Debt-driven model of economic growth is bankrupt

SERIOUS MONEY:It is troubling to note there are no growth engines available to push the world economy forward

THE WORLD’S major stock price averages have registered robust double-digit gains, since early summer, to within touching distance of multi-year highs, a somewhat puzzling development given that virtually all of the most recent data confirms global economic growth has slowed to the most sluggish pace since the Great Recession came to an end three years ago.

A troubling slowdown in economic activity is detectable almost everywhere, with stagnation or outright contraction evident across much of the developed world, while several emerging market economies have struck a nasty speed-bump. The deterioration in the global economic outlook is beyond dispute, and reflected in rising unemployment and falling investment rates, as well as the volume of world trade that has slowed to a standstill.

Hope continues to trump reason however, as investors continue to demonstrate blind faith in policymakers’ ability to deliver stimulus measures that will lift the global economy from its current soft patch. It is staggering to observe that many seasoned market players persist with such a belief, given that all the evidence suggests the various growth models responsible for the robust expansion in economic activity, in the years that preceded the global financial crisis, are now exhausted.

The debt-driven model that underpinned economic growth throughout most of the Western world for at least the past two decades is undoubtedly beyond rescue at this juncture. The rate of increase in non-financial private sector debt outpaced growth in gross domestic product by more than 3 percentage points a year on average through the 1990s, and the gap widened to almost 6 percentage points a year in the early years of the new millennium, which inevitably pushed debt ratios to dangerous levels.

The unsustainable private sector borrowing spree duly came to an end once the Great Recession struck in 2008, and the resulting plunge in economic activity required fiscal and monetary stimulus on an unprecedented scale to prevent a worldwide depression. The unthinkable did not happen, of course, but policymakers’ efforts to promote a self-sustaining economic expansion have been less than impressive.

The US economy, for example, is experiencing the weakest recovery in post-war history, with annualised economic growth, quarter-on-quarter, averaging little more than 2 per cent since the downturn ended, or less than half the pace recorded over a comparable time period following the previous 10 recessions. Additionally, although real output has reached new highs, not one of the four indicators that the National Bureau of Economic Research employs to date business cycles has exceeded their pre-recession peaks.

Meanwhile, European economic performance has been even less inspiring, with activity failing to recover its pre-recession peak in both the euro zone and the UK, such that GDP per capita is still roughly 2 per cent below its 2007 level in the former, and 6 per cent below in the latter. Further, the post-recession experience in both economic regions trails the Japanese record following the deflation of its twin property and stock market bubbles more than two decades ago.