Readers may know I am not much of a fan of Larry Summers’ occasional comments in the Financial Times. He has a tendency to come forth with views of how things work that sound nice but too often are at odds with facts on the ground.
His latest offering scores better than previous offerings as far as engagement with reality is concerned, although it has a few attention-grabbing departures.
Summers starts by lamenting that international economic polities are getting short shrift in pre-election debate (ahem, have they ever been front burner?) and warns:
The next administration faces the prospect of having to make the most consequential international economic policy choices in a generation at a time when the confidence of governments in free markets is being increasingly questioned.
This statement sound reasonable until you think about it. It presupposes that the next administration is an actor capable of making unilateral decisions that will affect the international game board. A growing theme on the FT’s comment pages is that we are in a multilateral world, and key international bodies such as the IMF and World Bank need new governance arrangements that reflect the important role and economic weight of developing economies (even that sobriquet is looking dated).
Brad Setser keyed in on the likelihood of the US facing circumscribed policy choices:
I don’t think it is realistic for the US to expect to be able to rely as heavily as it currently does on other governments for financing without giving up at least a bit of policy autonomy. The enormous holdings of Agencies by the world’s central banks (along with the Agencies held by US domestic banks) are — in my view — a constraint on the options available to US policy makers struggling to get ahead of a seemingly still deepening credit crisis.
Oddly, Summers in the very next paragraph notes how the fast the emerging world has risen and again draws some debatable inferences:
The current distribution of regional economic power is unlike anything that was predicted even a decade ago. The rise of the developing world, its growing share in global output and far greater share of global growth, is perhaps a quantitative but not a qualitative surprise. The qualitative surprise is this: with almost all the industrial world in or near recession, much of the momentum in the global economy is coming from countries with authoritarian governments that are pursuing economic strategies directed towards wealth accumulation and building up geopolitical strength rather than improving living standards for their populations. China, where household consumption has now fallen below 40 per cent of its gross domestic product – which must be some kind of peacetime record – is the most extreme example. Similar tendencies, however, can be seen in other parts of Asia, Russia and other oil exporting countries.
Um, it’s taken Summers this long to realize China, and before it, Japan, took a mercantilist stance towards the US? We noted in an earlier post:
While Summers admittedly undercuts that argument later by discussing how a more open economy can come out a net loser if its trade partners are better competitors, there is a more basic reason to take this idea with a grain of salt: we have lower trade barriers because some of our biggest partners (read Japan and China) are mercantilist and fundamentally have no intention of opening their markets very much; the advanced European economies regard maintaining surpluses and protecting labor as priorities, which again limits how much they will concede. We have lower trade barriers because we enter into negotiations with different premises and aims (at least historically) than our counterparts. (Some would also argue that our trade policy is designed more to benefit major US multinationals than the broader populace; that is harder to prove but may not be inaccurate.)
This is far from a new line of thinking. William Greider, for instance, made similar observations in 2005. At a minimum, trade negotiators with China and Japan have confronted this syndrome for years; many of our other trading partners play the game with more finesse.
Summers then has three rambling paragraphs which discuss, quelle horreur, how these developing countries, via their success in trade or by sitting on lots of oil, caused trouble:
The pressure created by the investment of these surpluses was one of the big factors driving the excesses that preceded our financial problems.
Note this comes perilously close to suggesting a causal relationship between high trade surpluses abroad and our financial meltdown. Back to Summers:
But the problems are much deeper than the question of who sits around the negotiating tables. For all the disagreements over the past decades, there has been a shared premise behind international economic policy discussions – the goal of increased economic integration, the spread of market institutions and more rapid growth for all nations. While companies may compete, the premise has been that nations co-operate to build a stronger economy in the interests of all.
Readers are welcome to correct me on this one, but whose consensus are we discussing, exactly? Again, China and Japan might give lip service to grand pronouncements while keeping their eye on the ball of what the gives and the gets were at the negotiating table. China, for instance, rebuffed Paulson in his recent entreaties to open its financial markets to foreign players. In fact, one could make a case that any country with a pegged currency (or as with China, a dirty float) is committed to maintaining a trade surplus, which means their commitment to achieving specific national outcomes ranks above any vision of international cooperation. And frankly, that’s a rational stance.
Note that despite Summers’ rhetoric, the US has not adhered strictly to this vision either. We’ve entering into bi-lateral and regional trade agreements, something the internationalists have decried.
Development economist and Harvard professor Dani Rodrik pointed out that deep economic integration, democracy, and national sovereignty cannot be pursued at the same time:
Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full….
To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs…..
So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man’s land.
I’ve omitted Rodrik’s discussion of choices, which might interest some readers. Again, to Summers:
It is no longer clear that this premise remains valid. Nations are increasingly preoccupied with their relative economic standing, not the living standards of citizens. Issues of strategic leverage and vulnerability now play a bigger role in economic policy discussions.
Hhhm. One might argue, as Thomas Palley has, that the US has pursued economic policies without regard to the standard of living of our citizens. Again, who are these unnamed countries preoccupied with their relative standing? That charge does not ring true for the UK or EU. One assumes Summers at a minimum means China, and he’s way off base. Joseph Stiglitz has determined that if you take China out of the equation, there has in fact been no reduction in global poverty (note that the improvements in conditions among the world’s poor has been one of the strong arguments for more liberalized trade). And China remains committed to rapid growth, which will again benefit its citizens. What Summers means is that China needs to switch from export driven growth to a more balanced economy with a more robust consumer sector. It would be more useful if he would say so directly.
Instead, he again comes at his argument in a round-about way:
At the same time, it is unclear which underlying driver of global growth will replace the one in place for the past decade – the US as importer of last resort. Global growth has depended on US growth, which has depended on the US consumer; and the US consumer has depended on rising asset values first of stocks and more recently of real estate. With falling house prices and a challenged financial system, US consumer spending is falling. The US is no longer in a position to be a net source of demand for the rest of the world. Indeed, with the drop in value of the dollar, US growth – which had been focused on imports and which had enabled the export-led growth of other countries – is a thing of the past. Already, Europe and Japan are in or are very close to being in recession.
The current global policy debate is a cacophony. It is all very well to advocate increased US saving and a cut in the US current account deficit but the process for bringing it about will mean less US demand for foreign products. That will put pressure on jobs and output growth in other countries if no countervailing measures are put in place. Conversely, the return of a stronger dollar without other policy changes will raise US demand for exports but at the price of cutting demand for domestically produced goods and compounding the recession.
These problems will be with us for some time. They may not be at the top of anyone’s agenda right now. But the success of the next administration could depend on its ability to engage with a wider range of global economic stakeholders, on a broader agenda, at a time when disagreements are increasing not just about means but also about ultimate ends.
I suspect there was never as much agreement about “ultimate ends” as Summers suggests. Other countries fell to the US lead when the US was more powerful economically. Long-standing differences of perspective that were suppressed are now being exposed.
Summers is vague about what needs to happen if there is to be anything resembling an orderly transition. Mohamed El-Erain, former head of Harvard Management and co-CEO of Pimco, has been far more specific, and also intimated that the sort of discussions that Summers recommends have been held and failed. From an FT comment by El-Erian:
Whatever happened to the debate on global payments imbalances?…At its roots, the policy solution called for simultaneous implementation of three sets of measures. First, a reduction in US domestic aggregate demand to contain imports and encourage a shift to exports. Second, an increase in consumption in Asia and the Middle East, including having China adopt a higher and flexible exchange rate. Third, structural reforms in western Europe to enhance the growth potential of the global economy….
The policy solution stalled because of a basic co-ordination problem, or what is known in game theory as the “prisoners’ dilemma”. While all parties had an interest in the outcome, any individual party that moved first risked being worse off if others did not follow. With multilateral co-ordination mechanisms such as the Group of Seven industrial countries and the International Monetary Fund lacking representation and legitimacy, there was no way to provide parties with sufficient assurances that their actions would be accompanied by others. As a result, no one took sufficiently meaningful action.
Now I am most certainly not privy to high-level policy discussions, and when this piece ran, expressed some doubts as to how far these discussions went. However, El-Erian said with some certainty that the idea of a coordinated approach was dead on arrival. He viewed the outcome as not pretty:
Under this scenario, the question for markets is no longer whether the global imbalances adjust. They will. Instead, the focus should be on the collateral damage of the adjustment process – damage that is region-specific given differences in policy flexibility and initial economic and financial conditions. In the US, look for renewed pressure for further fiscal stimulus and a monetary policy that, while appropriate for the US, is too inflationary for the rest of the world. In Asia and the Middle East, the spike in inflationary pressures may inadvertently slow the move towards more efficient tools of indirect economic management. In Europe, expect attempts to bypass fiscal responsibility guidelines in order to mute political protest.
Those who would like to read El-Erian’s article and our commentary can find them here.