Rich democracies have a problem: weak economic growth. In the past, reforms led to greater profitability. Today, state governments compete in two other areas.
This year has been a good year for the West. The alliance has surprised observers with its united front against Russian aggression. While authoritarian China is experiencing one of the weakest periods of growth since Chairman Mao, the American economy is booming. The wave of populism in rich countries that began in 2016 with Brexit and the election of Donald Trump appears to have peaked.
But apart from the interest of the world public, rich democracies are confronted with a deep, smoldering problem: weak economic growth. Last year, the gross domestic product of the industrialized countries grew by less than 2 percent.
Frequent measurement data suggests that the productivity of rich countries, which is the real source of higher living standards, is at best stagnating and quite possibly even declining. According to official forecasts, per capita GDP growth in developed countries will average less than 1.5 percent per year until 2027. In some countries, like Canada and Switzerland, the numbers will be closer to zero.
Perhaps the rich countries will have to settle for weak growth in the future. Many developed countries have rapidly aging populations. With the opening of labor markets to women and the democratization of higher education, an important source of growth is being exhausted. Many technological achievements such as flush toilets, cars and the internet are already available to the general public. However, this growth problem can certainly be solved.
Policy makers could facilitate cross-border trade and thus boost globalization. They could reform building codes to allow for new construction and reduce the sky-high cost of housing. They could take in migrants to replace retiring workers. All of these reforms would increase the rate of growth.
Unfortunately, economic growth is no longer in vogue. According to our analysis of data from the Manifesto Project, which collects information on political party manifestos over decades, politicians in the OECD, a group of mostly rich countries, are only half as pro-growth as they were in the 1980s. For example, today’s politicians are less likely than their predecessors to extol the benefits of a free market economy. They express themselves rather anti-growth, in that they advocate state control of the economy, among other things.
When politicians talk about growth, they do so in an undifferentiated way. When Gordon Brown, the British shadow chancellor, referred to the “post-neoclassical endogenous growth theory” in 1994, this was laughed at, but it at least suggested that the topic was being seriously considered. Politicians like Lyndon Johnson, Margaret Thatcher, and Ronald Reagan pursued policies based on a coherent theory of the relationship between the individual and the state. The small band of modern pro-growth advocates like Donald Trump and Liz Truss offer little more than warmed-up Reaganism.
The indifference to growth is not just rhetorical. Great Britain shows a great lack of energy. In the 1970s, the average household budget contained tax reforms worth 2 percent of GDP. Measures taken in the late 2010s had only half the impact. A 2020 paper by Alberto Alesina, a late Harvard University economist, and his colleagues at the IMF and Georgetown University measured the importance of structural reforms (such as changes in regulations) over time.
In the 1980s and 1990s, politicians in developed economies implemented numerous reforms that made their economies more efficient. In the 2010s, however, they lost momentum: reforms practically ground to a halt.
Our analysis of World Bank data shows that progress has slowed even further in recent years and is likely even declining. The US government has enacted 12,000 new regulations in 2021 – which is an increase over the last few years. From 2010 to 2020, rich countries’ tariff restrictions on imports doubled. Great Britain voted for and implemented Brexit. Other countries have also decided against immigration. In 2007, rich countries received almost 6 million migrants. In 2019, the number had dropped to just 4 million.
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Governments are no longer as positive about building new housing or infrastructure. A paper by three economists, Knut Are Aastveit, Bruno Albuquerque, and André Anundsen, finds that “supply elasticity” in American housing—i.e. H. the extent to which construction is responding to higher demand – has declined since the housing boom of the 2000s. This is presumably due to stricter zoning policies and stronger resistance from the Nimbys. In this decade, housing construction throughout the rich world has fallen to about two-thirds of its level.
Politicians prefer to squander the revenues from existing growth. Governments spend far more on social benefits such as pensions and especially health care. According to the Congressional Budget Office, in 1979 the bottom fifth of American earners received means-tested transfers that accounted for less than a third of their gross income. In 2018 it was already more than two thirds. According to a 2019 report, per capita health spending in the OECD will grow at a compound annual rate of 3 percent, reaching 10 percent of GDP by 2030, compared to 9 percent in 2018.
Politics increasingly resembles a vie for pledges of more health care money and greater social security. “Thirty or forty years ago, it was taken for granted that the elderly were ineligible for organ transplants, dialysis, or demanding surgical procedures,” writes ethicist Daniel Callahan. “That has changed.”
People may understandably rate spending on health care and pensions as good. But these expenses also have downsides. There are more and more people working in an area where increases in productivity and thus improvements in the general standard of living are difficult to achieve. Perfectly healthy older people drop out of the workforce to retire. In order to finance this, higher taxes or cuts elsewhere are necessary. Since the early 1980s, government spending on research and development has fallen by about a third as a percentage of GDP across the OECD.
Much of the additional spending was needed in times of crisis. Politicians are increasingly concerned with preventing bad things from happening to people, or compensating them when they do. The comprehensive system of loan guarantees, moratorium on evictions and debt forgiveness put in place during the pandemic has postponed bankruptcies and defaults. These were drastic measures, but also the beginning of the end.
In America, for example, the federal government has taken on huge liability provisions. She guarantees more and more bank deposits; it provides student loans; it offers a variety of implicit and explicit safeguards for everything from airports to highways.
We have previously calculated that Uncle Sam is liable for debts in excess of six times America’s gross domestic product. This year, European governments have rolled over backwards to provide financial support to households and businesses during the continent’s energy crisis. Even Germany, normally Europe’s most disciplined donor, has allocated 7 percent of GDP for this purpose.
No one is happy when a company goes bust or someone slides into poverty. However, the bailout state makes economies less adaptable and ultimately stunts growth by preventing unproductive resources from being turned into productive ones. There are already signs that the tax breaks granted during the pandemic have produced more “zombie” firms, i.e. H. Businesses that are profitable but generate little economic value.
Governments’ huge implicit liabilities also mean that they will have to spend more in difficult times, increasing the tendency to raise taxes.
Why has the West turned away from growth? One possible answer lies in the aging of the population. People who are no longer working or whose working lives are coming to an end tend to be less interested in getting richer. They support things that benefit them directly, such as health care, but are opposed to things that benefit them only after their death, such as immigration or housing. Their turnout is usually high, so their votes carry weight.
However, Western populations have been aging for decades, including during the reform-oriented 1980s and 1990s. The changing environment in which politics is made could therefore play a role. Before social media and 24-hour news, it was easier to push through tough reforms. The losers of a policy – for example companies that were exposed to more competition from abroad – often had no choice but to accept everything in silence.
When Franklin Roosevelt spoke about the critics of his New Deal in 1936, he could “welcome” the hatred of his opponents. Today, those affected have more opportunities to complain. As a result, policymakers have an increased interest in limiting the number of disadvantaged, leading to what Ben Ansell of Oxford University calls a ‘national decision by committee’.
The high level of debt has also restricted the political decision-makers’ room for manoeuvre. In the G7 group of rich, powerful countries, private debt has risen by a total of 30 percentage points of GDP since 2000. Even small declines in cash flow can make it difficult to pay off debt. This means that politicians intervene immediately when something goes wrong. They are focused on keeping operations running and avoiding a repeat of the September 2007 financial crisis, rather than accepting current difficulties as the price of a better future.
What might prompt the West to take a new direction is unclear. Aside from the misguided attempts of Donald Trump and Liz Truss, there is no sign of change just yet. Would another financial crisis turn things around? Will the turnaround only happen when the baby boomers are gone? Whatever the answer, unless growth picks up speed, Western leaders must hope that their enemies will continue to make mistakes.
The article first appeared in The Economist and was translated by Andrea Schleipen.
The original of this article “The bailout state hampers economic growth and leaves us vulnerable” comes from The Economist.