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Stagnation is a condition of an economy in which its rate of total output, or per capita output growth, is at—or close to—zero for a relatively long period of time. (Sometimes the term is applied to particular sectors, but in this entry it refers to the entire economy.) Stagnation is sometimes characterized by high rates of unemployment. It can be distinguished from other terms such as recession or depression, which usually refer to periods of low or even negative rates of growth but which are relatively shortlived phases of the business cycle. If stagnation is accompanied by high inflation, the phenomenon is called stagflation (although this may sometimes merely be a phase of the business cycle). The term stagnation is used both for economically advanced countries that have experienced growth in the past and have a high level of per capita income and for less-developed countries that have failed to grow.
The analysis of stagnation in this economic sense, as well as in broader terms, has a long history. The fourteenth-century Arab scholar Ibn Khaldun discussed the tendency of empires and societies to stagnate due to the erosion of solidarity and the spread of habits of luxury among rulers. In the twentieth century, this broad view about the rise and inevitable decline of civilizations was pursued by German philosopher Oswald Spengler (1880-1936), who analyzed stagnation in terms of factors like the domination of politics by the power of money and the concentration of populations in “barrack-cities” that turn people into mobs susceptible to demagoguery. This view was also explored by historian Arnold Toynbee (1889-1975), who examined how mature civilizations, due to the “intractability of institutions,” for instance, are unable to respond appropriately to challenges and therefore suffer stagnation. Heavy tax burdens and the corruption and excessive luxury of the ruling classes have often been highlighted in historical studies of stagnation. Stagnation in precapitalist countries was attributed by Adam Smith (1723-1790) to inadequate laws and institutions and to the neglect of foreign trade. Broad analyses of the problems of less-developed countries explain stagnation in terms of political and social factors. For instance, those enjoying political power and doing well outside of the economy are argued to be unwilling to makes changes to institutions and policies that are likely to worsen their own positions.
In more narrowly economic terms, stagnation in advanced economies has been explained both in terms of supply-side and demand-side factors. Factors on the supply side were stressed in the classical theory of the stationary state. In David Ricardo’s (1772-1823) analysis of the growth process, as more capital is accumulated and more workers are hired, the demand for food to be consumed by workers increases, which drives agricultural production onto increasingly less fertile land, increasing the competition for land, driving up land rent, and reducing the profits out of which capital is accumulated, which eventually brings capital accumulation to a halt. While Ricardo may have underestimated the extent to which diminishing returns to agriculture can be offset by technological improvements, the main reason for his stationary state— that is, diminishing returns—continues to be stressed. In Robert M. Solow’s 1956 model, for instance, as capital is accumulated, diminishing returns to capital set in to make saving and investment sufficient only to keep the capital-labor ratio constant, which implies a constant level of per capita income, unless exogenous technological change makes per capita output grow. The assumption of diminishing productivity of capital and other produced inputs has more recently fallen into disfavor, with empirical evidence suggesting that technological change and external economies can defeat the effects of diminishing returns, as usually assumed in new growth theory models. But structural changes increasing the weight of technologically lagging service sectors and environmental constraints remain possible causes of stagnation.
For the demand side, it was argued by John Maynard Keynes (1883-1946) that, in advanced economies, saving as a ratio of output tends to rise with increasing output and income as consumer wants are increasingly satiated, while investment incentives progressively decline with capital accumulation. With lower rates of investment and consumption, aggregate demand declines, and the rate of growth of output slows. These insights were used by Alvin Hansen (1887-1975) to develop a theory of U.S. stagnation in the 1930s due to inadequate aggregate demand. Subsequent events have shown that government aggregate demand policy can rescue economies from deficient aggregate demand and that there seems to be no inherent tendency for satiation in consumption. Nevertheless, governments may be unable or unwilling for political reasons to solve the problem of demand deficiency, and structural changes rather than any inherent tendency for consumption demand to become satiated may continue to make demand factors relevant. Josef Steindl (1912-1993) argued that the rise of monopoly power made possible by increasing industrial concentration tends to increase profit markups, which tends to increase saving in the economy, leading to a reduction in aggregate demand, a decline in capacity utilization, and a consequent decline in investment. Paolo Sylos-Labini (1920-2005) stressed problems created by the growth of oligopoly on the nature and consequences of technological change, which tended to increase profit margins of large firms and reduce aggregate demand.
Explanations of stagnation in less-developed countries sometimes focus on the demand side, for instance, stressing the absence of investment incentives due to the small size of markets and the high levels of uncertainty caused by external and internal shocks, and sometimes the supply side, emphasizing low saving and productivity. Many of the explanations invoke the concept of the vicious circle, according to which low per capita income, through a variety of channels, implies its persistence (see Nurkse 1953; Leibenstein 1957). The plethora of such mechanisms under discussion, in addition to low saving and investment incentives, include: poor nutrition and health and low productivity; low income, absence of collateral, and the inability to borrow and finance economic projects; and poverty, child labor, and low levels of education and human capital accumulation. More recently, vicious circles have been related to poor institutions, governance, corruption, and violence. Low levels of income may make corruption and violence more attractive, leading to poor economic performance. Some approaches examine how increases in per capita income may set off forces that lead to subsequent declines. Examples of such mechanisms include increases in population caused by better living conditions, which reduce per capita income; increases in consumption from very low levels when income increases; and the inability to adopt increasing-returns technologies that require a minimum size of the market (see Azariadis and Stachurski 2005). These mechanisms produce low-level poverty traps: if per capita income is initially below a critical minimum level, the economy will converge to a poverty trap, whereas if the economy happens to attain a level beyond that critical minimum, it sets off into self-sustained growth.
The newer approaches suggest that stagnation is not inevitable for advanced economies, and poor countries can escape from their low-level traps under certain circumstances. However, these approaches also suggest that broader political, social, and institutional factors emphasized in earlier approaches have continued relevance insofar as they interact with more narrowly defined economic factors in explaining stagnation.
Bibliography:
- Azariadis, Costas, and John Stachurski. 2005. Poverty Traps. In Handbook of Economic Growth, Vol. 1A, eds. Philippe Aghion and Steven Durlauf, 295–384. Amsterdam: Elsevier.
- Hansen, Alvin. 1938. Full Recovery or Stagnation? New York: Norton.
- Ibn Khaldun. [1375–1382] 1958. The Muqaddimah: An Introduction to History, 3 vols. Trans. Franz Rosenthal. New York: Pantheon.
- Leibenstein, Harvey. 1957. Economic Backwardness and Economic Growth: Studies in the Theory of Economic Development. New York: Wiley.
- Nurkse, Ragnar. 1953. Problems of Capital Formation in Underdeveloped Countries. Oxford: Oxford University Press.
- Ricardo, David. [1817] 1962. The Principles of Political Economy and Taxation. Cambridge, U.K.: Cambridge University Press.
- Smith, Adam. [1776] 1976. An Inquiry into the Nature and Causes of the Wealth of Nations. 2 vols. Oxford: Oxford University Press.
- Solow, Robert M. 1956. A Contribution to the Theory of Economic Growth. Quarterly Journal of Economics 70 (1): 65–94.
- Spengler, Oswald. 1926–1928. The Decline of the West. Trans. Charles Francis Atkinson. New York: Knopf.
- Steindl, Josef. 1952. Maturity and Stagnation in American Capitalism. Oxford: Blackwell.
- Sylos-Labini, Paolo. 1962. Oligopoly and Technical Progress. Trans. Elizabeth Henderson. Cambridge, U.K.: Cambridge University Press.
- Toynbee, Arnold J. 1934–1961. A Study of History. Oxford: Oxford University Press.
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