THE OECD INTERIM FORECAST: REMARKABLE MESSAGES ON THE NEED TO RAISE PUBLIC INVESTMENT

The interim economic outlook, published by the OECD today (OECD Interim Economic Outlook), is remarkably candid. By saying that “global GDP growth is projected to be no higher than in 2015, itself the slowest pace in the past five years five”, the OECD is openly expressing serious concern about the risks to economic recovery.

The OECD is certainly right to do so. First of all, the economy is hit not by one but by a series of negative shocks that are interrelated and mutually reinforcing. China, until now a major source of demand for global equipment and commodities, is slowing down as it is suffering from vast industrial overcapacity, a capacity which has been built on a private sector debt bubble. Then there is the Federal Reserve decision to raise interest rates and to restrict liquidity growth which in turn has helped trigger capital outflows that are destabilising many emerging economies and their currencies. Meanwhile, efforts of other central banks to intensify ‘beggar-thy-neighbour’ policy by moving into the unchartered territory of negative interest rates have backfired as markets fear the implications of negative interest rates have for the banking sector. Taking all together, these shocks risk producing an impact on both emerging as well as advanced economies that is not to be underestimated.
There is, however, a second reason for concern. This accumulation of shocks comes at a moment when the economy is still digesting the consequences of the previous financial crisis. This can for example be seen in the fact that the usual “macroeconomic ammunition” to fight downturns has now become severely constrained. Monetary policy is already facing the zero lower bound on interest rates, while the effectiveness of massively but unconditionally printing money (liquidity has gone up from 6% of world GDP at the end of the nineties to 30%) is increasingly being questioned. Add to this that inflation has now become so low that the slightest negative economic shock will tip close to zero inflation over into outright deflation and you understand why the OECD is worried.

The OECD does not just fire this warning shot. It is also t is calling for an ‘urgent policy response’ with macroeconomic policy “to become more supportive of demand”. Here, the OECD puts a special focus on a joint effort to increase public investment. This is very pertinent as the OECD (see graph below) is actually suggesting that a 0.5 per cent increase in public investment across all OECD countries will substantially boost GDP. In the OECD countries undertaking this public investment push, it would increase their GDP by 0.6%, whereas the troubles in the BRIICS would be alleviated by adding an extra 0.3% to their GDP. Moreover, the OECD is hinting at the fact that such deficit spending to increase public investment is perfectly compatible with fiscal sustainability. Indeed, as can be seen from the graph, public debt as a percentage of GDP would not go up but go down. This is actually not so surprising. As trade unions have been pointing out in their analysis of the effects of fiscal austerity, if you increase deficit spending, in particular if you do this in a coordinated manner and when you target public investment, then the boost in economic activity this produces, will not only trigger a flow of higher public revenue and lower unemployment benefits, but also reduce the (relative) stock of public debt by increasing real as well as nominal GDP (the so called ‘denominator’ effect).

It also seems the OECD has particular regions or economies in mind, when launching the call for higher public investment. Indeed, it devotes special attention to Europe which, according to the OECD, “needs to speed up progress on collective action”. What this means can be seen in the next graph which shows that the Juncker investment plan, more than one year after its launch, is not really taking off.

Coming from an organisation such as the OECD, all of this is, as said, rather remarkable. It seems some welcome rethinking is going on inside the organisation.

It needs to be said, however, that this process of rethinking is unfinished business, as the OECD continues to repeat its usual call for stepping up the pace of structural reform (without, as usual, going into much detail what structural reforms would actually mean).

Here, the OECD risks getting caught up in contradictions as it is at the same time also referring to low inflation and ‘inadequate’ wage growth. In doing so, the OECD seems to be oblivious to the fact that reforms to weaken labour market institutions, in particular wage formation, as this has been done in Japan and more recently in several EU countries, have weakened workers’ bargaining positions and have taken the bottom out of wage dynamics. By contributing to push inflation towards too low levels, reforms such as these have brought us into the dangerous situation we are now in. With the risk of low inflation getting entrenched in weak wage deals, robust and coordinated systems of collective bargaining that allow wage dynamics to be aligned with macro-economic objectives are part of the solution. The sooner the OECD and other international economic institutions come to grasp this, the better.