“Secular stagnation” isn’t our destiny

Market Comment 10/4/2017 by Christophe Bernard
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Every economic crisis has sparked fears of slow growth or no growth at all. In the 1930s, Franklin D. Roosevelt’s state-sponsored New Deal was able to pull the U.S. out of the Great Depression. Today, similar investments into infrastructure could boost the sluggish recovery since the financial crisis of 2008. However, it is new technologies that may do the trick.


“Secular stagnation” is a term originally coined in 1938 by Alvin Hansen, a professor of economics at Harvard University and advisor to American presidents Franklin D. Roosevelt and Harry Truman. In his definition, the term meant foregoing investment opportunities through, among others, the collapse of immigration to the United States. Almost 80 years later, economic luminary Larry Summers in a speech to the International Monetary Fund (I.M.F) referred to secular stagnation as a state where anemic growth becomes the normal condition of the economy. Central banks are then forced into permanent, massive monetary policy accommodation to offset a persistent shortfall in demand.

Low productivity, demographics as root causes

Given the current difficulty to shake off the burden of the recent financial crisis, are we in secular stagnation? There is little doubt that the ongoing recovery is the shallowest since the Second World War with nominal as well as real economic growth lagging behind historic comparatives (see chart 1).

Chart 1: Current recovery is among the weakest in U.S. history
Real GDP in upswing periods (end of recession = 100)

Current recovery is among the weakest in U.S. history

Source: Bureau of Economic Analysis, National Bureau of Economic Research, Thomson Reuters Datastream, Vontobel

Let’s examine the root causes behind such a development. Certainly, adverse demographic trends such as an aging working population tend to weigh on the economy. Some improvements in this regard are possible by increasing working hours, raising the retirement age or bringing more women back to work. However, the overriding force sustaining economic expansion is productivity growth. By definition, productivity is the quantity of goods and services produced for each hour of work. It underpins living standards and is the ultimate test of our ability to create wealth.

Where are we on that account? Productivity gains have slowed down to a trickle since the Great Financial Crisis (see chart 2, OECD data) that broke out in 2008 with Lehman Brothers filing for bankruptcy protection. Between 1999 and 2006, productivity gains totalled 2.9 percent per annum in the U.S. and 1.9 percent in the European Union (E.U.), respectively. This compares with modest 2016 gains of 0.5 percent and 0.8 percent, respectively (according to data from the Conference Board Institute).

Chart 2: Longstanding decline in productivity growth across developed economies
GDP per hour worked *
Longstanding decline in productivity growth across developed economies

* Five-year moving average in percent, annual change

Source: Organisation for Economic Co-operation and Development, Vontobel


Investment into infrastructure as potential game changer

It appears that the main reason behind such an unfavorable development has been insufficient investment in infrastructure, education and capital expenditure, with a substantial aging of the capital stock. There have certainly been efforts to better the wrong – remember Donald Trump’s campaign promises and IMF chief Christine Lagarde’s appeal that Germany reinvests its trade surplus into infrastructure. While it remains to be seen whether policies designed to boost infrastructure spending will be implemented in the U.S. and the E.U., there is little doubt that a capital expenditure cycle is upon us, which should provide the basis for an improvement of productivity. Given depressed levels of interest rates and diminishing labor slack, incentives for companies to rejuvenate their capital stock will increase. This should move productivity gains in the “west” towards an annual rate of around 1.5 percent going forward – clearly less than until 2006 but better than the past 10 years and much above currently depressed consensus expectations.

Technology has always been the savior

The recent financial crisis has clearly undermined confidence in the capitalist system and the ability of institutions and policymakers to prevent such a damaging outcome. It is easy to see how some people can lose hope for a better future. That being said, references to secular stagnation usually come after a deep crisis and, counter-intuitively, often precede a renaissance of productivity. Doomsayers often underestimate the potential of existing technologies. It is our conviction that the spreading of the “internet of things”, advanced robotics and artificial intelligence will soon contribute to a brighter future. According to Carmen Reinhart and Kenneth Rogoff, who co-authored “Eight Centuries of Financial Folly” published in 2011, the economy needs 10 years to fully recover from the fallout of a major financial crisis. Well, we are there now.

What would a productivity pick-up mean for markets?

The long-term determinant of the equilibrium level for real interest rates is productivity growth. As a consequence, one should expect a trend towards higher real rates over time, which wouldn’t bode well for government bonds of “core” countries, highest-graded corporate bonds, or gold. Improving prospects for productivity growth would allow central banks to gradually normalize monetary policy. It wouldn’t necessarily be bad for stocks, as long as corporate earnings go up as well.

About the author Chief Strategist Vontobel

Christophe Bernard

Christophe Bernard joined Vontobel 2012 as Chief Strategist. He is also Chairman of the company’s investment committee.

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