January 30, 2007
A divided world of economic success and political turmoil
The world’s economy is in excellent shape, but its politics is disturbing. This contrast, discussed by Lawrence Summers in his column of December 26 2006, was also a focus of last week’s annual meeting of the World Economic Forum in Davos. The question is whether and how this divergence might end. The facts seem clear: the world economy is in a golden period of broadly shared growth, high profits, modest real and nominal interest rates and low prices for risk. It has, on its way, adjusted with some ease to a series of shocks: the stock market crash after 2000; the terrorist outrages of September 11 2001; wars in Afghanistan and Iraq; friction over US policies; a jump in real oil prices to levels not seen since the 1970s; the cessation of negotiations in the Doha round; and the confrontation over Iran’s nuclear ambitions. It has coped, as significantly, with China’s and India’s economic resurgence. This list of shocks is itself partly a consequence of the political pressures: protectionist sentiment, turmoil in much of the Islamic world and nuclear proliferation. To this should be added the damaged moral authority of the US and its failure hitherto in Iraq, the discredit into which many of the world’s leaders have fallen, Russia’s slide into plebiscitary dictatorship, the political stagnation of the European Union and the inability to create a global regime for dealing with climate change. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Robert Wade: Martin argues that a benign outcome to the current disjunction (world economy in excellent shape, world politics unstable) is quite possible. If the excellent economy continues, it would calm the politics. ‘Governments would be increasingly forced by their publics to make the world we live in one we can also live with.’ Inter-state cooperation in providing public goods and reducing public bads would improve, and the global difficulties discussed at Davos might be handled successfully. But for all this to happen we have to choose cooperation over conflict, and ‘openness over turning one’s back on the world’.
A few comments. First, on ‘the world’s economy is in excellent shape’. I’m reminded of the remark of, I think, Jacque Rueff about the Post Bretton Woods monetary regime, which has enabled the US to pay for its net imports by printing dollars or dollar debt. He said something like, ‘If my tailor is prepared to go on making me suits and selling them on credit, without expecting repayment, then of course I am going to keep on buying suits’. I’m reminded, also, of the glow around the East Asian ‘miracle’ economies in the mid 1990s, when just about everyone projected fast growth indefinitely. And I’m reminded of Martin’s response to an earlier Forum comment of mine:
The big point, however, is that in a world in which some countries want to run large current account surpluses (or simply happen to have excess savings), someone has to borrow. The fact that the borrower is now the world biggest and most creditworthy country, with the best capital markets and a good central bank, which issues the world’s key currency (in which all the country’s debt is denominated) is a source of stability for the world system, not a source of instability.
To which one might reply: just as a fixed exchange rate is a great source of stability, until the moment when it can’t be sustained and the balloon goes up. Think East Asia in 1997, and Norman Lamont and black Wednesday, among many other cases.
There is no doubt that the growth of the US and of China and of some other parts of the world has been increased by the outflood of dollar liquidity resulting from the gigantic US current account deficit. This is an important up-side. But on the downside we have the propensity to asset bubbles in one economy after another, followed by crashes; and the propensity to excess supply capacity in many industries in response to abundant and very cheap credit. As long as the gigantic US current account deficit persists the world economy-even if in ‘excellent shape’ today-is subject to economic upheavals at short notice.
I would be more sympathetic to the ‘world economy in excellent shape’ thesis if (a) US growth was investment-led and (b) US exports looked like rising sharply. Instead, there is a consumption boom and historically unprecedented risk in the financial sector. Herbert Stein famously said, ‘Things that are unsustainable sooner or later come to an end.’ He should have added, ‘But always, clever people will explain why the seemingly unsustainable is really “new” - and sustainable.’ As in The Economist’s take on Japan shortly before the crash of early 1990: ‘What Japanese investors have become aware of is the dramatic way Japan’s blue-chip companies have changed the sources of their earnings through restructuring. This has made their profits too erratic to give any meaning to rigid measures such as a p/e ratio. Instead investors have started to assess a company’s future stream of earnings by looking at the total value of a firm’s assets….The implication is that shares may be underpriced.’
Having said that, I have to admit to surprise that we have not seen more economic upheavals over the past 5 years; which may indicate I have misunderstood the macroeconomics.
The second comment is on Martin’s version of the ’sweet commerce’ thesis: governments are orienting their politics around the goal of prosperity, and therefore (a) they are more likely to choose economic openness rather than ‘closedness’, and (b) they are more likely to cooperate with each other to solve global problems (in the interests of their goal of prosperity). I’m reminded of Norman Angell’s The Great Illusion. Angell argued that the world economy had become so interdependent as to make national independence an anachronism. The interdependence was being driven by science, technology and economics-the ‘forces of modernity’, which themselves were becoming the determinants of international relations, not governments. Thanks to this interdependence, war between modern nations was ‘an impossibility’. Unfortunately he got the timing wrong. The book was published in 1911.
Cooperation is more fragile when some of the players think the game is stacked against them. Some of the biggest players-China and India — are benefiting hugely from nearly open access to the US and European markets, outsourcing of services, and the like; and they have a strong stake in doing what is necessary to keep these markets open for their exports. But a majority of states (not people) have been faring rather poorly. Less than one in 10 developing countries (with more than one million people) sustained an average real GDP growth of 3% or more between 1960 and 2000. A majority of the world’s countries (56 percent) experienced negative growth of GDP per person in 1980-98. In international fora, states count for more and number of people count for less. The adverse income and wealth trends for a majority of states make inter-state cooperation more difficult, or so I conjecture.
As for, we must choose ‘openness over turning one’s back on the world’: some dichotomies are useful in the spirit of ’simplify, then exaggerate’ (The Economist’s credo). But this one, beloved by Larry as much as Martin, is positively misleading. It implies that the alternative to full openness (very low tariffs, etc.) is autarchy, or in Larry’s phrase, ‘walling off the rest of the world’. Larry and Martin deploy the word ‘protectionism’ for the latter, a doctrine espoused by people they call ‘protectionists’. By the logic of their dichotomy, one who argues for selective protection — eg for purposes of industrial upgrading — is a ‘protectionist’ who wants to ‘wall off’ from the rest of the world. In fact, however, the big issue facing governments of developing countries is not whether trade is ‘good’ or ‘bad’. It is how to combine the opportunities offered by international markets with coordinated strategies for domestic investment and institution building, in order to stimulate domestic entrepreneurs and intensify the integration of the national economy. One can be sure that the answer is not always, ‘give high priority to further trade and investment liberalization’ (though this may well be the high priority if the aim is to make these economies fitter for generating profits for western firms).
It is worth remembering that at the end of the 19th century, when US per capita PPP income was about the same as that of many developing countries today, its industrial tariffs averaged nearly 50%, compared to around 10% in developing countries today. I wonder whether Martin and Larry really think that the US would have experienced even faster growth and industrial upgrading in the late 19th and early 20th century if its industrial tariffs had been 10%? Or 5%? The example helps to suggest the nonsense of what the developed countries are demanding of the developing countries in the Doha round-on some proposals, average bound industrial tariffs as low as 3% (excluding the least developed countries). Yet the dichotomy of ‘openness’ or ‘turning one’s back on the world’ sanctions just this kind of nonsense. It occludes the point made earlier about combining the uptake of international opportunities with pro-active measures to dynamize the domestic economy; and thereby obscures the route by which the many economies currently performing badly could reach higher rates of growth.
Posted by: Robert Wade | February 7th, 2007 at 6:45 pm | Report this comment