Stagnant and Paralyzed

MILAN – The recent dramatic declines in equity markets worldwide are a response to the interaction of two factors: economic fundamentals and policy responses – or, rather, the lack of policy responses.

First, the fundamentals. Economic growth rates in the United States and Europe are low – and well below even recent expectations. Slow growth has hit equity valuations hard, and both economies are at risk of a major downturn.

A slowdown in one is bound to produce a slowdown in the other – and in the major emerging economies, which, until now, could sustain high growth in the face of sluggish performance in the advanced economies. Emerging countries’ resilience will not extend to double-dip recessions in America and Europe: they cannot offset sharp falls in advanced-country demand by themselves, notwithstanding their healthy public-sector balance sheets.

America’s domestic-demand shortfall reflects rising savings, balance-sheet damage in the household sector, unemployment, and fiscal distress. As a result, the large non-tradable sector and the domestic-demand portion of the tradable sector cannot serve as engines of growth and employment. That leaves exports – goods and services sold to the global economy’s growth regions (mostly the emerging economies) – to carry the load. And strengthening the US export sector requires overcoming some significant structural and competitive barriers.