Wednesday, October 22, 2014

The Global Economy on the Fly

ISTANBUL – In the last four weeks, I have traveled to Sofia, Kuala Lumpur, Dubai, London, Milan, Frankfurt, Berlin, Paris, Beijing, Tokyo, Istanbul, and throughout the United States. As a result, the myriad challenges facing the global economy were never far away.

In Europe, the tail risk of a eurozone break-up and a loss of market access by Spain and Italy were reduced by last summer’s decision by the European Central Bank to backstop sovereign debt. But the monetary union’s fundamental problems – low potential growth, ongoing recession, loss of competitiveness, and large stocks of private and public debt – have not been resolved.

Moreover, the grand bargain between the eurozone core, the ECB, and the periphery – painful austerity and reforms in exchange for large-scale financial support – is now breaking down, as austerity fatigue in the eurozone periphery runs up against bailout fatigue in core countries like Germany and the Netherlands.

Austerity fatigue in the periphery is clearly evident from the success of anti-establishment forces in Italy’s recent election; large street demonstrations in Spain, Portugal, and elsewhere; and now the botched bailout of Cypriot banks, which has fueled massive public anger. Throughout the periphery, populist parties of the left and right are gaining ground.

Meanwhile, Germany’s insistence on imposing losses on bank creditors in Cyprus is the latest symptom of bailout fatigue in the core. Other core eurozone members, eager to limit the risks to their taxpayers, have similarly signaled that creditor “bail-ins” are the way of the future.

Outside the eurozone, even the United Kingdom is struggling to restore growth, owing to the damage caused by front-loaded fiscal-consolidation efforts, while anti-austerity sentiment is also mounting in Bulgaria, Romania, and Hungary.

In China, the leadership transition has occurred smoothly. But the country’s economic model remains, as former Premier Wen Jiabao famously put it, “unstable, unbalanced, uncoordinated, and unsustainable.”

China’s problems are many: regional imbalances between its coastal regions and the interior, and between urban and rural areas; too much savings and fixed investment, and too little private consumption; growing income and wealth inequality; and massive environmental degradation, with air, water, and soil pollution jeopardizing public health and food safety.

The country’s new leaders speak earnestly of deepening reforms and rebalancing the economy, but they remain cautious, gradualist, and conservative by inclination. Moreover, the power of vested interests that oppose reform – state-owned enterprises, provincial governments, and the military, for example – has yet to be broken. As a result, the reforms needed to rebalance the economy may not occur fast enough to prevent a hard landing when, by next year, an investment bust materializes.

In China – and in Russia (and partly in Brazil and India) – state capitalism has become more entrenched, which does not bode well for growth. Overall, these four countries (the BRICs) have been over-hyped, and other emerging economies may do better in the next decade: Malaysia, the Philippines, and Indonesia in Asia; Chile, Colombia, and Peru in Latin America; and Kazakhstan, Azerbaijan, and Poland in Eastern Europe and Central Asia.

Farther East, Japan is trying a new economic experiment to stop deflation, boost economic growth, and restore business and consumer confidence. “Abenomics” has several components: aggressive monetary stimulus by the Bank of Japan; a fiscal stimulus this year to jump start demand, followed by fiscal austerity in 2014 to rein in deficits and debt; a push to increase nominal wages to boost domestic demand; structural reforms to deregulate the economy; and new free-trade agreements – starting with the Trans-Pacific Partnership – to boost trade and productivity.

But the challenges are daunting. It is not clear if deflation can be beaten with monetary policy; excessive fiscal stimulus and deferred austerity may make the debt unsustainable; and the structural-reform components of Abenomics are vague. Moreover, tensions with China over territorial claims in the East China Sea may adversely affect trade and foreign direct investment.

Then there is the Middle East, which remains an arc of instability from the Maghreb to Pakistan. Turkey – with a young population, high potential growth, and a dynamic private sector – seeks to become a major regional power. But Turkey faces many challenges of its own. Its bid to join the European Union is currently stalled, while the eurozone recession dampens its growth. Its current-account deficit remains large, and monetary policy has been confusing, as the objective of boosting competitiveness and growth clashes with the need to control inflation and avoid excessive credit expansion.

Moreover, while rapprochement with Israel has become more likely, Turkey faces severe tensions with Syria and Iran, and its Islamist ruling party must still prove that it can coexist with the country’s secular political tradition.

In this fragile global environment, has America become a beacon of hope? The US is experiencing several positive economic trends: housing is recovering; shale gas and oil will reduce energy costs and boost competitiveness; job creation is improving; rising labor costs in Asia and the advent of robotics and automation are underpinning a manufacturing resurgence; and aggressive quantitative easing is helping both the real economy and financial markets.

But risks remain. Unemployment and household debt remain stubbornly high. The fiscal drag from rising taxes and spending cuts will hit growth, and the political system is dysfunctional, with partisan polarization impeding compromise on the fiscal deficit, immigration, energy policy, and other key issues that influence potential growth.

In sum, among advanced economies, the US is in the best relative shape, followed by Japan, where Abenomics is boosting confidence. The eurozone and the UK remain mired in recessions made worse by tight monetary and fiscal policies. Among emerging economies, China could face a hard landing by late 2014 if critical structural reforms are postponed, and the other BRICs need to turn away from state capitalism. While other emerging markets in Asia and Latin America are showing more dynamism than the BRICs, their strength will not be enough to turn the global tide.

Read more from our "Falling BRICS?" Focal Point.

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  1. CommentedRitesh Kumar Singh

    I think, India's problems are relatively easier to tackle than that of any other large economies whether ifrom developed or emerging regions because India is not so dependent on external sector. Four steps can help it immensely:

    Agressive investment in infrastructure either through private sector or public or PPP route

    Removing restrictions on interstate movement of merchandize to leverage the size and diversities of a USD two trillion market

    Unshackling of agriculature and manufacturing sector by cutting red tape

    Labor market reforms and emphasis on skill development and R&D

    Success of none of the above measures is too much much dependent upon external sector, though favorable external environment will certainly help.

    Are India's Policy makers listening?

  2. Commentedsrinivasan gopalan

    The prophet of doom is no doubt intelligent in providing a synoptic picture of the world economy as it obtains today. But his concluding remarks that apart from China, other BRICS should turn away from state capitalism appears not grounded on reality as far as my country goes. The problem of India is not state capitalism but state profligacy in entrenching subsidies of food, fuel and fertilizers. That the public outlay on infrastructure in India is grossly inadequate while private investment is in trickle, thanks to weak regulatory structure, are by now widely known and disseminated. What is less advertised is the understated snail's progress of public-private partnerships to use public outlay as a catalyst for promoting private investment in crucial infrastructure domains. India's problems are structural in nature and as long as the underlying threats to its nurturing growth impulses are not recognized and remedied duly, the so-called demographic dividend on which India is set to cruise for a brighter future would prove to be a liability. It is time the authorities here as also global economists took due note of the real reasons for the slowdown and accordingly fashioned policies that would help regenerate growth. G.Srinivasan. Journalist, New Delhi

      CommentedRitesh Kumar Singh

      I think, India's problems are relatively easier to tackle than any other large economies whether in developed or emerging regions. India is not so dependent on external sector. Four steps can help it immensely:

      Agressive investment in infrastructure eith through private sector, or public or PPP route by ensuring timley regulatory approvals

      Removing restrictions on interstate movement of merchandize to leverage its size and diversities in USD two trillion market

      Unshackling of agriculature and manufacturing sector by cutting red tape

      Labor market reforms and emphasis on skill development and R&D

      Success of none of the above measures is too much much dependent upon external sector, though favorable external environment will certainly help.

      Are India's Policy makers listening?

  3. Portrait of Michael Heller

    CommentedMichael Heller

    Japanese panic decision today to restart lazy high-pressure monetary flushing exposes long-run chronic failure to do hard structural reform. Europe can be more practical. Dismantle the pipes. Clear the obstacles piece by piece.

  4. CommentedJonathan Lam

    Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!
    Mr. Gert van Vugt,
    You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.
    Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.
    How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;
    • The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.
    • The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.
    • And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.
    If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.
    It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.
    I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.
    May the Buddha bless you?

    I bet not many know of Keynes or Hayek, economist may find theories on the principles; however, the burden now lean on the majority who strive under the margin of affordability. The coming disaster with not be defaults of banks; it will be strike and riots within that supply and demand which became irrelevant to them. Social uprising demonstrates the defiance of the price and valuation that Central Bank and governments purposed. This is because they erased the deflation for the convenience of easier balance in the budget or stability as Ms. Thatcher demanded, and not within the pockets of the labor, and they do not get relief. Further stimulation could become the rift as interest rate or CPI rises. And, I said the chaos begin in October when CDS and CoCos and shareholders of the bank having conflict in reviving the debt or the banking. Goldman Sachs is the first sign, another Buffet?

  5. CommentedTim Chambers

    Everywhere it seems the problem is the same, the failure of the neo-liberal experiment. David Brooks quote for Edmund Burke in todays New York Times put it quite succinctly. We must rein in our private appetites, particularly the rentiers and financiers who produce nothing, and merely extract wealth from the productive sector. The only solution is to better spread the wealth around to all who contribute to producing that wealth, so that they can continue to consume and produce without going into debt peonage to keep up appearances.

  6. CommentedProcyon Mukherjee

    Do not want to add to the gloom already so much in evidence as in Roubini's note, but the divergence of commodity prices & wage with stocks under a constantly loose monetary policy regime has more than the usual suspects to be wary about; it is transience of a beacon of hope, much could change as real rates cannot further go negative, while fiscal actions are just conjectures over the moral divide.

  7. Portrait of Michael Heller

    CommentedMichael Heller

    Just as a rider, was it here or elsewhere, the repetitive ubiquitous claim about "austerity fatigue". Austerity has barely begun because the reforms ain't been done. It's simply a case of populist resistance to austerity on one hand, and weak leadership on the other. Not fatigue.

  8. Portrait of Michael Heller

    CommentedMichael Heller

    Nouriel: I think you’re probably right in most cases, though I wouldn’t be as confident about the boost to confidence in Japan. Emerging markets mentioned might not be big players, but they can still provide good examples to countries where the gloom makes things look intractable. By definition when they “emerge” they overcome obstacles that are far more daunting than those faced in the spoilt over-indulged European periphery.

    But I keep coming across a contradiction in the press and here -- those who wisely shout for (preemptive) capitalist structural reform in the BRICs are reluctant to shout so loud about the need for it in Europe. Instead, as you do too, they keep on offering the special case palliative of monetary and fiscal activism. This ignores the core principle in economics of *people respond to incentives*. Sometimes it seems that the Germans are the only ones who remember Economics 101 (a-la-Mankiw) -- i.e. premature easing takes away the incentive for reform. Then you’re in unchartered territory -- refusal to reform, perpetual crisis.

  9. CommentedPaul A. Myers

    An excellent tour de horizon of a world everywhere beset by problems that act as growth constraints.

    It would seem that virtually everywhere there is some set of structural problems holding back growth. A structural problem can only be ameliorated by some sort of "reform." Many of the structural problems are sustained by rent seeking of powerful interest groups.

    So, the need is to "reform" to get "rebalance" to create conditions for "growth."

    So, who is going to give up "something" to reestablish a positive-sum game for the many?