A Macroeconomic Framework for Growth under the New Normal: Lessons from Latin America - Economic Research Forum (ERF)

A Macroeconomic Framework for Growth under the New Normal: Lessons from Latin America

This Blog is written by Aalaa Halaka


“Six months ago, I warned about the risk of a ‘new mediocre’—low growth for a long time. Today, we must prevent that new mediocre from becoming the ‘new reality’.”

Christine Lagarde, IMF Executive Director

Is there a global new normal?

When attempting to define a new normal, one should either look for a change in characterization between past and current economic situation, or otherwise a change in perception of the world economy that would lead to a new “normal”. The way economists look at it, a new normal in effect is a product of change in growth and/or financial risk trends. According to the IMF, world growth has historically been —before as well as after the global crisis— lower than desired, needed or expected, whereas financial risks have always been higher than expected and rather out of control.

But considering the divergence in growth trends across the world, it is safe to assume that different countries -or regions- can have different new normals, relevant to their respective economic and political environments. For instance, the US expects its new normal to witness secular decline in Total Factor Productivity (TFP) growth due to slow growth in innovation, and an aging population which would result in a decline in labor force participation. Whereas China projects a decline in GDP growth from its pre-crisis annual growth rate of 10% to 7% in the following years, and to an envisioned decline to 5.5% by 2023.

On the other hand, global equity markets are witnessing continuous high uncertainty —despite the low volatility and interest rates, where real interest rates have come the closest ever seen to 0%. So where could the rising uncertainty be coming from? Here are some facts and expectations:

1- The post-global-crisis period brought about large-scale quantitative easing (QE), at the end of which the market expects the monetary normalization policy to result in costly market corrections.

2- The buildup of financial debt resulting from the low interest rates during QE, in terms of the magnitude of the reaction of financial assets once interest rates begin to rise again.

3- Effect of changes in US tax policy on the economy as well as the deficit and public debt, which is currently at 75% of GDP —highest among advanced economies.

4- Geopolitical uncertainties: cross-border economic integration, rising protectionism in western economies, brexit, inter-regional wars.

5- Corruption leading to political polarization, which has had its toll on many developing countries.

But really, what’s new?

Thus far, all of this is as good as ancient history! These trends have been observed over and over again throughout the course of history, which begs the question: What is new in the world? More specifically with respect to MENA. Our keynote plenary speaker Prof. Raimundo Soto (Universidad Catolica de Chile) argues that technological change holds important risks, the impact of which on production landscapes and social contracts can be dramatic.

Robots, 3D printers, artificial intelligence are but a few of the applications of technological advancement that could reshape markets and economies, particularly labor markets. Recent projections estimate that automation will be highest in countries where the cost of labor is high (23% in US, 26% in Japan, 24% in Germany, 21% in Kuwait), while the effect won’t be as drastic in labor-intensive, low-wage economies such as China (16%), India (9%), and Egypt (11%). So the question is whether MENA countries have the adequate regulatory and institutional frameworks to adapt.

Turning to resource-rich countries, Dr. Soto argues that despite the decrease in commodity prices over the past years, oil producers should -in theory continue to make profit, as prices remain generally higher than what they used to be prior to the “super cycle”, while the cost of production has decreased. On the other hand, price volatility is a factor of production and demand, where technological change plays an important role; mainly with respect to renewable energy and lowering the marginal cost of oil production (e.g. fracking).

In addition to the increasing demand of renewables, a systematic decline in the demand of non-renewables is forecasted in 2030s-40s. This will most likely be attributed to the substitution of a lot of fossil fuels for electricity due to the decline of OECD demand as well as innovation-driven decrease in prices. As a result, oil share in energy market is expected to decline, and the prices of non-renewables are expected to be flat over the coming years.

Preparing for the future: Macroeconomic institutions for sustained growth

“My new normal is that punches are going to come from everywhere… I would expect faster, continuous, deeper, and far reaching changes and challenges to be the norm for policymakers.”

With this background in mind, Dr. Soto constructs a comparative analysis of macroeconomic institutions across 32 LAC and MENA countries following the recession, focusing on exchange rate, fiscal and monetary regimes. He finds that while both regions had similar real exchange rate trajectories as far as exchange rate regime and natural resource endowment are concerned, inflation targeting was a better shock absorber in the face of inflation, current account deficit, and rising unemployment. Additionally, fiscal rulers had much lower procyclicality.

To sum up Dr. Soto argues that a modern macroeconomic framework must consist of the right combination of macroeconomic institutions with fiscal, monetary and intertemporal responsibility to act as a shock absorber, and support steady growth. His conclusion is shared by Dr. Kamiar Mohaddes (Cambridge University and ERF), who stresses the important role of Sovereign Wealth Funds, quality institutions, and advanced financial markets in mitigating the negative impacts of uncertainty and volatility on investment and economic growth in MENA.

The Economic Research Forum’s 24th Annual Conference is held in Cairo, Egypt, on 8-10 July, 2018. The main theme of the plenary sessions is “The New Normal in the Global Economy: Challenges and Prospects for MENA”. The conference aims to draw on the lessons learned from the restructuring of the economic order across the region, particularly in light of the wide-ranging consequences of the decline in oil prices. With social turbulence and conflict persist in several MENA countries, the main goal is adequately reconciling short-term social and economic concerns with long-term growth and reform efforts. Visit the conference website to find out more about the event and access papers, videos and blogs.