Martin Wolf on Risks to This Golden Era

Posted on by

Martin Wolf, the Financial Times’ lead economics commentator, in today’s piece, “Risks and rewards of the world economy’s golden era,” ponders our current prosperity and what might upset it. He highlights the risks of unforeseen shocks and backlash against globalization. The comments about shocks are somewhat novel; the ones on political backlash are more familiar.

Yet what I find striking about Wolf’s article is the unspoken assumption that what will follow these halcyon days will be a period of lower growth, perhaps a recession in some major economies, possibly a market break. In other words, a continuation, perhaps with some new wrinkles, of the familiar boom-bust pattern. And that is certainly the reasonable thing to anticipate.

Yet reading his article, I find myself thinking not of the 1890s or the 1920s or the Sixties or the Nineties, but of 1914. If you are familiar with the history of that period (if not, read Barbara Tuchman’s The Guns of August), it was a perternaturally quiescent period before a forty year storm. Europe, like the world economy now, was enjoying a sustained period of stability and economic growth. There has been no major war on its soil since 1870, so conflict seemed a distant memory; open markets and rising trade (this era featured the greatest economic integration until this last decade) led to improved living standards; and innovation and new technologies (electricity, automobiles, telegraph, the airplane) all held great promise. Even the weather that summer was glorious.

World War I and the upheavals that followed didn’t simply put an end to prosperity. It dismantled an entire world order. In retrospect, it ended rule by aristocrats and ushered in an unstable new system of both more self determination and more totalitarianism (the early 20th century elite, for the most part, governed with restraint and had a sense of noblesse oblige).

I can point to the things that have the concerned sorts worried, like global warming, unsustainable leverage, and regulators lacking the right playbook, but they don’t quite add up to my sense that we are on the brink of a much sharper historical transition than most envision. And I have long thought that what most people call intuition is in fact pattern recognition, but the dots are being connected in ways that aren’t readily accessible to our left brain.

From Wolf:

Posterity will regard the economic performance we are now witnessing as a golden age….

Even the International Monetary Fund was remarkably optimistic about the robustness of underlying growth in its latest World Economic Outlook…Indeed, measured at purchasing power, the world is in a period of economic expansion unmatched since the early 1970s (see chart). Most important of all, every region of the world economy is now doing well.

In 2006, for example, the world economy expanded by 5.4 per cent. The advanced economies grew by 3.1 per cent, while emerging and developing economies grew by an astonishing 7.9 per cent. Developing Asia led the way, with 9.4 per cent growth (with China on 10.7 per cent and India on 9.2 per cent). But other regions did well, too: 7.7 per cent growth in the Commonwealth of Independent States (with Russia on 6.7 per cent); 6.0 per cent in central and eastern Europe, 5.7 per cent in sub-Saharan Africa and 5.5 per cent in Africa as a whole; 5.7 per cent in the Middle East; and 5.5 per cent in the western hemisphere (even though Brazil managed only 3.7 per cent).

Behind this widely shared expansion lies the rapid growth in the volume of world trade (up 9.2 per cent in 2006), soaring capital flows (with net private flows to emerging markets at $256bn in 2006), robust external positions for the emerging market economies (with a further massive increase of $738bn in their foreign currency reserves in 2006), declining spreads on riskier liabilities, strong rises in commodity prices and, not least, a better distribution of growth among advanced economies. The eurozone at last managed a strong recovery, with growth of 2.6 per cent, up from 1.4 per cent in 2005.

Surveying the happy scene, the IMF argues that “the global economy remains on track for robust growth in 2007 and 2008…. It lists both short-term and long-term risks: a sharp slowdown in the US, a general flight from risk, resurgent inflation and disorderly unwinding of current account imbalances fall into the former category; the costs of population ageing, protectionism and environmental constraints fall into the latter. Yet the IMF’s heart does not seem to be in the gloom.

This is as close to euphoria as one is likely to get from economists. Should we believe, too? The big reason for doing so is that the underlying drivers of economic growth are indeed very strong: particularly, the integration of economies and the incorporation of Asia’s vast population into the world economy. A backlash against globalisation may well be occurring in politics. Yet it is not seen in policy, so far, except in countries too insignificant to matter. Also important have been two other features of the world economy: the unrestrained willingness to fund the vast excess of US spending over income; and the success in controlling inflation, notwithstanding the strength of commodity prices, particularly oil.

The most obvious reason for taking today’s euphoria with a barrel of salt is that nobody ever expects shocks. That is what makes them shocks. If I think back to the noteworthy events of my own adult lifetime, I observe that none of the big events was expected. The oil shocks of 1974 and 1979, the determination of Paul Volcker, then Federal Reserve chairman, to crush inflation in the early 1980s, the Mexican default of 1982, the stock market crash of 1987, Saddam Hussein’s invasion of Kuwait in 1990, the collapse of the Soviet empire between 1989 and 1991, the “tequila crisis” of 1994 and 1995, the Asian and Russian crises of 1997 and 1998 and, not least, September 11 2001 were, if not “unknown unknowns”, at least “ignored unknowns”. People who think they know what is going to happen next are fools. Surprises – or what the brilliant author Nassim Taleb calls “black swans” – are inevitable. Some are likely to be desperately unpleasant, too.

An entirely different reason for avoiding euphoria is that a dynamic world economy, even one that gives vast opportunities to billions of people, is not making everybody better off. The fact that the world economy is growing much faster at purchasing power parity than it is at market exchange rates (a forecast of 4.9 per cent, against 3.4 per cent, for this year) shows that developing countries with vast populations are growing much faster than the high-income countries. That, indeed, is true. But important regions of the world still contain vast numbers of desperately poor people. That, at current rates of progress, will remain true for a very long time indeed.

The right response to current balmy economic conditions is not complacency, but to treat them as an opportunity for action.

This is an ideal time to implement long-term reforms that will allow individual economies to grow faster and adapt better to change. This is, above all, the ideal opportunity to make the policy changes that will allow countries to exploit the opportunities provided by globalisation. US legislators are racing to “bash” China. They should provide a better safety net for displaced Americans, instead. China should expand domestic spending relative to output, thereby reducing its present massive rate of accumulation of foreign currency reserves. It is, more broadly, the ideal occasion for the world economy to wean itself off its dependence on US spending.

At the global level, a successful push to complete the Doha round is overdue. The Group of Eight leading countries is also failing to keep its own promise of increased aid for Africa. Aid is not going to rescue Africa, on its own. But it is part of what is needed. Rich countries should deliver on their promises. They should also accept a long-overdue diminution of their roles in the IMF and World Bank. Beyond this, there is now a need for an agreed policy on climate change that is both effective and economically efficient.

Golden periods such as these are rare and never last long. They must be exploited while they do. Posterity will condemn us if we let the chance of building a better world on today’s foundations pass by unheeded.

Print Friendly, PDF & Email