Temper Your Optimism, Says the IMF

Where I am, not many people need that advice.

I traveled to Madrid yesterday, partly to help run a seminar that the Aspen Institute has put together this weekend on the future of capitalism. I don't know whether the timing for the event is good or bad. Spain has 23% unemployment (the youth unemployment rate is 50%) and its output is still contracting. It's also the new focus of Europe's debt-crisis anxieties. It's the fourth-biggest economy in the euro area, so if it's allowed to go the way of Greece it will overwhelm the EU's inadequate financial defenses. In one way our subject couldn't be more topical--but it's hard to look very far ahead when the ceiling's falling in.

Our background reading includes the IMF's new World Economic Outlook. This says the global situation has improved a little, but only a little. Chief economist Olivier Blanchard:

With the passing of the crisis, and some good news about the U.S. economy, some optimism has returned. It should remain tempered. Even absent another European crisis, most advanced economies still face major brakes on growth. And the risk of another crisis is still very much present and could well affect both advanced and emerging economies.

The report goes carefully into both aspects--the brakes on growth and the risks of another disaster--and I recommend it. The Fund's basic advice is obviously right: to strike the necessary balance between restoring confidence in financial markets and supporting short-term growth, governments need to put longer-term fiscal restraint in place but take care not to overdo it right now. This isn't hard to do in principle but in practice, apparently, it's nearly impossible. It takes overkill to convince markets that governments are fiscally serious, then as soon as the growth implications of fiscal overkill sink in, the markets decide they don't like that either. The Fund calls them "schizophrenic", which they are. But then whose fault is it that governments have so little credibility in the first place?

One link from the here and now to the future of capitalism is shifts in the respective shares of labor and capital in national income. The report looks at this briefly Box 1.1 on page 36.

[T]he recent recovery in the United States appears unusual from a historical perspective. The rebound in profits relative to labor income is much stronger this time around (although during all recoveries the labor share tends to fall). In fact, the most recent U.S. recovery looks very much like a typical European recovery. One possibility is that workers' fear of long-term unemployment has led to more subdued wages relative to labor productivity growth during the recent recovery. But it will take further research to determine the actual causes.

In many European economies, workers are not worse off after the Great Recession in terms of their share of national income. The labor share is still higher today than just before the Great Recession in many economies. Yet, in the United States and in a few European economies (especially Greece and Spain), the labor share remains well below the pre-crisis peak. Only time will tell the extent to which the latest labor share losses will add to the general trend decline.

I've just written a column for Bloomberg that has something to say about this. I'll be coming back to the subject.