CAMBRIDGE – This year has begun on a note of cautious optimism for the global economy. Europe is back from the brink. The United States did not fall over the fiscal cliff. Japan is moving to change its economic strategy, and China appears to be getting back on track.
Financial-market indices in the US, moreover, are near pre-crisis levels, and expected volatility is at multi-year lows. Major financial institutions are, for the most part, better capitalized than they have been in a long time. Balance sheets have been repaired, and many actors are awash with cash. While 2013 will not be a banner year, it may nonetheless come to be viewed as the first year of the post-crisis period.
To be sure, the political environment remains challenging almost everywhere. The US will face a trifecta of new fiscal hurdles – lack of legal authority to pay debt, no operating budget for the federal government, and the dreaded prospect of sequestration – before the end of March. Crucial elections lie ahead in Italy and Germany. China’s new government comes to power amid unprecedented levels of public concern about corruption and inappropriate enrichment of public officials. And it is not clear that Japan’s fractured politics will permit stable governance in the years ahead.
But there is the prospect of a virtuous circle in which economic improvement leads to less surly politics, in turn reducing uncertainty and boosting recovery further. So far, at least, the worst fears about the adverse political consequences of poor economic performance have not materialized – even in Greece. So my guess is that if nothing else goes terribly wrong, politics will not undo the global economy.
Unfortunately, much else could go wrong. In particular, while each of the global economy’s major regions has a plausible growth strategy, these strategies may not add up. Virtually the only proposition on which international economists agree is that the sum of all trade balances must equal zero. And, as a corollary, every bit of export-led growth that countries enjoy must be offset somewhere in the system by output growth that falls short of demand growth. So, a major challenge now is that around the world there seems to be far more planning for export-led growth than acceptance of reduced competitiveness and increased imports.
At the beginning of 2010, US President Barack Obama set the lofty goal of doubling America’s exports by the end of 2014. More than halfway through that five-year period, the US is pretty much on track to meet that target, implying that export growth is ahead of import growth or growth in the global economy.
In Europe, the only way that the financially distressed countries of the periphery can reduce their debt is to run trade surpluses. With limits on Germany’s willingness to accept a reduction in its competitiveness and repeated signals from the European Central Bank that monetary policy will remain highly accommodating, export-led growth seems to be the goal here, too.
And, in Asia, Prime Minister Shinzo Abe’s new Japanese government has already depressed the value of the yen and buoyed export prospects by placing reflation through monetary easing at the center of its agenda, while the most recent statistics out of China suggest significantly faster export growth than was anticipated.
So, where will the extra imports needed to support all of this additional exporting come from? Perhaps weaker commodity prices will create space for other imports, and commodity producers’ trade positions will swing toward lower surpluses. But lower commodity prices in a highly buoyant global economy would not be in line with past patterns.
Perhaps emerging economies with improved prospects will attract higher capital flows, financing larger trade deficits as capital goods are purchased directly or indirectly. But will this be enough to offset all that is happening in the larger economies? It is quite likely that some would-be export champions will be disappointed as planned competitiveness increases do not materialize.
This is why serene views of the effects of austerity based on historical experience are misguided. A single country or region consolidating or deleveraging in a thriving global economy can expect that its lower interest rates will translate into a weaker currency and an improved trade position. But most major economies cannot expect this in a struggling global economy. Each country’s austerity imposes external costs by reducing demand for other countries’ products. In this sense, it has a beggar-thy-neighbor aspect, which may be enhanced if the austerity is offset by monetary expansion.
The implication for policymakers is clear. More than at almost any time in recent years, international coordination to avoid excessive austerity will be essential for global economic success. Ensuring that national strategies are not just locally prudent, but also globally consistent should be the central task for the G-20 and the International Monetary Fund in 2013. Otherwise, the global growth equation may not add up.