January 9, 2007
Globalisation’s future is the big long-term question
What is going to happen to the world economy this year? The most important points on the short-term outlook were made by my colleague, Wolfgang Münchau, last week (“The good, the bad and the ugly scenarios for the year ahead”). Let us ask, instead, a bigger question: how strong and sustainable is the underlying dynamic of the world economy? As Lawrence Summers noted in his most recent column (“A lack of fear is cause for concern”, December 27), the world economy in aggregate grew more during the past five years than in any five-year period since the second world war. Growth is not merely strong. It is also widely shared. In 2006, according to the World Bank’s Global Economic Prospects, the economies of the high-income countries probably grew by 3.1 per cent, with the US achieving 3.2 per cent, Japan 2.9 per cent and even the sluggish eurozone 2.4 per cent. Meanwhile, the economies of the developing countries, led by the rising giants, China and India, expanded by 7.0 per cent, after 6.6 per cent in 2005 and 7.2 per cent in 2004. This performance has occurred in spite of significant economic and political shocks: the collapse of the stock market bubble in 2000, the terrorist attacks of September 11 2001, wars in Afghanistan and Iraq, the continued uncertainty about future large-scale terrorism, the jump in oil prices, protectionist rhetoric in a number of high-income economies and a breakdown in the Doha round of multilateral trade talks. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Willem Buiter: I would like to take issue with Martin’s statement “…that much of the world suffers from a huge surplus of saving over investment”, whose consequences have been “…the emergence of the so-called “global imbalances”…” and “…a long period of relaxed monetary policy”.
I interpret this as meaning that the world as a whole suffers from a Keynesian excess of ex-ante saving over planned investment. This consumption-led potential weakness of effective demand has been countered effectively through global expansionary monetary policy. The distribution of the global ex-ante saving glut has not been uniform across countries, with the saving glut concentrated in China and the oil and gas exporters and with investment weakness in Japan and Germany. Saving weakness and relative investment strength are found mainly in the US.
If this interpretation of Martin’s statement is correct, I don’t believe it.
For the past five years the global economy has been in the exact opposite of a perfect storm – perhaps a perfect lull – with the happy coincidence of the Blessed Trinity of low long-term real interest rates, low credit risk spreads and high real growth. It is not plausible that that, but for global expansionary monetary policy, this high global growth would have been dissipated through Keynesian effective demand failure caused by an ex-ante global saving glut. Rather, spurred by the sticks and carrots of globalisation, world-wide animal spirits have been buoyant; global investment demand and public spending would have carried the world economy even without the early expansionary and more recently accommodating monetary policy in the US, Japan and Euroland. Expansionary monetary policy was certainly instrumental in preventing a global recession following the bursting of the tech bubble in 2001, but monetary policy simply does not have the oomph to produce and support the unprecedented five year growth spurt we have seen.
Evidence of continuing excess liquidity is lacking, unless one considers low real rates and low spreads themselves to constitute such evidence, which would make the argument impossible to refute. I too believe that the current levels of long-term real interest and credit risk spreads represent global asset market anomalies that will at some point be corrected. I don’t believe, however, that these asset market anomalies are reflecting a fundamental factors, in this case excess liquidity. Instead I believe they are evidence of bubbles and/or of asset market irrationality. As these asset market anomalies do not reflect fundamentals, the timing and modality of their correction cannot be predicted. The corrections are unlikely to be painless for the real economy. There is little the monetary and regulatory authorities can do now to mitigate the severity of the eventual corrections, but they should be prepared to clean up the mess when it happens.
The main direct threat to the ‘perfect lull’ is a reversal of the globalisation process through an increase in protectionism and other forms of economic nationalism (the kind we see today in Russia and Venezuela, for instance). The threat of destructive economic nationalism is real. Larry Summers and Martin have argued that the widespread perception that the majority of the US population has not shared in the recent growth may make a more protectionist policy stance in the US more likely, regardless of the true contribution of globalisation to the unequal sharing of the growth dividend. They may well be right. What are the policy implications of this observation? On the non-controversial side there is the ‘motherhood and apple pie’ argument for increasing trade adjustment assistance to the losers in the globalisation game, and perhaps for a generalisation of such policies to benefit all those who lose out because of industrial restructuring and shifts in comparative advantage, regardless of whether the driving force is conventional trade, off-shoring and outsourcing or technological change. This could include increased funding for training and (re-)education.
After that, the only instrument is overtly redistributional policies – a reversal of the trend of the past 25 years. This means higher (and probably more progressive) taxes on the winners in the global growth game - owners of capital, owners of human capital and superstars in all field - and either increased transfer payments or benefits in kind (health, long-term care, education) to the ‘anxious middle’. Larry Summers’ call for ‘fairness’ can only be a call for the more extensive use of redistributional taxation. If globalisation can indeed only saved by higher (and therefore in general more distortionary) taxation, it may be price worth paying. There is, however, a risk that the threat of protectionism cannot be de-fanged through redistributive policies, and that we could end up with more protectionism and a higher tax burden. The anxious middle might be less anxious, but the world would not necessarily be a better place.
Posted by: Willem Buiter, London School of Economics | January 11th, 2007 at 1:44 pm | Report this commentAkio Mikuni: Under the economic globalization, as might be described by Martin, Japan exports products in exchange for man made money, which we cannot use in Japan. Accordingly, Japanese consumers consume less than they diligently produce or they save money unintentionally. In order to run chronic surplus and to prevent the yen from appreciating, we have to export capital to offset current account surplus and we have to fund those capital exports with domestic deposits, which banks cannot lend in the domestic market. For the purpose of exporting capital, Bank of Japan has reduced interest rates as low as possible, resulting in hoaded cash in the estimated amount of 25,000 billion yen. Accordingly, Japanese banks suffer from both external and internal drains of reserve deposits, and do not appear to be in position to increase loans as rapidly as before the bubble bursting.
Everybody is tired of slow growth and is asking for higher growth in Japan. We badly need the banking system to extend credit and create money more aggressively. Walter Bagehot might suggest that a possible solution to restore liquidity in the banking system should be to raise interest rates sufficiently. I hope that he might be wrong in a world of fiat money, and globalization’s future remains promising.
Posted by: Akio Mikuni | January 12th, 2007 at 8:13 am | Report this commentRobert Wade: Martin reports that world economic growth over the past 5 years has been higher-and more widely shared-than in any other 5 year period since 1945. The fast widening circle of prosperity is likely to be sustained for a good while, he says, because: (1) economic growth in emerging market economies like China and India is not only faster than in the high-income economies but also substantially decoupled from their growth; (2) we have learned how to contain inflation and have no reason to unlearn; (3) oil prices will probably fall. Given these conditions, even a recession in the US is unlikely to provoke a global slowdown. Putting aside the possible economic effects of political shocks (Iraq, Iran, North Korea, etc.), the biggest economic threat, he says, is that a ‘protectionist’ backlash in the high-income countries may occur, slowing further ‘globalization’ (further integration of markets in goods, services and capital). A protectionist policy shift may be driven by those in the working and middle classes who perceive-incorrectly-that ‘globalization’ is the cause of their income stagnation over the past decade. His argument is intended as a wake-up call against growing protectionist sentiment, especially in the US. In his book, Why Globalization Works (2004), he says, ‘Social democrats, classical liberals and democratic conservatives should unite to preserve and improve the liberal global economy against the enemies mustering both outside and inside the gates. That is the central argument of this book’ (4).
Is the threat of a protectionist backlash so severe? An FT editorial (Multilateral muscle needed for Doha deal, 3 Jan., 2007) made much the same argument by way of urging states to press ahead with the agreements on the table of the Doha development round. But it undercut itself by pointing out that the last 5 years have seen very fast growth of global economic integration even without the liberalizing impetus of the Doha round. On the face of it, it seems that global integration is being driven by forces not much affected by policy stances–and will continue to increase even if some OECD states adopt higher protection. (See my Letter to the Editor, 8 Jan.)
But this begs the question: Is what is happening really ‘global integration’? Martin uses global and globalization–like just about everyone else–as ‘that which is not national’, and assumes that the global represents the tendency of all contemporary economic relationships. My guess is that part of the underlying dynamic of the world economy comes from the rapid formation of macro-regions, like China-Japan; Northeast Asia-Southeast Asia; US-Canada; continental western Europe; the Nordics. Macro-regions have become strong and are becoming stronger in terms of (a) correlated fluctuations of major economic variables, (b) trade, (c) sales of multinational corporations. (Alan Rugman et al. show that hardly any of the top 500 MNCs have ‘global’ sales, in the sense of at least 20% in each of North America, Europe and East Asia and less than 50% in any one of them.) The answer to the FT editorial’s implied paradox — little further trade/investment liberalization over the past 5 years yet very fast ‘global’ integration — may lie in the point that the integration is more regional than global, and that the regionalization drivers are not mainly to do with policy stances.
‘Globalization’ and the dichotomy between national and global obscure the important regionalizing tendencies of the world economy.
But my more serious doubts about Martin’s argument relate to his picture of the ‘immensely powerful’ expansionary dynamics of the world economy, based on the ‘real’ factors of technological innovation and global integration (including of the Asian labour force) and on the ‘financial’ factor of monetary stability. Given this picture of robust real and financial conditions, the main threat must be exogenous — such as a mistaken ‘protectionist’ reaction. I see the fast growth of the past 5 years as much more fragile, and its continuance more uncertain, for reasons based not on protectionists and other enemies mustering outside and inside the gates but on basic design flaws in the world economic regime in place since the end of the stabilizing framework we know as Bretton Woods, whose contradictions have now ripened to a high pitch.
The flaw lies at the intersection of the world monetary system and the world trading system: in the combination of (a) money as debt, where money creation is limited mainly by demand for credit, (b) the US dollar as the main international currency, (c) free capital movement, and (d) no strong incentive on countries running current account surpluses to reduce their surpluses, and no strong incentive on the US to reduce its current account deficit (an incentive such as a progressive interest charge on surpluses and deficits).
As Richard Duncan argues in The Dollar Crisis (2005), the great global reflation after the economic downturn of 2000-2001 was accomplished through a huge expansion of the US current account deficit and a resulting huge expansion of global money supply. In particular the Bank of Japan/Ministry of Finance obligingly agreed to create money on a scale never before seen in peacetime, and invest it in US Treasury bonds or agency debt-hence financing the sharp increase in the current account deficit at interest rates low enough to allow the US property boom to continue and US consumption to surge. By late 2004 Chairman Greenspan was warning in exceptionally clear language — for him — that ‘…net claims against residents of the United States cannot continue to increase forever in international portfolios at their recent pace….At some point, diversification considerations will slow and possibly limit the desire of investors to add dollar claims to their portfolios’. Yet the US deficit has continued to grow as a % of GDP, to the highest level ever recorded by a major economy (with the exception of Italy, in the year before Mussolini took power). Its growth raises the probability of uncontrollable asset price inflation around the world, including in the US. (Compare Martin’s point (2) above, that we have learned to contain inflation. Our inflation measures underweigh asset prices.)
The US government has run low on ammunition for reining in the imbalances. Greenspan suggested that cutting the US budget deficit was ‘the most effective action that could be taken to augment domestic savings’ and reduce the current account deficit. But evidence from the late 1990s suggests that the effect of a substantial reduction of the budget deficit on the current account deficit would be small. So the supply of government and agency new debt would fall (due to the cut in the budget deficit), while the demand of foreign central banks to buy US debt would continue (due to the continuing current account deficits). So foreign central banks would switch to existing debt, pushing up the price of those bonds and pushing down their yields, regardless of what the Fed did to the federal funds rate. Therefore mortgage rates would fall, amplifying the property bubble, stimulating US consumption, and making the current account deficit even bigger.
On the other hand, to reduce substantially the current account deficit the US would have to cut its imports substantially ( for the fall in the dollar needed to substantially improve the competitiveness of US exports would have to be huge. ) For all the indications of a decoupling of growth rates in some of the biggest developing economies from growth in the West, there is not much doubt that a substantial cut in US imports would send a recessionary wave through the world economy and cause a fall in US exports — leaving not much of a net change in the current account deficit…
And if the falling dollar prompted investors to diversify into euros, the result would likely be an increase in bond prices and a fall in bond yields in Europe, triggering knock-on difficulties in economic management over here.
All this is a long way of saying that the great global reflation after 2001, which Martin, Larry and others celebrate, is more fragile than they suggest. But the fragility is not mainly to do with the risks of a protectionist shift in policy. It is to do with what happens in the intersection of the international trade regime and the international monetary system. The inattention to the real sources of the current fragility is eerily reminiscent of the inattention to the real sources of fragility in the East Asian economies in the years approaching 1997. Then too analysts looked at headline growth rates and projected them into the future, overlooking the source of the oncoming crisis - fast growth financed by foreign debt, in combination with fixed exchange rates. Today we are in uncharted territory in terms of the size of the current global imbalances and their rate of increase. Yet the consensus about what to do is locked in to ‘more liberalization’, ‘avoid protection’. It is as blinkered as the consensus among economists in the early 1930s that soaring unemployment was voluntary.
Posted by: Robert Wade | January 12th, 2007 at 11:36 am | Report this commentJim O’Neill: I agree with the tone of Martin’s analysis, especially the point that protectionist forces represent one of the major risks. Given how globalization, and the incorporation of the BRICs into the world economy, appears to be one of the critical factors behind this positive era we are going through, his comments are bang on. Indeed, as I wrote in our first Global Economics Weekly for the year, it is this factor which is probably responsible for the vibrant financial markets we seem to be enjoying.
As I meet clients and others around the world, one constantly hears of concerns about excessive liquidity and how risky the world is. Undoubtedly, the world is risky, it always is! Perhaps, because of the relevance of the emerging world and especially the BRICs, the world is getting riskier; perhaps, but not necessarily. It is certainly different.
While there is plenty of liquidity, many of the measures that we have followed for years do not suggest excess. In addition, many of the valuation measures we use suggest that markets are not overvalued , with the important exception of government bonds. As and when real bond yields rise sharply, perhaps then markets could be challenged more, but there are reasonably understood forces as to why bond yields appear to be low, including the slow emergence from Japan from deflation, the domestic imbalances in the US, the decline of the equity culture and so on.
In the meantime, both relatively, and absolutely in an environment where world GDP growth can continue above 4 per cent, the equity risk premia seems unnecessarily high, indicative of the concerns many have. The wall of worry continues. So long as protectionist forces are kept as bay, one day investors might become less concerned.
Posted by: FT Forums | January 12th, 2007 at 6:49 pm | Report this commentMartin Wolf: We have had some impressive contributions this week. I have nothing to add to what Akio Mikuni and Jim O’Neill have written. So I will concentrate my comments on the other two.
As one might expect Willem Buiter and Robert Wade take a directly opposed view of what is happening: Willem thinks this is a boom driven by real forces, with little role for monetary policy; Robert thinks it is a boom driven by bad monetary policies, with little role for real factors. I, of course, am in the middle, though much closer to Willem than to Robert. It seems very clear to me that the underlying drivers of growth are, as I argued, real forces: technology; entry of Asia into the world economy; and globalisation. On this, I think, Willem and I are at one.
But it is also the case, as Willem notes, that long-term (and, for that matter, short-term) real interest rates are very low. How does one explain this strange combination?
Normally, one would expect an era of exceptionally rapid economic growth to be one of high real interest rates as strong investment demand pushes up the price of credit. But this is not what has happened. Willem argues that this is yet another asset price bubble. I don’t find this a satisfactory explanation. I suggest that the existence of the huge “global imbalances” is another indication of the underlying cause. According to my back-of-the-envelope calculations the rest of the world is exporting about a sixth of its gross savings to the US. The fact that real interest rates are also so low suggests that this is not because spending is being “crowded out” in these countries by the US but rather that these excess savings are “crowding in” spending in the US, via low real interest rates.
In a world of low inflation and low real interest rates caused by excess savings in much of the world, nominal interest rates will also be exceptionally low. In the interest elastic economies (such as the US, UK, Australia), low real and nominal interest rates lead to rapid increases in borrowing and spending. Much of the borrowing will go on house purchase, driving up house prices. That is the process I referred to in my column.
Is it puzzling that there should be excellent investment opportunities as well as excess savings, not least in some of the countries with the best opportunities? It is a little puzzling, perhaps, but it is hardly inconceivable. All one needs to assume is that desired savings rise even faster than does the propensity to invest. Given the huge worldwide shift to profits (including in China), plus the oil exporters’ surpluses, I find this combination quite plausible. Although I would not push this parallel too far, even in the 1930s there were good investment opportunities (many of them were exploited in the 1950s). But there was still a downward spiral in demand during that decade.
So my view is that the low interest rates are largely a consequence of real factors, not a bubble, and that these have had an effect on where some of the incremental demand has emerged. But I agree with Willem that adjustment to a (desirable) change in these conditions could occur without catastrophe, provided the underlying structural factors – globalisation and so forth – remain in place.
So I disagree on this point with Robert, even though I share the view that there are risks associated with the global imbalances. I also disagree with him on what is going on in “globalisation”. I agree that this portmanteau word is more than a bit misleading. But I don’t think we need to ask why there has been rapid growth of global trade and investment flows while there has also been little further liberalisation in the last five years.
We are still exploiting the opportunities created by the massive liberalisations of the previous two decades. The Uruguay Round was fully implemented in this decade (the Multi-Fibre arrangement disappeared, for example, only in 2005), while China only joined the WTO in 2001. So there was a vast amount of liberalisation in the pipeline at the millennium. Even a successful Doha round would only have an impact well in the future.
I have read Richard Duncan’s interesting (albeit often wrong-headed) book, but I think he has the causality the wrong way round: Asian mercantilism (or, more neutrally, its “excess savings”) causes US monetary expansion and their reserve expansion rather than the other way round. I also don’t believe the balance of payments adjustment that lies ahead need prove a big disaster, provided the underlying growth potential of the world economy is unimpaired. The current account surplus of the rest of the world is about 2.5 per cent of its aggregate GDP. Why should it be impossible, in principle, for highly solvent countries to expand demand to the extent needed to offset a sharp reduction in such a surplus? Meanwhile, the US will be more or less unconstrained, since it has borrowed in its own currency.
I agree with Richard Duncan that the massive reserve accumulations in Asia are unwise. But they are the price of these countries’ failure to have better balanced growth in demand. Nevertheless, I do not agree with Robert that these accumulations will lead to very high inflation, provided countries are prepared to accept nominal exchange-rate appreciations instead.
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. It is a way of avoiding the currency mismatches that did so much to make the Asian financial crisis so severe. It is also a great pity – but that’s another subject
So I stick with my view: provided the engine of the world economy continues to run, we can manage any likely financial instability. There may well be some years of painful adjustment ahead. But they should not lead to the kind of destructive reversal we saw between 1914 and 1945.
Posted by: FT Forum - Martin Wolf | January 15th, 2007 at 3:13 pm | Report this commentWilliam Dahmer: I liked the ideas from Robert Wade and Willem Buiter better than Martin Wolf’s, and now 9-months later than these original comments were made I think that Wade’s and Buiter’s have stood the test of time and are more inline with the credit crunch that we have seen in the intervening time.
Far from robust and stabilizing, high levels of US dollar denominated debt from ultra-low interest rates kept alive by excessive money supply creation, Wade’s so-called, ‘money as debt, where money supply creation mainly limited by demand for credit,’ can be seen as causing two problems - albeit related. One is that asset prices are over-valued by cheap credit. And secondly, by removing cheap credit - either by central bank rate increases to counter inflationary pressures, or by banks and investors re-pricing credit risks - causes a funding problem for those borrowers who bought those over-priced assets.
If we saw the same high growth world market in real products and services without global imbalances then I would agree that it is sustainable from an economic, but not a natural resource depletion perspective. However, as we have seen high headline world growth only in conjunction with an excess of savings from exporters to consuming nations that are also importing capital it is clearly a case of paying consumers to keep consuming through the use of cheap credit.
The so-called ‘Japan moment’ comes as tapped out consumers can no longer afford to keep buying even if interest rates are next to zero and/or as exporters get tired of low or negative real returns on their capital and US dollar devaluation. However, this is not only a US problem as high debts and deficits in such countries as Spain, Italy and France may be masked by high German growth and a currency union, but are none the less just as real. They just have different time horizons. In the name of stability, other eurozone members may be prepared to ignore imbalances, but as they accumulate sooner or later they can no longer be ignored if they threaten that very stability.
No matter how wealthy a country is it can still accumulate unsustainable deficits if it consumes more goods, services and credit than it can produce or service. It is not a production problem, but a consumption one.
Willem Buiter’s comment about ‘a pefect lull’ of low long-term interest rates, low credit spreads and high real growth was spot on. In January, 2007, but in the intervening months we have seen at least one of those threads become unwound. That of low credit spreads. And in the absence of almost immediate central bank easing and injections of liquidity to rescue borrowers, lenders and markets in general, the re-pricing of credit risk would have been more brutal. Again if high real growth was sustainable on its own such interventions would have not been necessary or even desirable.
The weakest argument of Martin Wolf’s is that such imbalances do not have to result in higher inflation ‘provided countries are prepared to accept nominal exchange rate appreciations instead.’ This is exactly what Asian exporters and many OPEC and non-OPEC oil producers are not apparently willing to accept. So the bulk of the re-balancing has been from the US dollar to the euro zone not from those exporters of both goods AND capital.
That exports have shifted from US shores to European ones is hardly re-assuring in the long-run if cheaper imitations undermine Italian and French production of textiles, fashion and luxury goods threatening jobs, exacerbating budget deficits and reducing those affected states’ ability to service those debts within in the context of their Maastricht Treaty obligations. While instead of addressing reform of their own capital markets and domestic economies to stimulate home grown demand those exporters with their sovereign investment funds are instead looking for higher value assets abroad rather than low yielding government debt. That can only trigger the protectionist policies that Mr. Wolf and other contributors fear the most.
William Dahmer is managing director of Reserve Invest Cyprus Limited
Posted by: William Dahmer | October 1st, 2007 at 10:16 am | Report this comment