Thursday, April 24, 2014
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Who Should Lead the Global Economy?

PRINCETON – In terms of global economic leadership, the twentieth century was American, just as the nineteenth century was British and the sixteenth century was Spanish. Some Chinese and Europeans think that they are next. Are they? And should they even want to be?

The most important prerequisite for global economic leadership is size. The bigger an economy, the greater its systemic importance, and the more leverage its political representatives have in international decision-making. The United States is the world’s largest economy, with a GDP of roughly $16.7 trillion. The eurozone’s $12.6 trillion output puts it in second place, and China, with a GDP of around $9 trillion, comes in third. In other words, all three economies are conceivably large enough to serve as global economic leaders.

But an economy’s future prospects are also crucial to its leadership prospects – and serious challenges lie ahead. No one thinks that the eurozone will grow more quickly than the US in the coming years or decades. While China is expected to overtake the US in terms of output by 2020, decades of rigid population-control measures will weaken growth in the longer run, leaving the US economy as the most dynamic of the three.

Another key requirement for global economic leadership is systemic importance in commercial, monetary, and financial terms. Unlike China, a large trade power with underdeveloped monetary and financial capabilities, the eurozone meets the requirement of systemic significance in all three areas.

There is also a less concrete aspect to leadership. Being a true global leader means shaping and connecting the global economic structures within which states and markets operate – something the US has been doing for almost 70 years.

At the 1944 Bretton Woods conference, the US crafted the post-World War II international monetary and financial order. The basic framework, centered around the US dollar, has survived financial crises, the Soviet Union’s dissolution, and several developing countries’ integration into the world economy.

Today, American leadership in global trade and financial and monetary governance rests on inter-related strengths. The US provides the world’s key international currency, serves as the linchpin of global demand, establishes trends in financial regulation, and has a central bank that acts as the world’s de facto lender of last resort.

Beyond delivering a global public good, supplying the world’s central currency carries substantial domestic benefits. Because the US can borrow and pay for imports in its own currency, it does not face a hard balance-of-payments constraint. This has allowed it to run large and sustained current-account deficits fairly consistently since the early 1980’s.

These deficits raise persistent concerns about the system’s viability, with observers (mostly outside the US) having long predicted its imminent demise. But the system survives, because it is based on a functional trade-off, in which the US uses other countries’ money to act as the main engine of global demand. In fact, export-oriented economies like Germany, Japan, and China owe much of their success to America’s capacity to absorb a massive share of global exports – and they need to keep paying America to play this role.

Given this, the big exporters have lately come under intense pressure to “correct” their external surpluses as part of responsible global citizenship. While this has contributed to a sharp contraction of the Chinese and Japanese surpluses, the eurozone’s current-account surplus is growing, with the International Monetary Fund expecting it to reach 2.3% of GDP this year (slightly less than the Chinese surplus).

A global economy led by a surplus country seems more logical, given that creditors usually dictate terms. At the time of the Bretton Woods conference, the US accounted for more than half of the world’s manufactured output. The rest of the world needed dollars that only the US could supply.

Chinese or European leadership would probably look more like the pre-World War I Pax Britannica (during which the United Kingdom supplied capital to the rest of the world in anticipation of its own relative economic decline), with the hegemon supplying funds on a long-term basis. But this scenario presupposes a deep and well-functioning financial system to intermediate the funds – something that China and the eurozone have been unable to achieve.

Despite the 2008 financial crisis, the US remains the undisputed leader in global finance. Indeed, American financial markets boast unparalleled depth, liquidity, and safety, making them magnets for global capital, especially in times of financial distress. This “pulling power,” central to US financial dominance, underpins the dollar’s global role, as investors in search of safe, liquid assets pour money into US Treasury securities.

The belief that a common currency and a common capital market would buttress financial institutions and deepen markets was a driving principle behind the eurozone’s formation. But, given the lack of a single debt instrument equivalent to a US Treasury bill, the crisis caused eurozone member states’ public-debt yields to diverge. Bank lending subsequently withdrew to national borders, and the idea of a European capital market disintegrated.

Likewise, in China, the absence of currency convertibility – together with a weak financial supervisory framework, which reflects a broader problem related to poor implementation of the rule of law – is impairing the economy’s prospects for leadership.

Europeans and Chinese should question whether they really want to assume the risks associated with a position at the center of a large and complex global financial system. Control of the system is the chalice of global leadership; but, for economies that are not adequately prepared for it, what should be an elixir may turn out to be poison.

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  1. CommentedJohann Savalle

    You suggest that leading an economy can be done only by force, if one is de facto stronger than others, it can impose its decisions and lead the game. I just would like to read more about a truly global economy where there can be some global perspective, and not to have a political block trying to dominate the international scene. Our world is smaller than it has ever been and no political or economical decision that would be taken unidirectionally can be claimed good, as it would surely be made at someone expenses. While I am not hoping for a perfect global governance, I am wondering why you do not even mention the fact that something can done to get closer to a true collaboration at a global level.

  2. CommentedVictor Tolok

    One should also remember that the first-time in mankind history such a global financial system was created and orchestrated by Bretton Woods agreements. Nothing like it existed before, ever. This system in its turn served (amongst other uses) as a basis for redistribution of wealth and resources generated by exploiting numerous technological advances made during WW2 and divided between the victor economies. And incorporating them into the united Western economies. Pretty much the same function was served by it again after overtaking ex-Soviet Union economies and including them into global market both as supplier of resources and technology – and consumers of goods and (USD-based) finances.
    In both cases all the economies already united under the system gained significant acceleration with inertia to last for decades to come. Naturally this growth is associated with leading world economies – the USA, Eurozone (primarily the Germany of course), Japan and China.
    Yet now the first-time united global financial system seems to have come to first-time united world challenges. And it's not just global warming, famine or lack of profound democratic governance though out all member economies. For the first time in Western-pattern world economics system we’ve come to a point where we witness technological advance (the one powers underpinning integrated world's growth) – slowing down. For no reason obvious to an average observer. This drive is not driving mankind’s development anymore with same efficiency as it used to since first industrial revolution. Global market has shrug off vast majority of rivals in every kind of high-tech industry there is - from IT services to aviation, from chemistry to maritime. No longer bright ideas and brave solutions can make a difference - it has all come down to stream line process control, minute advances and cutting costs of processes that were in fact devised and built decades ago.
    So do the terms “global” or “growth” actually even posses the same meaning as we’re all used to attribute to them? Because now efficiency is more than ever before is linked to cheap financing, cost cutting and fighting for mere percentages for saturated markets worldwide.

  3. CommentedAriel Tejera

    Odd to think of the great powers life cycle (in general) as "mission driven". Is it not power, and overpowering, essential, so then what's the relevance of any other world power "mission"? But take the US, and how well it has led the world towards this unfettered capitalism we now enjoy. The US dismantled the Anglo-French colonial system (1914), forced Western Europe to work together (1950), brought China into the fray (1972), forced the Russians to the same (1989), ant then, lastly, India, as loose end (2008). Well, that's .... a job very well done, I may say. "Mission accomplished, indeed". Understandable the exhaustion. And sad, in a way, that the same world order, so effectively groomed, is now feeding on the American people, in the form of discord, inequality, insolvency. Sad indeed.

  4. CommentedGunnar Eriksson

    It is not because China or EU desires to offer the world a reserve currency that the dollar is up for questions.
    It is because of the dysfunctional political system we see developing before our eyes. Half the wage earners in the US make 26 000 dollar or even much less, In the first 10 years of this century the country reduced the federal income by 5% of GDP and at the same time increased expenditures by 5% of the same GDP.
    The US is copying China with more and more money spent on spying on their own population not to speak about”The other".

    The thinking goes that we need to find a common trade weighted payment system, in order to make the world less dependent on national dysfunction.

  5. CommentedOsmar Oliveira

    Seems to me that the authors are hoping more than analysing. China is about to begin to gradually loosen its one-child policy, after the new reforms anounced last month; its demographic characteristics are rather a bonus than a threat. It is important to consider the new Chinese strategy that means to change the profile of its manufactured production into high technology goods, which tends to increase the volume of trade (let aside the fact of already being a major commercial power) and consequently the force of influence on dicision-making process. The financial rising is on its way, now that the Yuan is the second most used currency in global trade, and with the Chinese efforts to create a regional network to use the Renminbi in foreign trade and investments. Leadership, however, will be ever more related to what the big economies can offer to others in terms of perspectives of meeting the different interests and considering these interests in the making of arrengements; in other words, the ability of showing to the partners that the development of the leader expresses everyone elses development, something that the United States cannot anymore, unless to the elites of a few countries.

  6. CommentedZsolt Hermann

    I am sorry I do not understand the article.
    The two expressions "global" and "leader" simply do not match, it is as if we wanted to mix two something completely different substances like oil and water, or we wanted to listen to a frequency with a radio receiver that has no match for that frequency.
    The global world is interconnected, interdependent and by default mutual.
    Leadership cannot be applied to it the way we understand it today.
    In a mutual, integral system a "leader" is the part of the system that is "below" everybody else, serving the whole system in an absolutely altruistic way. The "higher" a part is in the "hierarchy" of the mutual, interdependent system the more serving, "invisible", facilitating for others it is.
    Just like how cells and organs in the body complement each other.
    This misunderstanding, the paradox we stubbornly try to force, competitive, exploitative, individualistic behavior in a round, integral system what is breaking global economy and every facet of human life.
    Instead of being great heroes, pioneers, always trying to twist and turn, always trying to rewrite the rulebook we simply need to learn to adapt to the system we exist in.

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