The current vogue for optimism about the prospects for the developed economies is overdone. There may be a slight cyclical upturn but its significance is limited.
It is all too common for commentators on the global economy to base their assessments of economic health on such indicators as consumer confidence and business sentiment. The idea is that they are a measure of the positive ‘animal spirits’ in the economy. But such metrics, whether positive or negative, can easily shift. Upbeat sentiment can quickly dissipate and low levels of confidence can easily turn.
Inflation, too, is an unreliable indicator of economic vitality. Falling prices can be a sign of economic strength (when prices are falling as a result of rising productivity) or depression (with demand collapsing). Similarly, rising prices can coincide with an economic pick-up or they can be the prelude to runaway inflation.
The indicators that really matter are all too rarely discussed. Productivity – the average amount of goods and services produced by each worker in a given time – is the fundamental indicator of economic strength. Increasing productivity depends, in turn, on the levels of business investment. High investment – rather than sentiment – is what drives healthy growth.
From that perspective, the current level of economic dynamism in the West is pitiful. As the Organisation for Economic Co-operation and Development (OECD) has shown, the recovery of investment since the last recession is far lower than the average of the previous three recessions.
That is not to say that the economic outlook is bad. On the contrary, it could be, to use one of Donald Trump’s favourite words, ‘tremendous’. But the precondition for an economic take-off is the pursuit of policies designed to bolster investment and raise productivity.
An important new book by Phil Mullan, an independent economist, spells out in broad terms what such an approach would involve. Its title, Creative Destruction, indicates that there needs to be both a creative and a destructive side to this process.
The destructive element involves allowing weak companies and moribund sectors to fail. Through a policy of low interest rates, its emphasis on economic inability, the state has propped up a large number of decrepit firms. The problem with this is that it stands in the way of promoting new areas of growth and development.
That, in turn, points to the creative side of economic restructuring. It means the government playing a role in creating the conditions for new enterprises to emerge. Necessary measures could include a substantial increase in research and development, as well as much more emphasis on improving the physical infrastructure.
Without creative destruction the confidence in a global upturn looks certain to prove unfounded.