In a 1938 paper, economist Alvin Hansen had argued that the post-Great Depression economy of the United States could be in secular stagnation – an economic condition where growth is low or negligible because of low population growth rate and reduced immigration. He proved to be wrong because of Keynesian policies to recover from the Depression-era economy and the post-war baby boom years which significantly raised the population growth. But Hansen could be correct now: developed economies could be experiencing secular stagnation due to a different set of conditions.
Economic growth in advanced countries after the Great Recession of 2007-2008 has been anemic. In the presence of austerity measures and, therefore, in the absence of any significant fiscal expansion (fiscal expansion being a Keynesian policy prescription), economic recovery has been slow and prolonged despite quantitative easing and zero and negative interest rate policies of central banks.
Advanced countries are experiencing two phenomena at the same time: income inequality is rising and the working population is aging. Both of these trends do not bode well for consumption which makes up close to 70% of the gross domestic products (GDPs) of these countries. As income inequality rises, lower and middle income portions of the population whose marginal propensity to consume (MPC) is higher than that of the upper income group will not have sufficient disposable income to spend thus putting a downward pressure on consumption. Also, once in retirement, bulk of the aging population will have less income, their capacity to take on new debt will be significantly less, and will not be able to consume as they had during their earning years.
Despite the expected tendency to consume less because of lower and uncertain incomes in the face of rising income inequality, majority of the households in lower to middle income quintiles have thus far spent more than they could afford by raising their debt-to-income ratios until the housing bubble burst. The ensuing financial crisis has crimped debt-driven spending, further dampening GDP growth in advanced countries for the foreseeable future.
Then, what to do about secular stagnation? Keynesian policy prescriptions actually work. First, income redistribution is necessary. A tax policy which taxes the wealthy to provide quality public education and healthcare for the rest of the society is needed. More importantly, wages have to be made less unequal by a tax policy which ensures equitable wage distribution in the corporate sector through more socially responsible corporate governance. Also, expansionary fiscal policy that raises government investment in public works and infrastructure to renew it and to create jobs should work just as it did in response to the Great Depression though the short-term boost any economy receives from war should be avoided (it has been argued that primarily the US entry into World War II had put the United States back on a growth path more than public works).
The world is experiencing a paradigm shift in how it uses energy and water, two critical resources for economic development and growth. All governments around the world would be wise to incur tax expenditures to incentivize the ongoing transformation so that fiscal policy is in support of and in coherence with the expansionary monetary policy that is underway globally to make monetary easing more effective by showing avenues where the private sector can gainfully invest and be an important part of the long term structural change the global economy is undergoing.
That fiscal policy has not adequately or not at all supported monetary expansion in the post-financial crisis period since 2009 is a fact. This must change if the developed world is to extricate itself from grip of both income inequality and the consequent secular stagnation because the financial cycle which is ahead of the economic cycle in the United States faces the danger of collapsing at some point, despite the extraordinary monetary policy, if economic growth does not support the high private corporate valuations.