OREANDA-NEWS. April 10, 2015. 

Davdie Furceri, Economist, IMF Research Department
Daniel Leigh, Deputy Division Chief, IMF Research Department
Ismaila Dieng, Communications Department

MR. DIENG: Good morning, everyone, and welcome to the launch of the analytical chapters of the World Economic Outlook for April 2015. This is Ismaila Dieng from the Communications Department here at the IMF. Joining me today are the lead authors of the two chapters, Davide Furceri and Daniel Leigh. Each of our authors will start with a short introduction and then we’ll open it up to questions in the room and online. So without further ado, I’ll hand over to Davide.

Mr. FURCERI: Thank you very much. Chapter 3 of the World Economic Outlook is about perspectives on potential output. You can think of potential output as an economy’s speed limit, or in other words how an economy can expand its production of goods and services without increasing inflation. In turn it depends on the supply of factors of production, capital and labor input, and their productivity. For example, the growth of the supply of labor depends in the medium term by changes in working age population or changes in participation rates, the growth in the capital stocks, it depends ultimately on investment, and the productivity of these two factors, it depends on business improvement and innovations.

To contribute to the policy debate on perspectives of potential output, this chapter estimates potential output for 16 major advanced and emerging market economies, which are a member of the G-20 and which accounted for about 75 percent of GDP in 2014.

With these estimates in hand, the chapter try to assess what happened to the evolution of potential output and its components before the crisis? What happened to potential output in terms of level and the growth rate during the crisis? And then with these estimates what it’s likely to be, the projected potential output going forward in the medium term, let’s say in the next 5 years.

The findings of the chapter suggests that before the crisis, the pattern of potential output between advanced and emerging market economies was actually different. In advanced economies potential growth was declining while in emerging market economies potential growth was increasing. In both cases this pattern was mostly due to changes in productivity growth. In advanced economies the decline in productivity growth mostly reflected the slowdown following an exceptional period of growth due to the innovation in the information and communication technology sectors.

In emerging market economies, the increase in productivity growth mostly reflected structural transformation in these economies and previous structural reforms.

Then in September 2008 came the global financial crisis. And the global financial crisis has been exceptional in the sense that unlike previous financial crises, it has been associated not only with a reduction in the level of potential output, but also with a reduction in its growth rate. In particular in advanced economies, potential growth declined by about 0.5 percentage point from the years just preceding the crisis to the most recent years, to 2014, and this decline mostly reflected two factors. On the one hand, aging put a brake on labor supply growth and the reduction in capital growth as a persistent weak demand negatively affected investment and capital growth.

In emerging market economies, this decline was actually larger, about 2 percentage points, and it reflected mostly a reduction in productivity growth. The key question is what is likely to be the trajectory of potential output going forward? The finding of the chapter suggests that in the absence of policy action, potential growth in advanced economies is expected to slightly increase as crisis-related effects wears off, but to remain below pre-crisis rate. The reasons are aging, which will put a brake on the growth rate of labor supply, but also capital growth as capital growth will slowly increase from current rate as investment and output recover from the crisis.

In emerging market economies, the findings of the chapter suggests that potential growth may further decline due to aging, same as in advanced economies, weaker investment, and lower productivity growth as these economies converge to the technological frontier. These reduced prospects of potential growth, compared to pre-crisis rates, of course, raise new policy challenges. For one thing, achieving fiscal sustainability in both advanced and emerging market economies will be more challenging. Also, in some of these economies, this lower prospect of potential growth may imply a slower expansion of living standards in the future.

Increasing potential output is a priority for most advanced and emerging market economies. Of course, the reform and the policy action needed to restore potential growth vary across countries. In advanced economies there is need to support demand to offset the projected weakness in investment as well as unemployment, as well as structural reform to boost productivity and innovation.

In emerging market economies, increasing infrastructure spending is key to removing bottlenecks, and structural reforms must be directed at improving business conditions and foster human capital growth.

Mr. LEIGH: Chapter 4 is entitled “Private Investment: What’s the Holdup?” It contributes mainly to the debate on why, in advanced economies, businesses have not been investing more. In advanced economies, business investment, the largest component of private investment – which includes spending on machinery, equipment, building plants – contracted much more during the global financial crisis than in previous recessions, and there has been little recovery since. There are worrying signs, as Davide just mentioned, that this has eroded long-term income growth.

So getting the diagnosis right is critical if we want to devise policies that will encourage firms to invest more. If low investment is just a symptom of a weak economic environment, then policies to expand activity could be warranted. But if special impediments, such as, for example, policy uncertainty or financial sector weaknesses, are to blame, as some have suggested, then these must be removed before investment can rise.

What we find in the chapter is that weak economic activity is the key factor holding back business investment. Although investment contracted more severely following the crisis than in past recessions – it’s been some 20 percent below pre-crisis trends in recent years – the contraction in output has also been much more severe. So the joint behavior of business investment and output has not been that unusual. Our analysis therefore suggests that investment has deviated little from what could be expected given the weakness in overall economic activity. Firms have reacted to weak sales, both current and future expected sales, by reducing capital spending. And, indeed, when businesses are asked about the main challenges facing them, they typically report a lack of customer demand as the dominant factor.

Beyond this general pattern, we see some cases of investment weakness that go beyond what you’d expect based on weak economic activity. Particularly in euro area countries that had high borrowing spreads during the 2010-11 sovereign debt crisis, there is more going on than just weak economic activity. Financial constraints and policy uncertainty have also held back businesses investment there.

Overall, our conclusion is that a comprehensive policy effort to raise economic activity is needed to encourage private investment. Fiscal and monetary policies can encourage firms to invest. More public infrastructure spending could spur demand in the short term, raise supply in the medium term, and, therefore, encourage firms to invest more today in countries where the conditions are right. And that means having well-defined infrastructure needs, having efficient public investment processes. Structural reforms, for example, those that strengthen labor force participation, could also enhance long-term economic output and give firms reasons to invest more today.

Finally, in areas where financial constraints have been holding back investment, there’s also a role for policies aimed at relieving crisis-related legacies such as debt overhang and cleaning up bank balance sheets. Thank you very much.

QUESTIONER: My question is that in the report you mentioned that the decline of potential output growth actually started as early as the 2000s, which is before the crisis. So I just wonder is this like a new finding or has it always been acknowledged that way? That will bring the monetary policy carried by certain countries, for instance the last two rounds of easing by the Federal Reserve into question given the fact that when the potential output grows at a low level either monetary or the fiscal policy can be used as kind of helpful to solve the problem. Thank you.

Mr. FURCERI: So what we find and in the chapter is that for advanced economies, potential growth started to decline even before the crisis. In terms of evidence, it’s been documented for the United States that some key element of potential growth such as, for example, total factor productivity growth, has declined since the mid-2000s. The chapter shows that this pattern of declining potential growth didn’t occur just for the United States, but in most of the advanced economies that we cover in the chapter. So in some sense it’s a new finding. We find that this decline was partly expected in some components such as, for example, aging, but actually it occurred mostly for something that was unexpected; indeed, this decline in productivity growth.

MR. HELBLING: Let me add two points here. First, I think it’s important to keep the decline in total factor productivity, which is underlying the decline in potential, in mind. It’s a relatively small decline in total factor productivity before the crisis.

The second point, I think when it comes to what you mentioned, the findings that potential output growth has slowed do not overturn the fact that there were large output gaps after the crisis and these output gaps have been persistent. So I think it’s important to keep that in perspective.

QUESTIONER: Good morning. Daniel, you mentioned some European countries without being specific. Can you talk to the situation of these countries a little bit more in detail, particularly Greece? The Greek Finance Minister has been to town very recently. How confident are you that Greece is on its path to reform, and are you sure you’ll get the money tomorrow?

And another question: We have an entire region, the Middle East, that is engulfed in civil war, terrorism. This region seems to be getting bigger and bigger, spilling over into Africa. There’s hardly a day, hardly a week, that passes without very, very negative political headlines. I wonder whether you see any blip on your radar screens whether this starts having a measurable impact on economic activity.

MR. LEIGH: The questions you’ve raised could be for the press conference for Chapter 1 on our overall outlook. I’m not going to get directly into specific countries in the Eurozone. But just to clarify that, indeed, what we’ve looked at is not just the overall performance of advanced economies. We’ve also looked country by country and, again, on the whole, in most countries the main conclusion is that weak economic activity is the reason for weak investment. But there are some countries, and those are the ones with the high borrowing spreads in the euro area in the past, that had weak investment that you cannot just explain using this sort of “accelerator model” and their financial constraints and policy uncertainty have been playing a role.

Let me just quickly add that this is borne out by some of the analyses we do on individual firms. We have additional analyses on that, which confirms that firms that depend more on borrowing to finance investment have been cutting back more on investment. So that confirms this idea that financial constraints have been playing a role there as well.

QUESTIONER: Could you give me more comment on Japanese potential output growth? How do you think Japanese economy will be in future? Thank you.

MR. FURCERI: In the chapter we don’t provide specific details for each country, but one striking element for Japan, and also for some other advanced economies such as Korea as we describe in the chapter, is that going forward aging will have a severe effect on what we call potential employment growth, so the growth rate of the labor supply. And this in turn will have an important effect, given that the share of labor in the total economy, for potential growth going forward. Again, in terms of projected potential output what we see for Japan is similar to those of other advanced economies. It could be different in magnitude, but we observed that aging is a factor affecting more Japan than some other advanced economies.

ONLINE QUESTIONER: . It’s on potential output, too. It says “Chapter 2 looks at 16 measured economies. Do you think these estimates of potential growth for these countries are representative for smaller countries in each respective group; i.e., advanced economies in emerging markets? Are advanced economies as a group more homogeneous than the EMs?”

Mr. FURCERI: So what we find in the chapter is that up to let’s say the most recent years -- so if you look at the past, so the period before the crisis and the period during the crisis -- we see that these two groups are quite homogeneous. So we see that potential growth was declining in most all advanced economies before the crisis. We also see that the potential growth was increasing in all emerging markets. The effect of the crisis or the decline associated with the crisis has been also similar. If you look at emerging markets, if you take China or other emerging market economies, you see that the decline has been a similar magnitude. And the same to some extent also for advanced economies. We noted in the chapter that the decline in potential growth has been relatively larger in some of the euro area economies than U.S. or other advanced economies, but again, the pattern is quite similar.

What we also mention in the chapter that going forward there could be some specific factor in some specific emerging market economy such as, for example, Brazil or Russia, which may be different. Each country will have its own specificity in some sense. China will face rebalancing. Other economies may face other challenges.

So going forward perhaps the pattern will be less homogeneous, but what we observe in the chapter is that until 2014, the pattern has been similar.

Let me also add that that the methodology used the chapter allows us to cover these economies. Using a similar methodology, which provides similar results for the group that we cover, for other emerging market economies to some extent we see a pattern, a trajectory, that is similar with emerging market economies. So we have seen an increase in potential growth in the years before the crisis, a decline in potential growth in the aftermath of the crisis.

Mr. DIENG: Thank you. Is there a question in the room? I see that we don’t have any more questions online, so this will bring an end to our briefing today. We hope to see you next week for the launch of Chapter 1 of the WEO on April 14. Thank you very much.