Claudio Borio and co-authors on secular stagnation and what the real problem is

From VoxEU, with Enisse Kharroubi, Christian Upper, Fabrizio Zampolli:

But what if, in addition to the persistent – but not structural – hole in aggregate demand a financial bust inevitably generates, a key part of the true story has less to do with the level of aggregate demand than with its composition and impact on the structure of supply? What if what some see as a rather disappointing pre-crisis US growth performance despite a strong financial boom was actually disappointing, in part, precisely because of that boom? What if the protracted post-crisis weakness reflects in no small measure the difficulties in correcting the resource misallocations that accumulated during the previous financial boom and emerged once a financial crisis subsequently broke out?

This is indeed what we conclude by examining the experience of 21 advanced economies over the last 40 years (Borio et al. 2015). The hitherto unsuspected villain in this story is the misallocation of resources – in our case, labour – during the credit boom and its long post-crisis shadow. More generally, the findings support the view that the disappointing developments we have been witnessing may be the result of a major financial boom and bust that has left long-lasting scars on the economic tissue (e.g. BIS 2014, Borio 2014, Borio and Disyatat 2014, Rogoff 2015) rather than the reflection of a structural, deep-seated weakness in aggregate demand.

Here is the full article.


What caused the misallocation of resources? The authors imply that it was the financial boom (i.e., the financialization of the economy) and its bust. If that's true, then what caused the financialization of the economy? All roads lead to . . . . if not Rome, then what? And why do the authors pin the blame on a misallocation of labour? The rapid growth of the financial sector wasn't just about labour, it was primarily about capital, capital that at one time would have been devoted to productive capital, instead fining its way into financial assets with ever increasing complexity. Is the explanation that financialization happens. Finacialization and death - they just happen.

Financialization funded a lot of home building and remodeling. There was a lot of leveraged investment for (on a national basis) zero return net inflation.

Chinese government demand for US housing bonds wasn't natural demand.

Then you have European and Asian pension funds flowing in - more natural but perhaps based on faulty market signals.

Interest rates breaking the taylor rule also leading to faulty buy signals.

What I've seen on the "root causes of financialization" suggest that its part of the general political trend that took root in the '70s in order to deal with the general decline of profits; financilization was a way to boost profits, along with other structural changes in the global economy (i.e. outsourcing, automation/cybernation, structural adjustment in the Third World, transportation logistics boom, deunionization, and of course the IT revolutions) that all fed into one another.

Does anyone else have a large icon that looks a bit like a file at the bottom of every story on MR at the moment? Oli from UK

I thought it was the face of a young man with a quiff, and an oddly-placed ear-piercing.

"The hitherto unsuspected villain in this story is the misallocation of resources – in our case, labour – during the credit boom".

How on earth could misallocation of resources be an unsuspected villain? Unsuspected by whom?

Only by someone that pays absolutely no attention to the econoblogosphere, esp. Arnold Kling.

giant print button much?

More seriously, I suggest it be text only, after the "permalink" up top

I'm glad the StumbleUpon link is gone. Too many times I'd accidentally mouse-over it and have it pop up.

This is very much echoes the analysis of the estimable Arnold Kling.

This "strong financial boom"... how is it defined? What years are we talking about? I presume he's referring to 2002-2007 or something. There was a real estate boom, there was an increase in household leverage, but I don't know what people mean when they say that somehow the economy was 'financialized' during this period, and I suspect others don't know either.

Who thinks the 21st century has been some kind of cornucopia for finance? The stock market has had a rotten century so far, and I reckon real estate ain't any prettier.

The general argument is here including the typical manufacturing vs finance as a percent of gdp plot. There is definitely a spike after 2000.

What I see there is a significant increase between 1980 and 2002, since corrected. Employment in finance (as a % of total) appears to have peaked in the late 1980s.

So, the Great Moderation was actually the evil Reagan/Clinton financialization of the economy?

I thought all of the excesses and malinvestment Austrians are always going on about happened after 2002.

There's a lot in the conventional wisdom that doesn't hang together too well.

Wall Street is being brought to heel. Not by Dodd-Frank, though, by Vanguard:

I agree. This constant chatter about financialization and the supposedly self-evident misallocation of resources caused by too much capital is really driven by the same old instincts and moral intuitions that made us fearful of, and even revolted by, usury in previous times.

If you want less misallocation, remove regulations that "nudge" or impose specific allocations. Duh.

The idea that rising real estate values, rising housing starts, and rising debt levels are all related seems so obviously true. And, it is entirely wrong.

Very interesting essay, although I'm not sure I fully grasp it. The basic idea that misallocation of labor into low-productivity, credit-fueled work can lead to very distortive feedback loops in the general labor market makes sense, but I'd be curious to see more comments on what specifically is productive and non-productive work. It sounds like they are generally arguing that the huge boost in demand for construction workers during the credit-fueled housing bubble is the core of the labor misallocation?

This makes sense, but I'd also wonder how much this dynamic of labor misallocation is also present within the financial sector itself. I've heard lots of anecdotes since the mid-2000s about how people with high-productivity skills (engineers, in particular) have been increasingly migrating into the financial sector, which intuitively seems like a much lower-productivity sector than, say, working in high-technology R&D, automation development, and other "real" engineering fields.

"...which intuitively seems like a much lower-productivity sector than, say, working in high-technology R&D, automation development, and other “real” engineering fields."

Sounds like you have a good handle on this. I vote Arjun as Grand Allocator of Capital and Labor.

There is a difference between "least bad" and "best of all possible worlds."

Allocation of resources by market capitalism may be least bad of available choices, but not the best of all possible worlds. I mean, we're still growing tobacco, right?

There is a difference between "least bad", "best of all possible worlds" and "What would [Arjun or alternative armchair genius] do?"

It doesn't take a hypothetical genius. Every successful country in the world is a regulated market economy.

The odd thing is the armchair folk who pretend they live in another world.

The really odd thing are armchair denizens who create strawmen on the Internet for the sole joy of demolishing them.

Then again, some people think you can boost the economy by digging a ditch and filling it in, which is similarly productive.

Huh? Arjun talks about malinvestment. You straight up say that the only alternative to misbehaving markets is a "grand allocator." I remind you that successful countries (democracies) do regulate .. and you think I have the straw man?

Buy some self-awareness for a dollar.

I would have thought about it more in terms of the brilliant science- and engineering-oriented people who end up in finance because there is "too much" profits in the sector, leading them to attract labour away from things which would contribute more to longer-term technological gains. What sector would Einstein have gone into if he'd been born in 1975?

I.e., if I read you right, I agree that the "excessive" allocation into construction probably isn't that big of a deal. Those people were just going to be working in some other labouring jobs and the assumed misallocation of financial capital for construction might not be such a huge deal when considering the finance people who otherwise have been involved in some form of scientific inquiry if those superprofits had not brought them into finance.

What misallocation of resources? Keep in mind here the difference between the real economy and the paper economy. If we are talking about slack GDP growth, then we only have two vehicles, supply and demand.

Slack demand seems like it should never have to be a problem. All that has to be done is increase spending so if you can't get consumers and businesses to do that, just do it directly via gov't. Loose monetary policy is about avoiding gov't spending and inducing consumers and businesses to spend by lowering interest rates and buying paper assets (QE).

Resource allocation, though, sounds like a supply issue. Something the economy may need more of (say Uber rides) cannot be supplied because resources were invested in producing something else that the economy doesn't need or want (say McMansions in Nevada).

But the symptoms of a supply problem should be inflation. Since people don't want Nevada McMansions, increasing demand doesn't cause anyone to get employed making more of them but since there's some roadblock to more Uber rides being available (say local regulations about taxi services), the result is increased demand will cause prices but not real output to change.

Yet we see little evidence that even with low unemployment inflation is picking up. We see no evidence that some piece of the economy is yearning to take off but cannot because some essential resource is lacking (and it's lacking because in the past the economy erred in underestimating how much would be needed of a particular resource today).

So leave aside the lack of inflation problem. If there was a resource allocation problem then that means today the economy has too much of Resource A and too little of Resource B because in the past the market made errors either because predicting the future is impossible or some imperfect incentives caused things to be misaligned. That should not be a game changer in a market economy. The 90's were not slow growth because in the 1980's the economy overestimated that VHS tapes would always be huge while not realizing DVD's and CDROMs were coming. All that happens is that Resource A drops in price while those who invested in producing Resource B enjoy unexpected economic rents. Shifts happen all the time in a dynamic economy so what would be inhibiting them now?

When I think of misallocation, I think of investment that goes nowhere, provides no return. In 1995 I could have bought Apple stock or Beanie Babies, and I bought Beanie Babies (not really). Opportunity cost would be huge on that one.

If that's the case, isn't it disinflationary? It gobbles investment money and reduces future returns and in turn spending.

Did it gobble up investment money? Sure but did it cause real resource mis-allocation? Did the US open up too many Beanie factories and too few Apple factories because your stock purchases provided investment funds to Beanie but not Apple? AND now do iphones get more expensive because demand for Apple products is high but the economy is unable to quickly open new Apple factories?

Your personal investment decisions was a flap and today you have less money to spend because of that. But on an economy wide scale some smarter guy realized Beanie stock was a dud and he sold it for cash (which might have been provided by you). That guy maybe brought Apple or did something else with it.

This illustrates the difference between the real economy (factories to make Apples or Beanies) and the paper economy (ownership of stock in both companies).

Everyone on all sides wanted housing to go up, so it did. One part of that was a labor interest in construction, sales, etc. Pensions wanted things that behaved like CDOs. Banks wanted to write more loans. Customers wanted more and bigger houses. The government wanted to help people with bad credit to get in the game, so they explicitly and implicitly covered those bets. Existing homeowners spent every waking moment fretting about and voting to ensure preservation of value. Everyone wanted it and the risk was covered so it happened. Labor and money flowed into the sector.

Guess what? Everyone still wants it. All those lost jobs! Banks should be about ensuring cheap loans to bad credit risks sez Bern. Round and round we go.

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