Stuck with One Engine

Putin,_Modi,_Rousseff_and_Jinping_at_document-signing_ceremony_at_6th_BRICS_Summit

By Matthew Rock.

The world economy is headed down several worrisome paths.  One is the growing concentration of wealth among a tiny fraction of the world’s population; unsettlingly, over half of total wealth will fall within the hands of one percent of the world’s population by 2016.  Another is the rapid replacement of human workers by automated robots; automatization is replacing workers faster than they can develop new skills to make themselves profitable again, exacerbating the wage gap between highly skilled and low skilled workers.  However, one particularly pressing dichotomy has begun to characterize the world economy over the past couple years, one that risks establishing an unstable global climate. While the U.S. economy has been growing more powerful, the rest of the world has been growing progressively weaker.

The Engine

The United States seems to be in a sweet spot for its recovery.  With economic growth projected at 3% for 2015, inflation low, the dollar strong, and corporate profits soaring, the U.S. is again resting on the resilience of its take-no-prisoners brand of capitalism. Assuredly, there have been hiccups that have led people to question the strength of this growth, such as the noted stock market downturn early this January and the weak uptick in wage growth for most Americans.  However, even now, slack is being used up quickly enough that most experts predict 3% gains in wage growth over the next two years.

Unfortunately, the U.S. seems to be an isolated example, and just as in the late 1990s, there are signs that the rest of the world is yet again dropping below the de facto superpower.  Both the low gas price and other tumbling commodity prices, though on the surface beneficial to businesses, reflect weak global demand and weak projections for economic expansion in the near future.  

Taking It Easy on the Slow Ride

The European Union, on the brink of break-up two years ago, is projected to grow below 2% yet again this year, while it tilts ever closer to a deflationary spiral, with an inflation rate below 1%.  Germany, the backbone and financial support of the EU, narrowly avoided a recession during the third quarter of 2014 after the disastrous implementation of its renewable energy scheme and its insistence on the Black Zero, its zero deficit policy.  Although most of Europe’s southern peripheral economies have stabilized, they, along with other key players such as France, have failed to implement the necessary structural reforms that would help put the EU back on track.  As for Russia, its economy is crippled both by sanctions and abysmally low gas prices, sending investors fleeing and pushing the ruble close to its value during Russia’s 1990s bankruptcy.

Asia, too, is showing signs of weakness.  China is slowing in growth, with its 2014 growth rate of 7.4% down .3% from 2013, while Japan’s Abenomics has fallen far short of its implementer’s promises.  Rather than focus on economic development, Shinzo Abe, Japan’s prime minister, has instead let his administration fall into the distractions of territorial disputes and constitutional revision to allow its army to undertake collective self-defense; furthermore, it made a disastrous decision to increase the personal consumption tax before the economy could gain momentum.

On the other hand, India, currently under the reform-minded administration of Narendra Modi, is pegged to grow at 5.9% and is even threatening to overtake China’s growth rate in 2017.  At best, this figure is a positive for India that is drawing attention to the slowing growth in China; at worst, it is an overoptimistic forecast that fails to take into account the waning global appetite for exports and the slowing pace of Modi’s structural reforms.  

South America’s growth is projected to be a lackluster 1.8%.  Although Africa and Southeast Asia are potential hotspots for economic growth this year, several trouble areas could land these two regions far below their projected growth rates.  In particular, the Ebola epidemic, which shaved whole percentage points off of the affected countries’ growth targets, exposed the inability of the African continent to respond to health crises without rapid international intervention.

When the Engine Gives Out

A world “running on one engine” is dangerous not only for those places that aren’t experiencing much growth but also for the United States itself.  The 1990s saw a very similar situation, when American growth was accelerating and world growth was descending rapidly.  By the early 2000s, an overvalued dollar, hurting American exporters, and a bust stock market, sent tumbling by the dot com crash, had dragged the United States—and the rest of the world—into a mild recession.  Admittedly, the current stock market price-earning ratio, an indicator of potential overvaluation in the stock market, is much closer to its historic average than it was during the late 1990s, and the world has much less debt and many more foreign currency reserves to keep currencies afloat.  However, with interest rates essentially at zero, there is much less that the Fed could do to rev the American economic engine if crisis were to hit.

Fix ‘er Up

The rich world can take a series of steps to avoid this outcome.  The European Central Bank could begin a round of quantitative easing to push down long-term interest rates and spur investment, while Angela Merkel could abandon Germany’s Black Zero campaign and engage in deficit spending.  Mr. Abe could reorganize his priorities to ensure Japan’s Lost Decade does not become plural, and France and the Eurozone’s peripheral economies could take on long overdue structural reforms to restore competitiveness.

The developing world’s to-do list, though less easily done, is just as important.  China, rather than conduct undue stimulus measures to try to overheat the economy back to double-digit growth, should work to develop policies able to ease the transition between a production-led economy to an economy driven both by producers and consumers. In India, Mr. Modi must be dynamic enough to confront the growing opposition in the Upper House of Parliament and make sure long-awaited reforms do not stall.  For Russia, South America, and Africa, the medicine, as always, would be to diversify the economy, avoid fiscal deficit, and establish a stable investment environment (how to accomplish these is fortunately far beyond the scope of this article).  

At the very least, we should hope for the rich world to accomplish a handful of these recommendations, and for the governments of China and India to make well-informed decisions in their time of economic transition. Otherwise, anemic growth will continue, political unrest will further spread, and before too long we may be forced to call on other, more radical leaders to make these changes, which would then be far less likely to occur.




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