LONDON: Confidence in the global economy is steadily improving, as shown in the financial markets’ bullish behaviour and confident comments from companies and policymakers over the past few weeks. Though these columns have argued in favour of a robust recovery, when investors get uniformly bullish, the pessimistic case deserves attention.

Many distinguished economists believe that the current improvement in global conditions is just a blip. They insist that the world faces years, if not decades, of “secular stagnation.” How seriously should we take them?

The good news is that there is little evidence of secular stagnation in global statistics. The “new normal” for the world economy since 2008 has not been very different from the pre-crisis period. The average growth of the global economy from 1988 to 2007, the 20 years before the crisis, was 3.6 per cent, according to the International Monetary Fund World Economic Outlook database. The IMF latest forecast for 2014 is exactly the same — 3.6pc. Though Christine Lagarde, the IMF managing director, hinted at a modest downgrade this week.

At first glance, this continuity seems hard to square with the slowdown in economic activity in all major economies since 2008. The IMF expects only 2.2pc growth this year in the developed countries, compared with an average of 2.8pc during the two decades before the crisis. In the emerging economies, meanwhile, growth is projected at 4.8pc this year, slightly below the average of 4.9pc of the pre-crisis decades.

Since both emerging and developed economies have weakened, how can it be that the world economy as a whole has not slowed? The answer is the shifting balance of economic activity from slower advanced economies to faster-growing developing economies.

The emerging economies now account for 51pc of global economic activity, compared with 36pc in 1994. This means that emerging economies, even as they slow down, contribute more than ever to global growth.

China, for example is now growing at a rate of around 7pc instead of the 10pc it achieved in the pre-crisis decades. But that 7pc gross domestic product growth, from a base of $10 trillion, adds $700 billion to global demand. This is over three times more than China added 15 years ago, when it was growing by 10pc annually from a base of $2 trillion.

Now for the bad news. While the steady or slightly accelerating global growth rates predicted by the IMF is the most likely outcome, it may not be achievable because of three imbalances: social, geographical and demographic. These seem deeply embedded in the structure of global capitalism today. They are weakening demand, creating excess savings and driving the build-up of borrowing and lending that has been both a cause and consequence of the global financial crisis.

The most dangerous imbalance is in the distribution of wealth and income. Income disparities have become a source of political and moral controversy, but their macroeconomic effects have attracted less attention. The mechanism whereby income inequality causes economic stagnation was recognised by Karl Marx and other 19th-century writers.

If too much of the income created by capitalism’s capacity to increase production flows to people who are already rich and likely to save rather than spend, then crises of under-consumption become almost inevitable, as described by Marx in Das Kapital and analyzed more rigorously by John Maynard Keynes in the 1930s. The only way to avert such crises is to create financial systems that recycle ex­­cess incomes from rich savers to poorer consumers via a build-up of debt.

Geographical imbalances are a second major cause of weak demand. The global imbalance that generated controversy before the crisis was between the United States and Asia. This has largely disappeared as US consumption and borrowing have subsided, while China and Japan have shifted away from export-driven growth models.

In the meantime, however, an equally troublesome imbalance has emerged between Germany and the rest of the Europe. Germany’s current account surplus of 7pc of GDP is now larger and more persistent than the Japanese or Chinese surpluses before the crisis. Yet on the global stage, Germany is not subjected to the same sort of pressures. Germany’s political dominance in Europe also makes it immune to the kind of demands for policy changes that Washington applied to Japan and China, while the existence of the euro rules out the currency adjustments that ultimately removed the imbalances between Asia and the United States.

The third imbalance is demographic. Believers in secular stagnation have drawn attention to the downward pressure on labour supply as baby boomers retire. But this is unimportant in a period of high unemployment, when there is no shortage of workers to limit economic output. The bigger impact of demographic aging is on macroeconomic demand. Particularly when this problem is aggravated by Social Security and labour policies that shift incomes and economic opportunities in favour of retirees and older workers at the expense of younger generations.

Since 2008, governments the world over have protected or even increased pensions and healthcare “entitlements,” while slashing spending on in-work welfare, education, family policies and child support. This redistribution of income toward older voters has been exacerbated by employment policies that favour job protection for older workers, especially in Europe, over flexibility and job-creation policies that would provide opportunities for the young.

Because the aging baby boomers are already richer than their children and grandchildren, this policy imbalance has widened wealth inequalities, forced young people deeper into debt, increased excess savings and added to deflationary demand pressures. Given the electoral weight of older voters, however, the political favouritism for baby boomers is deeply entrenched in most modern democracies.

Published in Dawn, July 13th, 2014