Thursday, January 22, 2015

Chronic economic and political ills defy easy cure


JANUARY 22, 2015

What sort of world are we now living in? The right answer is one characterised by chronic economic and political ailments. Here then are six enduring conditions of the “new normal”.

First, deficient demand. The idea behind “secular stagnation” is that, without rapid asset-price inflation or exceptionally aggressive monetary policy, it has proved impossible to generate enough demand to absorb potential global supply.

[Perhaps this is where over-consumption is killing the planet?]

Chronic demand deficiency is a global condition. It was in operation well before the 2007-2009 global financial crisis. It is in operation today. If anything, it is even getting worse. Overall, debt overhangs in crisis-hit economies remain very high. Meanwhile, the emerging economies, including notably China, have seen their own freedom of policy manoeuvre diminish as public or private debts (or often both) have soared. The only plausible offset is the fall in oil prices, which shifts income from savers to spenders. It should give relief, but only temporarily.

While demand is strengthening in the United States and United Kingdom, as one might hope after years of aggressive monetary policies, the eurozone remains in a dangerously depressed condition. Meanwhile, Japan has still to escape its deflation trap.

[Perhaps many sales or consumption were "borrowed" from the "future" in the past, so now there is little demand left.]

Second, stagnant productivity. Since the latter part of the last century, underlying growth of labour productivity in the high-income economies has fallen from close to two per cent a year to well below one per cent. Low growth of productivity tends to inhibit both investment and consumption, as expected future incomes are depressed, so exacerbating the deficient demand. It also makes the bite of rising inequality more severe. Happily, however, emerging economies can still catch up on the productivity levels of the rich.

Stagnant productivity makes the bite of rising inequality more severe.

[Is there some natural limit to productivity? When one person is doing the job of 1000 persons, is that the max of human productivity?]

Third, fragile finance. The global financial system is in some respects even more fragile than it was before the crisis. The Western world’s banking system is even more concentrated than before. The leverage — ratio of assets to equity — of many large global banks is about 25 to 1, which is bound to make them vulnerable. Incentives to move financial activity outside the highly regulated core of the global financial system are, nonetheless, strong. One source of worry has been the financing of emerging market corporations via dollar-denominated bonds.

Moreover, the lack of transparency of balance sheets remains daunting. In a complex global financial system, the ability of participants to understand balance sheets is limited. This tends to generate cycles of overwhelming risk-affection followed by panic-induced aversion.The low real returns on safe assets tend to exacerbate the intensity of the affection and so the extent of the aversion.


Fourth, unstable politics. Deteriorating economic performance and rising inequality are generating substantial political stresses. Hitherto stable Western democracies are displaying both sharp divergences of domestic opinion and hostility towards domestic political and business elites.

A common element is hostility to both foreigners and supranational political projects. The UK, for example, once an exceptionally stable democratic polity, is one no longer. Such tensions are particularly threatening to the eurozone.

The current turn of the economic wheel will also stress politically fragile emerging countries, as commodity prices decline, bad debts emerge and the days of cheap capital inflows end. Some areas of the world are characterised by weak or non-existent states. Sometimes, states have never really functioned. Sometimes, brittle despotisms have collapsed, as in Syria. Either way, the absence of order invites interventions and spreads chaos.

Fifth, tense geopolitics. Ours is an era of rapid changes in relative economic power, with the rise of China, above all, and the relative decline of Europe and the US. China is assertive; Russia is irredentist; the West is cautious. In this world, the possibility of serious miscalculation is a permanent reality. A year ago, the talk was of friction between China and Japan. Now it is of Russia and the West. Nobody can be sure what will come next

Sixth, challenge overload. These stressed political systems confront large domestic and international challenges. Among those challenges are the supply of global public goods, which includes preserving the open world economy, peace and the global commons. It is always hard for a large number of states to cooperate closely. But some of these challenges are particularly tough. Managing climate change is the hardest. Yet 2014 was the hottest year on record.

These conditions are chronic, not critical. They cannot be cured quickly or easily. They can, however, be managed. They should not prevent continued economic growth, particularly in emerging economies. But this process of convergence is operating in the context of stressed economies and fragile politics. Indeed, convergence is, in important respects, exacerbating stress. We cannot afford to ignore all these difficulties. On the contrary, we must work much harder to reduce them.


Martin Wolf is chief economics commentator at The Financial Times.

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