August 6, 2008
Welcome to a world of diminished expectations
by Willem Buiter
From a cyclical perspective, things look bad for Europe, the US and most of the global economy. My contribution to summer cheer is to note that longer-term local and global economic prospects are likely to be worse than expected. So welcome to boom and bust. Welcome to subdued long-term growth prospects.
The ancient Greeks knew hubris to be one sin the gods will punish. When Gordon Brown, the British prime minister, announced “the end of boom and bust”, Jove must have checked his thunderbolts. Capitalist market economies are inherently cyclical. The private credit system is intrinsically prone to alternating bouts of irrational euphoria and unwarranted depression. Busts play an essential role. They clean up the mess created during the boom by inflated expectations, overoptimistic plans and unrealistic ventures. These become embodied in unsustainable household debt, productive capacity with no foreseeable use, excessive corporate and financial sector leverage and enterprises whose only asset is hope. The correction is painful, even brutal: unemployment rises, as do defaults, repossessions and bankruptcies. We entered such a cathartic phase around the turn of the year in both the US and the UK. Continental Europe is not far behind.
The remainder of this column can be read here . Debate from our panel of economists appears below.
William Easterly: Willem Buiter is as qualified as any economist in the world to forecast growth in the world and in emerging markets. Unfortunately, such qualifications are still barely above zero. We economists have done VERY badly on forecasting individual countries, for decades. (Example: South Korea and Singapore were deemed unlikely to succeed in the early 1960s by development economists, who predicted that Burma would be the star of Asia). One reason we are so bad at this is that the predictive value of high growth in one period for high growth in the next period in the same country is almost zero. A symptom of this weak cross-period persistence is that there IS strong reversion to the mean. This means that one of Buiter’s predictions - that China will slow down - is probably correct, but for reasons that have nothing to do with “totalitarians” (a rather careless word for unlovely leaders who are a lot better than that genuine totalitarian Mao) responding to athletes’ gasping dirty air. It’s a pretty safe (mean-reversion) prediction that growth will slow down in the world’s fastest growing economy.
As far as world or regional growth, our forecasting record is almost as bad. Both the world boom from 1950 to mid-70s, the slowdown from mid-1970s to mid 1990s, and the re-acceleration in the new millennium since the mid-1990s were all surprises (even more so when we tried to guess what would happen in each region). There’s no particular reason to expect a long-run global down-shift now, since there are many positive technological and institutional trends offsetting the currently negative obvious factors (even if the current panic makes the latter seem more weighty). The only likely thing is that we will be surprised again, positively or negatively.
I think the best we can do is to observe that world growth (since about 1950) seems to fluctuate around a long run trend of about 2 per cent per capita per annum, which is probably the safest prediction for most individual regions and countries as well. Of course, there will be huge (but mostly temporary) divergences in particular regions and countries both above and below average. High growth is surprisingly common at the country level (no way that it a “thing of the past”)but it is almost always a temporary phenomenon. Sounds awfully boring, but that’s about all the evidence tells us for looking forward.
Which is not so bad when we figure that this global long run growth trend of 2 percent per capita since 1950 just happens to be the highest growth in human history and has lifted myriads and myriads out of poverty. What’s so gloomy about that?
Posted by: William Easterly | August 6th, 2008 at 7:18 pm | Report this commentMartin Wolf: Not for nothing is economics known as the dismal science. Willem, at least, is in a dismal mood at the moment. I largely agree with what he says, but would add two qualifications.
First, on the upside, as Bill Easterly remarks, our ability to forecast is remarkably small. So now that things look so gloomy, maybe the outcome will surprise us on the upside. I am not quite as gloomy as Bill on our ability to forecast. But it is true that things are rarely as good or as bad as we think.
Second, the incorporation of environmental and resource factors into growth is not, in truth, a slowing of growth, but rather a recognition of the truth that growth rested on inadequately priced resource depletion and environmental degradation. In short, growth was not as fast as we thought it was. If we were to price environmental services properly, measured growth might fall, but true growth would not.
Furthermore, the success of Japan in dealing with local pollution in the 1970s and 1980, while continuing to grow rapidly, suggests that China might be able to cope even with a substantial shift in the allocation of its investment resources. After all, this is a country that is investing more than 10 per cent of gross domestic product in the low-yielding liabilities of foreign governments, particularly the US. Shifting that into environmental investments would surely not lower growth. It would certainly raise welfare.
Posted by: Martin Wolf | August 7th, 2008 at 8:06 am | Report this commentMr Buiter goes a long way to destroying his credibility when he makes blatantly false statements. His claim that real interest rates in Brazil are negative is a humdinger: the official SELIC rate is over 13 per cent while year-on-year consumer inflation is less than 7 per cent. Thus, while there is some justification for his argument that further tightening is called for, real rates are anything but negative.
Peter Jarrett is head of country studies, division one, at the OECD and oversees the economics department’s work on seven or eight countries, including Brazil
Posted by: Peter Jarrett | August 18th, 2008 at 8:33 am | Report this comment