Tuesday, July 29, 2014
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The Political Economy of 2013

NEWPORT BEACH – Watching America’s leaders scramble in the closing days of 2012 to avoid a “fiscal cliff” that would plunge the economy into recession was yet another illustration of an inconvenient truth: messy politics remains a major driver of economic developments.

In some cases during 2012, politics was a force for good: consider Prime Minister Mario Monti’s ability to pull Italy back from the brink of financial turmoil. But, in other cases, like Greece, political dysfunction aggravated economic problems.

Close and defining linkages between politics and economics are likely to persist in 2013. Having said this, we should also expect much greater segmentation in terms of impact – and that the consequences will affect both individual countries and the global system as a whole.

In some countries – for example, Italy, Japan, and the United States – politics will remain the primary driver of economic-policy approaches. But elsewhere – China, Egypt, Germany, and Greece come to mind – the reverse will be true, with economics becoming a key determinant of political outcomes.

This duality in causation speaks to a world that will become more heterogeneous in 2013 – and in at least two ways: it will lack unifying political themes, and it will be subject to multi-speed growth and financial dynamics that imply a range of possible scenarios for multilateral policy interactions.

With an election looming in Italy, the country’s technocratic interim administration will return the reins of power to a democratically elected government. The question, both for Italy and Europe as a whole, is whether the new government will maintain the current economic policy stance or shift to one that is less acceptable to the country’s external partners (particularly Germany and the European Central Bank).

Monti may or may not be involved in the new government. The further removed from it he is, the greater the temptation will be to alter the policy approach in response to popular pressures. This would involve less emphasis on fiscal and structural reforms, raising concerns in Berlin, Brussels, and Frankfurt.

Japan’s incoming government has already signaled an economic-policy pivot, relying on what it directly controls (fiscal policy), together with pressure on the Bank of Japan, to relax the monetary-policy stance, in an effort to generate faster growth and higher inflation. In the process, officials are weakening the yen. They will also try to lower Japan’s dependence on exports and rethink sending production facilities to lower-wage countries.

The economic impact of politics in the US, while important, will be less dynamic: absent a more cooperative Congress, politics will mute policy responses rather than fuel greater activism. Continued congressional polarization would maintain policy uncertainty, confound debt and deficit negotiations, and impede economic growth. From stymieing medium-term fiscal reforms to delaying needed overhauls of the labor and housing markets, congressional dysfunction would keep US economic performance below its capacity; over time, it would also eat away at potential output.

In other countries, the causal direction will run primarily from economics to politics. In Egypt and Greece, for example, rising poverty, high unemployment, and financial turmoil could place governments under pressure. Popular frustration may not wait for the ballot box. Instead, hard times could fuel civil unrest, threatening their governments’ legitimacy, credibility, and effectiveness – and with no obvious alternatives that could ensure rapid economic recovery and rising living standards.

In China, the credibility of the incoming leadership will depend in large part on whether the economy can consolidate its soft landing. Specifically, any prolonged period of sub-7% growth could encourage opposition and dissent – not only in the countryside, but also in urban centers.

Then there is Germany, which holds the key to the integrity and unity of the eurozone. So far, Chancellor Angela Merkel has been largely successful in insulating the German economy from the turmoil elsewhere in Europe. Unemployment has remained remarkably low and confidence relatively high. And, while growth has moderated recently, Germany remains one of Europe’s best-performing economies – and not just its paymaster.

While some would have favored greater policy activism, Merkel’s Germany has provided a steady anchor for a eurozone struggling to end bouts of financial instability and put an end to questions about its survival as a well-functioning monetary union (one that aspires to becoming much more). A change in German leadership would, therefore, raise questions about Europe’s policy underpinning.

How politics and economics interact nationally and globally is one of the important questions for 2013 and beyond. There are three scenarios: good economics and effective politics provide the basis for a growing and more cooperative global economy; bad economics interact with dysfunctional politics to ruin the day; or the world muddles through, increasingly unstable, as a tug of war between economics and politics plays out, with no clear result or direction.

Part of the answer depends on what happens in three countries in particular – China, Germany, and the US. Their economic and political stability is essential to the well-being of a world economy that has yet to recover fully from the 2008 global financial crisis.

Current indications, albeit incomplete, suggest that the three will continue to anchor the global economy in 2013. That is the good news. The bad news is that their anchor may remain both tentative and insufficient to restore the level of growth and financial stability to which billions of people aspire.

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  1. CommentedVictor Morris

    As "Winston Churchill" said, "All wars are created by poverty and oppression, war is hell!"

  2. CommentedMargaret Bowker

    An engrossing article. The US seems to be gradually going through a transition period, in which The American Dream achieves a basic safety net through a sense of balance and co-operation. A positive, can-do attitude towards the Debt Ceiling and spending cuts negotiation will enable the US to start 2013 with increased confidence that Congress has purpose and drive. That neither side is asking too much, that reasonable proposals are being put forward, that decision making has momentum. Mohamed El-Erian warns what might happen if impasse becomes the norm, although I trust in a deep sense of responsibility to safeguard growth and a balanced reduction programme. Similarly with Japan, change is in the air, but it seems, not to the extent of leaving behind previous sound policies. Japan is going for growth and the vote is there to activate it. A 2% inflation target is usual in a number of economically important countries, so making space for growth in this way seems well worth considering. The commentary on Germany and the Eurozone described the situation very well.

  3. CommentedOdysseas Argyriadis

    In Greece, as always, the biggest problematic factor is corruption. Running the news atm is the case of a businesman who forged public documents pertaining to insurance costs of his employees and, hear hear, the public insurance office, IKA, agreed to a settlement with him for the amount of money due. The fun fact is that the settlement agreement for the full payment of the amount ends on 2.404. So, expect popular unrest, but based on corruption, not so much on poverty.

  4. CommentedProcyon Mukherjee

    It is a matter of great debate that political convergence / divergence on a topic by the polity when crisis has already struck and that when a crisis is to be averted is mysteriously shrouded in the understanding of what the policy action would ‘impress’ on the general public as viewed by the cohorts of the political system; I do not know how to describe the current state, one where crisis has already struck or where we are trying to avert one. This tends to make policy actions quicker or slower to evolve, but more importantly the trappings of an engagement process that has asymmetric gains and losses for a partisan approach versus a non-partisan one have never been more visibly demonstrated than the current one, where one is moving from one cliff (fiscal) to the other (debt ceiling).

    Procyon Mukherjee

  5. Portrait of Pingfan Hong

    CommentedPingfan Hong

    "In China, the credibility of the incoming leadership will depend in large part on whether the economy can consolidate its soft landing. Specifically, any prolonged period of sub-7% growth could encourage opposition and dissent": this statement has oversimplified the linkage between politics and economics in China. While GDP growth remains an important indicator, more concerns are focused on the widening income inequality, as well as environmental pollution.

  6. CommentedCarol Maczinsky

    Germany seems the only remaining sane nation. No fiscal drama, no growth fantasies based on unavailable funds, no drone assinations and pro-torture discussions. Steinbruck is only more determined than Merkel. Monti can solve their fiscal troubles anytime by selling South-Tyrol back to Austria.

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