The well-being of current and future generations depends on successfully addressing the ten big issues just outlined (Article #1, Article #2, Article #3 Article #4, Article #5 ). In book The Only Game in Town – Central Banks, Instability, and Avoiding The Next Collapse, Mohamed El-Erian concluded that if central had the ability, they would be addressing them more effectively, conscious of how much is at stake. Rather than seek a full solution – and, in the process risk analytical paralysis and/or implementation hell – governments are advised to use a “Reduced-Form” approach – not seeking to speak to every element of the problem, instead, attempt to encompass enough of them – say 75-90 percent – to find a solution that is both actionable and desirable.
Here are four key outputs of a reduced-form approach to the ten major challenges facing the global economy.
********#1. Getting Serious About Inclusive Economic Growth ********
The first component of a comprehensive solution involves rejecting financial engineering as a growth strategy and instead returning to the basic building blocks of economic prosperity. It entails a decisive exit from a global monetary configuration, public and private, that has depended for more than a decade now on injection after injection of artificial liquidity to mask the real, structural impediments to growth. This must succeed in an overall context that has gotten more complicated due to the unusual worsening in income inequality within nations, political polarization, and institutional degradation.
From revamping the education system to strengthening infrastructure, and from removing antigrowth fiscal distortions to improving labor competitiveness an flexibility, this First Policy Component involves a host of structural reforms that are often classified as “supply-side measures” – that is, they influence the ability of the economy to supply goods and services that are consumed domestically and traded internationally. The pursuit of such polices can be successful only if underpinned by a medium-term program that is also subject to annual review and tweaking. It also requires consistent communication and broad-based buy-in from key segments of society. This approach will require an uncommon degree of experimenting by governments on the way forward, and for a simple reason: it is too analytically complicated and historically challenging to know in advance all the answers on policy effects. As such, government, as well as financial investors and some companies will need to overcome the current excessive degree of short-termism.
For some countries, it is a mindset change that cannot be achieved without also reforming economic institutions. And it is not just about breaking down the influence of vested interests and the paralyzing power of bureaucratic turf battles…. It is also about modernizing operational approaches, updating data and analytical tools, and making decision makers more accountable. It is also about escaping the trap of overly ideological debates that inhibit the dynamism needed to overcome the challenges we face. Without that, the following much-needed policy initiatives will prove hard to sustain and expand on:
- Higher public infrastructure investment
- More leveraegable public-private partnerships
- Greater emphasis on human productivity
- Labor retooling
- Pro-growth tax reform
Professor Michael Spence of New York University, Nobel laureate in economics, coming from solid theoretical underpinnings with empirical observations, he comment that for any given set of labor/capital/natural endowments, structural flexibility plays key role in facilitating economic recovery and helping countries “adapt to long-term” technological change and global market forces. Such flexibility normally requires a good “quality of government” as it inevitably involves lifting economic rigidities that favor specific interest groups.
*******#2. Matching Ability and Willingness to Spend *******
Fiscal policy has a key role to play here, and it is high time to break the paralysis that has taken hold of this critical instrument of economic management – “can’t, won’t, and shouldn’t” syndrome. In large part due to concerns about slipping back into old habits of overspending, the political approach to fiscal policy has been reduced to silly extreme discussions – so much so that, in a country as advanced and sophisticated as the United States, it has proven impossible for Congress to deliver on the most basic of all economic functions, that of actively agreeing to an annual budget for the nation – law makers have resorted essentially to simply rolling over last year’s budget.
This is not just about revisiting approaches and mindsets that result in excessive rigidity and austerity, and do so by chronically underestimating the extent to which fiscal cuts unleash a dynamic that causes a disproportionately large reduction in overall aggregate demand. It is also about using tax and expenditure measures more actively to improve the quality of spending without unduly impacting the incentives that fuel innovation and entrepreneurship.
In the United States, for example, this would include – going from the least to the most controversial – closing tax loopholes and cascading exemptions, increasing the taxation of carried interest earned by private equity firms and hedge funds, reforming inheritance taxation, streamlining home mortgage subsidies, and a higher marginal tax rate for the highest-income earners. It would also involve decisive steps to modernize a system of corporate taxation that is littered with anomalies, distortions, and misaligned incentives that undermine rather than promote economic growth – including by encouraging firms to spend a lot of money on to purchase foreign entities in order to geographically shift and reduce tax burdens while keeping productive operations as is. And it would involve improving the impact of fiscal spending in promoting productivity and better unleashing human potential, including, as noted earlier, through greater emphasis on investments, infrastructure, education reform, and health.
Such measures would also serve to temper the worsening in the inequality trifecta that accentuates challenges to both supply and demand drivers of prosperity. The more that incremental income accrues to the rich, and it has done so in a pronounced fashion in recent years, the lower the increase to consumption at the margin, given that rich households spend a smaller portion of their income than middle- and lower-class households. Individual and corporate tax measures need to be accompanied by credible commitments to ensure incremental receipts be spent on sectors that are key to long-term productivity growth.
There is also scope for greater use of modern approaches that better match the ability to spend with important national priorities. Despite analytical progress, the focus on enlarging the scope of private-public partnerships continues to lag. The potential is definitely there. It is a gap that is especially glaring given that a part of this pool is also seeking to have socially beneficial impact. Yet too little has been done by governments to offer a matching menu of partnership options. The demand mismatches are even ore visible at the regional level, especially within the Eurozone. Moving forward on the fiscal component of European regional integration would also have gone a long way in addressing such issues, including avoiding unfortunate hiccups in the historical process of regional political integration. But, once again, there was strong need to ensure that the implied fiscal transfers would not be wasted. These requires early confidence-building measures to signal that funds are being used to support structural reforms rather than substitute for them; it also needs evidence-based verification processes. Neither challenge is overwhelming but they both require greater mutual trust and active adherence to the overall goal of regional integration.
Then there is the global mismatch, which is even harder to solve. It is illustrated in a pattern of national surpluses and deficits that are frustratingly stubborn to change, and in an insufficiently productive recycling of surpluses. In sum, we remain very far from what the founding fathers of the Bretton Woods Agreement envisaged in terms of symmetrical adjustments of imbalances among surplus and deficit economies in a manner that promotes global prosperity and reduces bilateral tensions and forgone opportunities.
As it is wired and operates today, the global economy consistently solves at a level of aggregate demand that is lower than what is both feasible and desirable. And as much as one is tempted to propose grand architectural solutions, they involve such a fundamental restructuring of the system and its multilateral institutions as to make them unrealistic from the get-go.
A clear G20 diagnosis of the problems could be combined with some progress on the deployment of underutilized pools of capital. And this is yet another reason that, if they are serious about their common endeavor, G20 members would be much better off creating a small permanent secretariat for the group rather than experience the inevitable interruption in continuity associated with annual handoffs among countries in both chairmanship and secretariat. The Tokyo G20 coming next week is a perfect time to tackle on all these issues.