0.5 per cent over the forecast period via 16+ population growth”.
Indeed in the WEO it relegates the discussion of the potential impact of immigration on its forecasts to the footnotes:
Given the subject matter (the slowing rate of employment growth) and the implications of the lower growth for government policy options, that seems a very odd omission.