Leadership and luck
Sep 18th 2003
From The Economist print edition
The world economy needs both
TO GET a sense of the challenges facing the global economy,fast-forward four years to
September 2007 and consider the following three scenarios,
The world's top finance ministers arrive in Washington for an emergency summit after the
dollar has crashed and financial markets have seized up,Foreigners are deserting American
assets following the announcement of a $50 billion derivatives loss at Fannie Mae,America's
mortgage giant,Bond yields have soared three percentage points in two weeks; the dollar is
down 40% over the same period,Several large banks are rumoured to be on the brink of
collapse,
With America's trade deficit topping $800 billion and the budget deficit close to 7% of GDP,
Congress is in a protectionist frenzy,A bill sponsored by Hillary Clinton,the leading Democrat
contender for the presidency in 2008,to impose a 25% surcharge on imports from all countries
with large trade surpluses looks set to pass,More radical legislation calling for America to leave
the WTO is gaining support,
After six years of poor growth,America's economy has been widely written off,The dollar is
weak,and the administration is preoccupied with painful budget cuts,Top of the business
bestseller list is a new book by Lester Thurow called,A Haemorrhaging Hegemon,How
America's Economy Owned the '90s and Flunked the Millennium”,Attention has shifted to
Europe,where productivity and investment are soaring,China remains the world's most
buoyant economy,but Japan,too,is growing at a fair clip,catching up after a decade of
stagnation,
Of course these scenarios are flights of economic fancy,but they make two serious points,
First,the world's reliance on America as its only engine is increasingly risky,Second,moving
away from a one-engined world will not be painless,In America,in particular,the economy is
likely to remain weak for the next few years,That may sound depressing,but sluggish growth
for another half-decade is much better than a dollar crash,a deep recession or a stampede into
protectionism,
A sudden dollar crash precipitated by a big shock in America's financial markets may not be
likely,but it is certainly possible,The longer that America's current-account deficit—and hence
its reliance on foreign capital—continues to grow,the greater the risk that a shock to America's
financial markets will send the dollar crashing,This would probably push the world economy
into recession,Spiking interest rates would deflate American consumer spending,A soaring
euro would darken Europe's economic outlook,If the euro rose far and fast enough,it might
even put European monetary union at risk,And poor countries would be hit by a double
whammy,a sharp drop in export earnings as the rich world plunged into recession,and a sharp
rise in interest rates as investors abandoned risky assets,
Protect us from protectionism
But a dollar crash and global recession are not the only gloomy possibilities,Equally worrying,
and much more likely,is a surge in protectionism,especially if America's current-account deficit
continues to rise rapidly,In 1985,Congress seriously considered an import surcharge of the
sort described in the imaginary scenario above,Many American politicians are already
ambivalent towards the WTO,If the government loses a few more big trade cases,that
ambivalence could turn to antipathy,
A slide into protectionism would have grave consequences,Since the end of the second world
war,America has championed the multilateral approach to freeing global trade,though with
varying enthusiasm,If it were to give up this leadership role,even temporarily,the global
trading system would be in deep trouble,The WTO is a fragile organisation,less than ten years
old,It would not survive a lengthy period of American disengagement,
The intellectual consensus in favour of free trade,particularly in poor countries,could also
wither in the face of American protectionism,Poor countries would ask why,if it was fine for
America to raise barriers against the Chinese threat,they should hold back from doing the
same,Given that trade integration plays a crucial role in economic development,the world's
poorest would find it that much harder to escape from poverty,
The most important message,however,comes from the third and most optimistic scenario,It is
that the best outcome the world economy can hope for in the next few years is a fairly sluggish
performance by America's economy,combined with faster growth elsewhere,A few more years
of below-average growth but no serious recession would help America to work off its excessive
debt and increase its savings rate,The best-case scenario would be for both Europe and East
Asia simultaneously to pick up the slack,That would allow the dollar to decline gradually rather
than crash; but with relatively slower growth at home and faster growth abroad,America's
current-account deficit could be trimmed sharply,Just when Mr Thurow published his book on
hegemonic decline,America would be set to prove him wrong (once again),With the
imbalances worked off,its highly productive and flexible economy would be ready to roar,
Sadly,the chances of such a gradual adjustment are not good,The trend remains towards ever
bigger American imbalances and continued reliance abroad on American economic growth,
European and Japanese leaders seem to take this for granted,much as they rely on America's
security umbrella,Reversing that attitude,and with it the trend towards ever bigger American
indebtedness,will take political leadership as well as a large dollop of luck,
Yet to judge by their rhetoric,today's politicians have little sense of the mess that the world
economy is in,The Bush administration does not even acknowledge that there is a problem,
Europe's leaders are too busy squabbling over who has broken the Stability and Growth Pact's
3% deficit target to see the global economic picture,And Japan's politicians spend too much
time bad-mouthing China and too little offering solutions to their own economic troubles,
This must change,The Europeans and Japanese need to understand that they are not only
facing a demographic hiatus of their own,they are also operating in a global economy that
could come seriously unstuck unless they act soon,China's leaders,too,need to make the
connection between their own economic policy and the global picture,Unless they loosen their
dollar peg soon,they will find the protectionist backlash against them will get a great deal
worse,
The heaviest responsibility to act differently,however,falls on America itself,which is as guilty
as anybody else of causing the world's current lopsidedness,And until Mr Bush's economic
team acknowledges the size of the problem,others will hide behind American nonchalance,
In the 1980s,the turning point came when James Baker,Mr Reagan's Treasury secretary,
acknowledged the global imbalances and recognised the risks involved,He instigated the Plaza
Accord not out of an idealistic commitment to the global good,but because the global
imbalances imperilled America's own prospects,
Mr Bush's current team need not—and,as this survey has argued,probably could not—replay
the 1980s,But as in the Reagan days,it must force the world to recognise the need to adjust,
If America does not lead in global economic policy,no one else will,And if nothing is done,the
imbalances will worsen and the dark scenarios of financial crashes or protectionism become
ever more likely,
America's biggest contribution to shifting the world away from one-engined growth—and
towards improving its own economic prospects—would be some serious medium-term fiscal
belt-tightening,The country's dramatic shift into budget deficits may have underwritten the
American,and thus the global,economy in the short term,but it risks making the medium-
term problem much worse,Bigger American budget deficits mean bigger current-account
deficits and an ever greater American reliance on foreign funding,
Worryingly,Mr Bush's deficits show no sign of being temporary,The president's tax cuts have
not yet been fully phased in,and numerous accounting gimmicks have been used to massage
down their apparent cost,The official estimate of the cost of the latest tax cut is $350 billion
over ten years,but most budget-watchers put the real figure at twice that level,Nor is the
government merely aiming to give the economy a temporary fillip; its declared intention is to
reform America's tax code and entirely eliminate the taxation of investment income,That
suggests there are more tax cuts to come,
Spend,spend,spend
Yet there is scant sign of any spending discipline to match the lower tax revenue,Despite his
rhetoric to the contrary,Mr Bush has proved himself to be no Scrooge with federal dollars,On
his watch,federal spending has soared by more than 20%,Only part of that rise can be
explained by higher spending on defence or homeland security,
Defence spending,though,is heading ever higher,according to estimates by Steven Kosiak at
the Centre for Strategic and Budgetary Assessments,He reckons that adding together Mr
Bush's grand plans for military modernisation and existing commitments in Iraq and
Afghanistan,the defence budget over the next decade will increase by nearly $700 billion more
than assumed in Mr Bush's budget projections,
And there is more,Mr Bush's planned expansion of Medicare,America's health-care programme
for the elderly,to include prescription drugs,will supposedly cost $400 billion over the next
decade,But most health-care experts—and privately some economists within the Bush
administration too—expect the real bill to be much higher,Far from reforming America's
entitlement programmes as baby-boomers head for retirement,Mr Bush is expanding them,
The risks of these policies have not gone unnoticed in Washington,Democrats have been
bemoaning the rise in deficits a decade before the ranks of pensioners are due to swell,Still,it
has all seemed a long way off,And yet if this survey proves right,America's budget deficit
could cause big problems long before the baby-boomers start retiring,
American policymakers' main responsibility,therefore,is to improve the medium-term fiscal
outlook,The budget rules that forced discipline on spending and tax-cutting plans during the
1990s must be revived,The Bush team must put forward detailed proposals for controlling
Medicare costs,The spending frenzy must be controlled and the tax-cutting momentum slowed,
perhaps even reversed,
If America acknowledged both the danger posed by global imbalances and its own responsibility
for reducing them,putting political pressure on others to play their part would become much
easier,In continental Europe,the pressure should be least necessary,For the policy recipe that
is best for Europe is also best for the world economy,determined structural reforms coupled
with a sensible (read looser) macroeconomic policy,
In Asia there is a greater tension between the short-term domestic agenda and what the world
economy needs,China,as this survey has argued,must break the paralysis on its exchange
rate and gradually move towards greater flexibility,To support that shift,the Bush team must
beat back domestic China-bashers but keep up the pressure on the Chinese government for
gradual change,At the same time China and America together must push other emerging Asian
economies to follow suit,
In Japan,in the short term,the trade-off between domestic requirements and global
responsibilities is even more difficult to judge,The global economy needs a stronger yen; the
Japanese economy does not,But if the government were to begin serious financial-sector
reform and simultaneously to reflate the economy,the contradiction would soon disappear,and
the yen would strengthen without undue risk to the domestic economy,
If America shows the necessary leadership,and others live up to their responsibilities,there is
still time to replace the one-engined global economy with a safer model,But if nothing changes,
get ready for a crash landing,
Copyright? 2004 The Economist Newspaper and The Economist Group,All rights reserved,
