Martin Wolf is the Financial Times’ chief economic writer and is always thoughtful and balanced. This column in today’s paper presents a more jaundiced view than the sunny forecasts from most US economists. In particular, he focuses on the role of liquidity in the current expansion:
What is going to happen to the world economy this year?…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 implication of this perspective is that any slowdown – or “mid-cycle correction” – will be short-term and shallow. Not only would the underlying dynamic remain but such a slowdown would trigger offsetting forces, including more relaxed monetary policies and, in all probability, lower oil prices, as well.
Unfortunately, there is an alternative perspective. It is that much of the world suffers from a huge surplus of savings over investment. For this there are several explanations: the fact that the need for investment in Japan and Germany has fallen from their high-growth days; the high savings of China and a few other east Asian economies; and the greater caution of oil exporters towards spending their gains than in the 1970s and early 1980s.
The effort at absorbing this surplus has had two closely interconnected consequences: the first has been the emergence of the so-called “global imbalances” in which the US has absorbed about three-quarters of the excess savings of the rest of the world; the second has been a long period of relaxed monetary policy, particularly in Japan and the eurozone, but also for some time in the US as well. This, it is argued, has had powerful effects on asset prices, particularly house prices in a number of high-income countries. Strong house prices have, in turn, sustained demand at high levels, particularly in the US, the UK and Spain.
The more persuasive is this “liquidity” story, the more plausible it becomes that the correction is going to be more painful than conventional wisdom believes. HSBC has recently expressed this bearish point of view, forecasting economic growth in the US at just 1.9 per cent this year and in the high-income countries as a group at 1.8 per cent. Yet even with this somewhat more pessimistic slant, HSBC forecasts emerging market growth at 6.6 per cent this year. Even a relatively bearish forecast assumes that growth in the developing world is largely decoupled from that in the high-income countries.
How then does one assess prospects? Provided the broad story of economic dynamism remains credible, the world economy will probably overcome temporary difficulties, including any needed adjustment of external imbalances or volatility in oil prices. But if the credibility of that broad story came into question, then such optimism must vanish.
So how plausible is maintenance of the underlying dynamic? For economic policy, this raises two big questions: the first is whether inflation will be contained; the second is whether globalisation will be sustained. On the former, there is no reason to forget what we have so painfully learned. On the latter, however, there is greater uncertainty.
One reason for this is that even a relatively mild slowdown might shift policy in high-income countries, especially in the US, in a much more protectionist direction. The widespread perception that the majority of the population has not been gaining from recent growth makes that outcome more likely, because it erodes support for globalisation, however little the latter may have to do with this unhappy outcome. The economy may be global. But democratic politics are local. An open economy will become unsustainable if a majority concludes it is against its interests.
Even more important are the fragile political underpinnings of global economic integration: the US is on the verge of what may ultimately prove the most significant defeat in its history; an attack on Iran looks possible; and North Korea has become a nuclear power. Above all, we live in a world marked by shifting relative power and religious and political turmoil in much of the Islamic world.
The big question then is not whether there will be some correction – even, at worst, a US recession – this year. The world economy should be able to survive such a jolt, provided its underlying dynamism remains in place. What matters far more is the future of economic globalisation. On that we can hope, but cannot be confident. Its viability will depend on wise leadership – a commodity, as usual, in frighteningly small supply.