Thursday, July 16, 2015

Greece: Growth or Recovery?

It's no secret (not anymore!) that macroeconomics, as a social science discipline, has problems.  Best known, of course, is the fact that research into macro stabilization policy has made no substantive progress -- and arguably has regressed -- over the last forty years or so.   But there's a second problem, which runs deeper and which may have helped cause the first.

I call this "Barro's Disease," based on the observation by economist Robert Barro that once you begin to study the determinants of long-run growth, it becomes hard to pay much attention to anything else.

Here's a slightly more elaborated version of that statement, excerpted from Barro & Sala-i-Martin's leading textbook, Economic Growth:
Even small differences in these growth rates, when cumulated over 40 years or more, have much greater consequences for standards of living than the kinds of short-term business fluctuations that have typically occupied most of the attention of macroeconomists. To put it another way, if we can learn about government policy options that have even small effects on long-term growth rates, we can contribute much more to improvements in standards of living than has been provided by the entire history of macroeconomic analysis of countercyclical policy and fine-tuning. Economic growth—the subject matter of this book—is the part of macroeconomics that really matters.  (Barro &  Sala-i-Martin, Economic Growth, 2nd Edition, p. 6).
While there is something to be said for this point of view (although see Aside 1), the consequence is a sort of blindness to anything that happens on a one-to-three decade time scale.  It is this blindess that I call "Barro's Disease."  (Aside 2).

What has all of this to do with Greece?  Simply this: the assertion that structural reform should be the highest priority for the Greek economy is nothing more than a symptom of Barro's Disease.  It rests not on an analysis of alternative policies and paths for the Greek economy, but on an unexamined assumption that "growth is what really matters."

But is it?  My view is that this is primarily an empirical question:  magnitudes matter.  But before we get to the arithmetic, we do need to deal with the question of how to weight costs and benefits in different time frames.  On this subject, I propose a pragmatic punt:  let us recognize that we are not discussing permanent policies to determine the growth path of the Greek economy into the infinite future.  Instead let us assume that, whatever we do now, twenty years from now, Greece will adopt optimal growth policies, the effect of which will, naturally, dwarf anything that happens in the next twenty years (at least within the inter-temporal discounting framework implied by growth theory).  (Aside 3.)

Alright -- let's talk numbers.  First, let's stipulate that the Greek economy in the late 2000's was sclerotic, corrupt, and very, very inefficient.  Under these conditions, Greece was able to produce an aggregate annual output of roughly EUR 240 billion (Greece's GDP in 2008).  Today, its annual output has fallen to about EUR 180 billion (Greece's GDP in 2014) .

Now, let's consider two policy scenarios.  In "growth scenario," structural reforms are imposed, boosting Greek output by 3% every year for the next twenty years.  In the alternative "recovery scenario," Keynesian stimulus pushes Greek GDP back to its 2008 level, but reforms stall and, as a consequence, Greek GDP stagnates -- zero growth for the ensuing eighteen years.  (The latter is basically the nightmare scenario invoked by reform enthusiasts warning of the dire consequences of "taking the easy way out.")

These assumptions, plus a few minutes with a spreadsheet, yield two hypothetical twenty-year paths for Greek GDP.

Under the "growth" scenario, Greek GDP in year 20 is 35% higher than under the "recovery" scenario.  However, it takes ten years for "growth" GDP to even catch up with the "recovery" GDP level.  It takes seventeen years for the cumulative "growth" GDP to match the corresponding number for the "recovery" scenario.  And over the entire 20 year time frame, cumulative "growth" GDP outstrips cumulative "recovery" GDP by only 4%.

Which path is better?

Well, if you have access to time travel or a cryogenic stasis chamber with which to "skip over" the next decade or two, the "growth" scenario has a certain appeal.  If, on the other hand, you actually have to live through those years, there's a pretty strong case for "recovery," even followed by a couple of decades of stagnation.

What if you're a creditor?  Assuming (I know, this is a hard one to swallow) that Greek debt service payments will be constrained by Greece's ability to pay (proxied by cumulative GDP), and if you care at all about the timing of the payments you receive, the "recovery" scenario is clearly preferable.

Now, does all of this mean that structural reforms, economic efficiency, and growth are unimportant?  Not at all.  In fact, the balance of trade-offs depends crucially on the depth of the recession, which determines the size of the boost received from simply recovering to the current-efficiency-full-employment level of GDP.  If "recovery" only meant, say, a 10% increase in GDP from the depressed level, all other assumptions being the same, the outcome would be quite different.

And that, I think, is why "Barro's Disease" merits being called a disease.  By inculcating the notion that long-run growth is always and everywhere more important than counter-cyclical policy, it tends to insulate economists' policy advice from the concrete facts of the problem at hand.

(Aside 1)  I've always thought that there was a fundamental problem with the evidence used to denigrate the importance of the cyclical stabilization in modern economies: the scale of cyclical fluctuations tends to be inferred from periods in which governments were actively stabilizing the economy (or in which the "fortuitous" advent of a global war forced governments' hands).  That counter-cyclical policy has had some success in recent decades does not seem valid evidence that counter-cyclical policy does not matter.

(Aside 2)  As an exercise for the reader, try to write down an inter-temporal utility discount function that corresponds with this weighting of near- and far-future events.  For extra credit, describe the effect of applying this function to the evaluation of global climate policy.

(Aside 3) If the optimism of this assumption seems troubling, the reader should feel free to adopt the alternative assumption that, twenty years from now, Greece will adopt disastrous economic policies, and remain stuck for all eternity at the level of prosperity characteristic of, say, Sub-Saharan Africa today.  The implications for current policy are the same.

1 comment:

  1. It seems there is a problem with assume the "reform" are pro growth. If would be humorous if it weren't so consequent that modelers often specify g without reference to where it comes from, especially not considering ROI and investment. Probably the worst example is the g embedded in typical models assuming time to recover to trend GDP.