Long Term Resilience
Bruce Greenwald | Episode 118
Bruce Greenland joined Markus’ Academy. Greenwald is the Robert Heilbrunn Professor Emeritus of Finance and Asset Management at Columbia Business School and the academic Director of the Heilbrunn Center for Graham & Dodd Investing.
Watch the full talk below. A summary in five bullets:*
Type 1 resilience is about responses to shocks: how much economies fall during crises and how quickly they recover. This has been the focus of the discussions.
Type 2 resilience however involves the ability of countries to adjust to structural changes/shifts to attain a new (and better) steady state.
Economies that are not able to adapt will stay down after crises. A prime example of this was the Great Depression: it was about the transition from agriculture to manufacturing, but policymakers failed to promote this transition, perpetuating the crisis.
Today we face the transition from manufacturing to services, but countries have rejected the transition by protecting manufacturing jobs, boosting exports, and keeping consumption low, which cannot be a global solution.
In many cases a lack of Type 2 resilience is self-inflicted and due to politically-imposed transformations. Numerous examples from history show that centralized interventions will lead to the wrong path of economic stagnation.
Highlights
[0:00] Markus’ introduction:
There is a difference between concerns about risk, robustness, and resilience. Mitigating risk is a static approach. Measures of risk are variance, standard deviation or value-at-risk. Robustness is about rigidity and being resistant to most shocks.
Resilience is about the ability to adjust and bounce back. To secure resilience one should consider that endogenous responses to a crisis may foster negative feedback loops. Also, often a system can be more resilient if its parts are less resilient. Consider zombie firms: if an economy prevents all firms from failing its overall resilience will decline, while if it allows some of these to fail resilience will improve.
[8:11] Two kinds of resilience
Type 1 resilience is about responses to shocks: how much economies fall during crises and how quickly they recover. This has been the focus of the discussions.
Type 2 resilience concerns shifts and transition periods. It is an order of magnitude more important. It involves the ability of countries to adjust to structural change to attain a new (and better) steady state. Economies that are not able to do so will stay down after crises.
Type 1 resilience is more concerned with external shocks, while with Type 2 they can be internal. Type 2 crises have a more gradual onset, and entail more long term consequences.
A lack of Type 2 resilience can come in two forms. First are willed transformations through political intervention, which often fail because of excessive centralization (with too many decision makers and yet a lack of diversity of opinion).
Second are failures to adapt. The Great depression is the prime example. People often attribute the crisis to the stock market crash and a failure of monetary policy. However the crash was temporary, while one still saw a depression in countries with different monetary policies.
Together with the persistence of the downcycle, this suggests that the crisis was structural in nature: it was about the transition from agriculture to manufacturing.
With input-neutral technological change and a low income elasticity of demand for agricultural products, agricultural productivity growth (beyond demand growth) brought a lowering of farmer’s incomes. Given that a third of the population relied on farming income, this ultimately brought down industrial demand as well.
Capital and labor was hard to redeploy to manufacturing because of the financial constraints brought by the crisis. Workers were unable to move into cities and retrain.
But the government was also reluctant to have people’s lives uprooted, and they intervened to keep farmer’s jobs by having them reduce their output. The Great Migration had to wait until the industrial policy of WWII.
[35:51] The transformation from manufacturing to services
The transition from agriculture to manufacturing was costly due to relocation, retraining, and cultural adjustment.
But more structurally it brought a shift from small production units to large (more productive) units. Higher density in cities brought spillovers, while the shift from individual to collective production brought wage inequality. Globalization brought a reduction in corporate profits.
Now we face the transition from manufacturing to services. Large investments in healthcare, education, and housing are required, along with a cultural adjustment due to there being less male jobs.
There is a turn from production in large to small units, so there is a productivity impairment in the long term. In services you value individual performance rather than the collective’s, which fosters inequality.
Services are small local markets, allowing for monopolies and high excess profits. Even the large tech firms have segmented themselves to attain market power. Profits also grow as a share of national income since unions don’t have power in services.
[50:12] The problems with policies that reject the transition
Examples of an inability to adapt are Japan and Europe post-1990, or China since 2010.
Countries have been trying to save their manufacturing jobs by boosting exports and keeping consumption rates low, but in the aggregate the world can’t export its way out of the problem. These policies generated long-term international imbalances which led to the financial crisis.
Avoiding a transition, governments have implemented “temporary” deficits chronically. Low interest rates sustained demand but brought slow recoveries. Not considering monopoly power brought an unexpected persistent inflation.
Industrial productivity is high, but we care about the aggregate. With real wages falling and a low labor participation rate, we see a failure to adapt to changing productivity conditions. Governments need to focus on technology diffusion.
[1:09:30] Are there good degrees of centralization?
Some countries like Singapore or South Korea have been able to adjust to transitions with systems of “crony capitalism” and pervasive institutional connections.
These are small countries, but their experience suggests that in adapting to Type 2 transitions one can’t ignore local cultural differences. How well countries can deal with structural change has to do with the nature of their institutions.
[1:13:33] The end of the export-led development model
The export-led development model has been successful in the past. It only required moderately advanced technology and large productive institutions that could receive a lot of attention. It could also be implemented independently of local cultures.
But as industrial productivity outstrips its demand it will become a dying sector. As labor productivity grows and labor input shrinks, the value of a country having cheap labor will disappear. With manufacturing coming back to the developed world as a result, emerging countries will need a substitute development model
One proposal is to allocate 500bn in the IMF’s SDRs to countries, and tax each country’s allocations at 50% of their current account surpluses. Proceeds would be provided to deficit countries, especially ones in need of development aid, in exchange for a commitment to a structural adjustment to boost consumption (and local services).
Of course, the US would benefit from this scheme, but they also benefit from the status quo by being the reserve currency.
[1:18:10] The bottom line
To achieve long term resilience we must recognize that structural changes are taking place. To do so we need intellectual and ideological diversity, and we must be able to conduct reasoned evaluations of previous responses to crises.
We have not conducted an evaluation of the covid response; it is not clear that the costs from broad lockdowns outweighed the benefits, even when measured by lives saved.
For a positive note, Chile has shown a remarkable ability to get off bad paths. Things are not irreversible.
* Summary produced by Pablo Balsinde (PhD student, Stockholm School of Economics)