DETROIT, MI- JULY 28: Young paint can artists flock to the abandoned Packard auto plant in Detroit. Though an eyesore to many, the place has become an unofficial artists haven in recent years. The Detroit housing market faces changes as it tries to recover. Though there's still thousands of abandoned homes and businesses, there's been a rise in the sale of higher-end homes. There's also been a bit of a resurgence in the Downtown area. (Michael S. Williamson/The Washington Post via Getty Images)
Abandoned: graffiti artists outside a disused Detroit factory © Getty Images

Responsive leadership — the theme of this year’s World Economic Forum in Davos — is absolutely crucial for corporate success. Similarly economies also need to be able to respond to a changing world.

A responsive economy can adapt to change; it is resilient in the face of adversity; it encourages innovation and transformation, helping all within it to prosper. Most important is its ability to harness rapid productivity growth while remaining sufficiently flexible to ensure there are few idle resources, whether they be labour or capital.

Many advanced economies are failing on the flexibility front. With unemployment rates still averaging almost 10 per cent across the eurozone, and much higher in southern Europe, the pain of the past decade’s economic weakness has been concentrated among those who cannot find work.

Almost all countries are failing one of the necessary conditions of a responsive economy — the ability to harness rapid productivity gains. As most countries have seen falling productivity growth rates this century, this has cast the world into a low-growth trap. In this snare, sustained economic weakness generates expectations of low returns, thereby reducing investment and generating the lower levels of potential economic growth.

Maurice Obstfeld, chief economist at the International Monetary Fund, says, “compared to the 1998-2007 averages, long-term potential growth is now projected to be lower in all regions, and current growth rates are lower still in much of the world, notably in emerging market and developing economies”.

If even flexible economies, such as the US, struggle to harness new ideas for more productive output, then low growth will generate disappointing tax receipts and governments will struggle to offset the negative effects of trade and new technology on their populations. There will be little money to help the “left behind” and their anger will mount.

“Productivity growth isn’t everything, but in the long run it is almost everything,” said Nobel Prize-winning economist Paul Krugman in 1994. Rarely has his adage been so important.

The productivity challenge is stark. In the US, sluggish growth has not prevented unemployment falling to a new low of 4.6 per cent, but this has merely highlighted the weakness of labour productivity — the output per hour worked. It fell 0.3 per cent in 2016, having grown at an annual average rate of 2.8 per cent between 1999 and 2006, the Conference Board, a research group, estimates.

Labour productivity growth has also declined in Europe — from 1.5 per cent to 0.3 per cent over the same period in the eurozone — and Japan, from 2.2 per cent to 0.8 per cent. Part of the decline is the result of ageing populations, but more can be attributed to a fall in the growth rate within industries and a smaller change in the composition of work, with some middle-skilled jobs being replaced by lower-productivity employment.

The result of low productivity growth has been historically small rises in incomes, adding to the sense that economic structures no longer satisfy the public’s expectations, especially where rising inequality has concentrated gains among a very few.

To raise productivity growth rates and generate more responsive economies, at least three ingredients are required. The first, says the OECD, is faster growth rates. This would ensure an escape from the low-growth trap. The US economy is already closest to becoming the global test bed of whether rapid growth can restore responsiveness and productivity to an economy.

Janet Yellen, chair of the Federal Reserve, said in September that a faster rate of expansion might itself lead to more rapid productivity growth, increasing speculation that the Fed could keep interest rates low to encourage faster growth. But minutes from its December meeting, when it raised interest rates, showed the Fed was ready to put up rates faster than expected if the new US administration stimulates the economy in 2017 with tax cuts and spending increases.

A second ingredient is fulfilment of structural reforms to improve potential growth. In 2015, the G20 nations pledged reforms to improve their economies’ growth rate by 2 per cent, but they are falling behind in their efforts to reach this target.

A third is for leaders to avoid the increasingly harsh protectionist language regarding trade. Trade growth has fallen to no more than economic growth in the world since 2010 (it has traditionally grown at twice the level, intensifying competition and helping to boost productivity growth). The OECD has calculated that this drop in the growth of trade has shaved 0.2 percentage points from annual global productivity growth since the 2007-09 financial crisis, leaving it growing at only 0.5 per cent a year.

Catherine Mann, the OECD’s chief economist, says that adoption of protectionist measures will fail to create responsive economies: “Trade protectionism shelters some jobs, but worsens prospects and lowers wellbeing for many.”

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