Keywords: Macroeconomics & Money;
September 2008 – or perhaps August 2007 – is likely to remembered in a manner similar to the Wall St crash of October 1929, or the terrorist attack of 9/11. It was the point at which it became clear to all but the most ideological that the world economy had been going up the wrong path, although it will be years before there is a consensus about the right path.
As with great political events there were many precursors to the collapse in the path we were on. You could even go back to Bretton Woods, with Keynes’ proposal that surplus countries as well as debtors should be penalised – a position at that time was unacceptable to the US which was the primary creditor country; today with the US as the primary debtor country many more can see Keynes’ logic. You might want to cite the Smithsonian Agreement, when the world left the gold standard, and took a discipline off the banker of the world – the US. Paul Volcker’s move to free up interest rates and Reagan’s huge fiscal deficits followed (note the ten year lag) but while Bush senior and Clinton reined in the fiscal deficit, they could not restrain the rampant ideology which said the private sector did not need regulation; pursing its own selfish ends everyone would benefit – and they did for a while. Nor should we forget that the logic of liberalisation and low regulation was pursued in the Clinton years, including by those who are now among Obama’s chief economic advisers. However we are unable to evaluate the success of the Clinton regulatory environment because of the extremely ineffective way the recent Bush regime administered it.
The Reagan deficit had its victims. Throughout the 1990s there was a series of financial crises off centre stage – the Mexican tequila crisis, Brazil, Argentina, Russia, the Asian Crisis, five other countries defaulted on their debts … The world monetary authorities scrambled together rescue packages, often penalising the innocent poor. Despite its reputation, the IMF was ineffective during a large crisis unless it was backed by the US Treasury, because unlike a conventional central banker, the Fund is unable to issue unlimited quantities of the international medium of exchange, the US dollar.
Then the US had troubles. There was the bailout of LTCM which seemed minor since the private sector picked up the tab. There was Enron (and some other corporations), which showed there were problems of valuing assets not easily tradeable in the market and that auditors could not be relied on. What were then seen to be fringe problems are now seen as precursors of the current crisis. There was the dot-com boom and bust, which seemed manageable, although one view is that Greenspan resolved it by engineering the housing boom which precipitated the current bust.
While today there are widespread doubts about Greenspan’s monetary management, even at the time some thought he was too permissive – both verbally and operationally – when Bush junior increased the US government deficit to Reaganite proportions. This time, there was the Euro, so the US dollar depreciated. What was not fully appreciated was that the US government and national deficit was being funded by surpluses generated by the East Asians and Middle East – a cruel summary is that China financed the Iraq war. Global imbalances will continue to preoccupy us for years to come, in monetary terms and, consequentially, in terms of raw economic power.
Then there was the rise of the highly geared hedge funds and the plethora of unregulated acronymic financial instruments, which nobody understood; certainly not the credit rating agencies which gave them – we know with hindsight – excessively high ratings. (As for auditors, credit rating agencies’ independence appears to have been compromised by being hired by the people whose assets they were judging.)
Time limitations mean I have gone through quickly – and simplified – this multitude of events and processes. In any case there is not consensus as to their relative importance. Where there is a broad consensus is that the path of the world economy over the last three decades has proved unsustainable. The technical issue is how to get onto a sustainable path, with the minimum of social distress; although whatever happens the distress is going to be very great for some.
It is big an issue – too big to discuss today. Instead I want to focus on four retrospective and prospective issues: international trade, international economic coordination, the balance of international economic power, and future economic ideology.
International Trading Relations
The Doha round has ground to a halt, and there is fear of rising protectionism. I dont want to understate its threat, but this time will be different from the Great Depression when the Smoot-Hawley tariff compounded the difficulties. This is not because we have learned from history – Hegel reminds us we do not. Rather globalisation has changed the political economy.
The critical transformation has been the rise of intra-industry trade, where economies exchange products from the same industry. About a quarter of the world’s trade is intra-industry. Its politics are quite different from inter-industry trade where the exchange is between different industries. So when the US Congress included pro-American sourcing for its programs’ steel outlays, the steel industry recognised that their exports would be compromised and so that there was not a pro-protectionist consensus within the industry, making it easier for the President to resist Congress.
New Zealand thinking tends to be trapped into inter-industry trade; we have one of the lowest intra-industry trade involvements in the OECD. Our exports often do not have strong producer lobbies in our destination markets. So I expect that our traditional difficulties, particularly with discrimination against our foodstuffs, to continue.
On the other hand world food prices may benefit if the Chinese have a consumption-led reflation, perhaps to moderate social unrest. While our export prices will not be as high as they were six months ago, our terms of trade may not plunge into the abyss as that they did during the Long Depression of the 1880s and the Great Depression of the 1930s. Perhaps I am too optimist.
International Economic Coordination
The alternative to international protectionism is international cooperation. The US Congress wanted to use US taxpayers’ money (or, to be more precise, their future liabilities) to benefit US taxpayers; they recognised that much spending would leak out into imports, benefiting other economies. However if every economy stimulates demand, each’s imports swings will be roughly offset by its export roundabouts.
That was the import of the December economic summit in Washington. There will soon be another, partly to deal with laggards but also to put President Obama’s mark on the world economic scene. Any summit will also have to pay attention to coordinating the individual monetary systems. Were the various government interventions to bail out their financial corporations applied to production industries there would be howls of outrage by anti-protectionists and foreign competitors. While there is too much fear among financiers to look further ahead than their next bonus, some will work out that with the ‘right’ government assistance they will have advantage over their competitors.
The Balance of World Power
The balance of world economic power is changing. The G8 is no longer relevant as it ignores China, now the world’s third economy behind the US and the EU, and the major source of the savings which financed the US deficit.
This is too big an issue to discuss here, but it needs to be recognised. The globalised world economy has been dominated by a hegemon – initially Britain, later the US. While the US will still be the largest economy in the world (or roughly equal to the whole of the EU) , it is unlikely to retain sufficient economic dominance to remain the hegemon. That does not mean there will be another hegemon; rather that there will be four or five economies (treating the EU as one) competing for world economic leadership, in which three of them, say, may overrule the other two even if the US is in a minority. For a longer period the US will be the military hegemon, but – as we saw for Britain – that military expenditure will drain the economy.
This forecast is not anti-American. I hope – and expect – that American energy, optimism creativity and innovation will continue to contribute to the world. The forecast is presented by one who watched the British adjust so painfully in the tail end of their loss of hegemony. America needs friends as it goes along the same path, but friends who are realists.
Economic Ideology
The enormous ramifications of the future multipolar world need consideration in another forum. It leads naturally to my final topic – the change in economic ideology.
For the last thirty years the world economic discourse has been dominated by an ideology which emphasised the merits of unrestricted private enterprise and the minor role of the state. It was never an intellectually robust ideology; its strength came from the apparent success of the world economy which it justified.
You will recall that a year ago, its ideologues were saying that the adjustment would be minor; after last September they have been silent and the ideology in retreat. That its companion neo-con political ideology has also failed reinforces the demise.
What will replace it is unclear. It will take time to evolve and dominate. It may be a synthesis of the liberalism of America, the social market approach of Europe and the paternalist government of East Asia; there may even be no future ideological hegemony.
However let me make a prediction about the future of the world economy – assuming political stability and military reticence. As long as there are falling costs of distance, intensification of economies of scale and continuing technological innovation, globalisation of product markets will continue. However, I shant be surprised if there are increasing restrictions on short term money flows, although foreign direct investment will be encouraged. How the national and international financial systems will be regulated is unclear. We may be sure, however, that the anything-goes regimes of recent years are likely to be rejected for a very long time.