Thursday, October 23, 2014
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In Search of Global Demand

Once again, Germany and Japan have slipped into recession. Once again, the second and third largest of the world’s major industrial economies are subtracting from, not adding to, growth in the world’s aggregate demand.

From the standpoint of German and Japanese citizens, this is bad news. Rapidly improving global technologies should make it relatively easy to deliver rising levels of output and living standards. Yet the German and the Japanese economies have had a hard time doing so for the past decade and a half. Certainly, everyone anticipated fifteen years ago that the current state of both economies would be much better.

From the standpoint of global political stability, recession and stagnation in Germany and Japan is potentially even worse news. Democratic governments make a bargain with their people, gaining their long-run legitimacy from their ability to deliver rising living standards and high employment.

Crisis, depression, and stagnation make people’s thoughts turn to the fecklessness and corruption of mainstream politicians, the illegitimate powers of special interests, and the cretinism of parliaments. The thoughts people think in times of crisis and depression are not false. Mainstream politicians are often feckless and corrupt (morally if not legally), special interests do
have mighty and illegitimate powers, and legislatures are often cretinous. But there is no country in which attempts to draw political conclusions from these popular sentiments have not ended in disaster.

From the standpoint of global economic stability, the failure of growth in Germany and Japan is perhaps the worst news of all. Six or seven years ago, there were vague worries that the world economy’s developed core could not run indefinitely on one locomotive, the United States, alone. Now, due to appalling fiscal policy on the part of George W. Bush’s administration and some bad luck, the US economy has wedged itself into a very uncomfortable position, hemmed in by its huge budget and trade deficits.

Un-wedging America without a crisis – attaining the economists’ grail of a “soft landing” – requires that a great many people and institutions with enormous holdings of dollar-denominated assets passively stand by and take no action while those dollar-denominated assets lose a third or more of their value against other currencies. There is a recent precedent for this: from 1985 to 1987, holders of dollar-denominated assets took a similar, but much smaller, bath. But can you step into the same river twice?

Moreover, achieving a successful soft landing requires more than that holders of dollar-denominated assets be tranquilized into catatonia while they lose their shirts. It also requires that at least eight million American workers who are now employed in construction, consumer services, and related industries find new jobs in export and import-competing industries.

That’s not all. At least sixteen million workers outside America who are now employed making exports to America would have to find jobs in other sectors as well. These jobs will have to fulfill demand coming from outside the US, because as a falling dollar and possibly a domestic recession shrinks the gap between American demand and American production, there must be a countervailing boost to demand relative to production outside the US. When the rebalancing comes – and it has already been delayed longer than I would have thought likely – it is important that, as former US Treasury Secretary Larry Summers used to say, the world economy balance up rather than down.

Without a rapidly growing Germany and Japan, where will the demand needed to “balance up” the world economy come from in the next several years? A generation from now, we will probably be able to point to China and India as rapidly growing capital-hungry markets capable of filling gaps in global demand. But not yet. While China and India are enormous in terms of workers, they are still small in terms of output and demand.

Without rapid demand growth somewhere in the developed world outside the US – and Germany and Japan are the best places to look – it is hard to see how the global economy can balance itself at a high level over the next few years.

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