Ten key aspects of developed economies, post recession

20 12 2010

There are times when the ideas of the world’s rulers and the institutions through which they govern are adequate to the needs of the era, and there are times–like the present–when they are not.   Walter Russell Mead

1. The shift in economic weight from west to east has been accelerated by the recession and its outcomes, leading to growing tensions

The latest G20 meeting took place in South Korea, a symbolic recognition of the growing importance of the east both from the venue and from the fact that the G20 itself, containing the dynamic eastern growth countries, is now the main international economic forum. The global imbalances between developing countries which helped to fuel the credit boom remain in place. Tensions over currency valuations between the US and China reflect both the interdependence between the two countries and their long-term divergence.

Low interest rates in the US and elsewhere lead to investment money pouring into China. This continues to stimulate the Chinese economy and promotes exports back to the US. This continues to make US exports less competitive. The US tries to combat this through more stimulus to the domestic economy and therefore the requirement for lower interest rates persists. The US would like China to allow the value of its currency to rise, something the Chinese have resisted up until now.

China is by far the largest holder of foreign exchange reserves, with stockpiles of $2,454bn at the end of June, around 65% of which is dollars – almost 30 per cent of the global total. In addition China holds 22% of foreign-owned US government debt or$843.7bn. As Hillary Clinton said recently in relation to China ‘how do you deal toughly with your banker?’

2   The US remains the global consumer of last resort

While the US continues its slow decline as a global power it remains the only one with a global reach. It also continues to play its role as the global consumer of last resort. 70% of US GDP is consumption based and its recovery from recession is based on increased domestic consumption not exports.

3. Political incoherence is encouraging the pursuit of narrow national self-interest

Most western economies are struggling to get out of the recession. This has led to a breakdown in international cooperation and the pursuit of what Philip Stephens calls ‘a pinched nationalism’ of countries that have ‘lost confidence’ in their future.

As Sean Collins argues

The underlying pressure comes from the fact that the major economies have not seen a robust recovery, and countries are pursuing their national interests, defined narrowly.

In particular the loosening of US influence has encouraged a breakdown in international cooperation between debtor and creditor nations

 4.  The eurozone may buckle under the pressure

Nowhere is the breakdown of political cooperation clearer than in Europe, whose eurozone countries constitute together the second biggest economy in the world. The long-term contradiction between countries whose currencies are linked but which have separate political systems has come to the fore. Germany, which is the main dynamo of the European economy, has now decided it is no longer going to bail out the weaker peripheral countries, the so-called PIGS. These economies can only exist in their current form on the basis of continued economic support from Germany and other large European economies.

This pursuit of a narrow self-interest by Germany could lead to the break up of the eurozone.

5. There has been insufficient restructuring of developed countries to create the conditions for growth

Wikileaks revealed that even the Governor of the Bank of England, Mervyn King, recognises that the UK economy has not been restructured enough to create the conditions for a new growth spurt

As Sean Collins has argued, even the kind of limited restructuring that General Motors has undergone in the US, under US government control, is both atypical and probably inadequate to return GM to its dominant position in the car market.

6. Big corporations are saving not investing

The main outcome of the recession for big western corporations is that they are sitting on piles of cash. In Europe cash now comprises between 9 and 10 per cent of assets on balance sheets and may break 12 per cent in two years time, a third higher than the peak of the previous cycle. As the graphs below illustrate, this cash hoarding is at the expense of investment

The opportunity to take advantage of the new growing markets in developing countries is being spurned due to conservatism and risk aversion.

 

7. Austerity not growth is the watchword

With the exception of the US all western economies are being subjected to austerity packages. While these are being justified on the basis of the need to appease global bond markets there is no doubt that governments really have no idea of what else to do. George Osborne, the UK Chancellor of the Exchequer, recently had to abandon plans to produce a white paper on growth because there were insufficient ideas to put into it. Austerity is the only policy they have, which leads to a decline in domestic demand, a dampening of international trade and probably an increase in protectionism.

8. The recovery,such as it is, is jobless

Austerity policies and the absence of investment has led to a situation that while most economies are now growing slowly, this has not led to an increase in employment.

9. The debate about our economic future is painfully inadequate

Both free market and neo keynesian economists have been discredited by the recession. Economic debate is now characterised by its pessimism, and a general belief that slow or even no growth in the west is both impossible to avoid and in some cases desirable. The door has also opened wide for those who have psychological explanations for economics, the behaviouralists. David Cameron’s attempt to switch the focus of the economic debate from ‘growth’ to ‘happiness’ is a sign of how bankrupt the economic debate has become.

10. The absence of opposition leaves considerable room to manoeuvre

The absence of any political opposition or economic alternative to austerity means that the elites have plenty of room to manoeuvre in managing their domestic economies: indeed, there is even some popular support for austerity measures.

On that note I would like to wish you all a merry Xmas and a very happy new year!!

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4 responses

20 12 2010
Leigh Caldwell

Hi Rob

Despite being a “behaviouralist”, I agree with you on the pursuit of growth not austerity. We may differ on the economic policy steps that will best achieve it, and perhaps we may disagree on the relative benefits of services and intangible goods versus manufactured products, but at base: growth is good and is the only way to really improve our lives.

However I have some questions on the details of your post:

1. Do you have a source for the details on China? My understanding is that the $2,454bn of Chinese holdings is mostly in government bonds and T-bills, not cash; and therefore I’m not sure what the $843bn refers to. Plus, can $843 billion really represent 22% of US government debt? That would imply the US national debt is only $3.8 trillion, while in reality it is around $9 trillion.

My next thought was to question whether Hillary Clinton really said that, as it doesn’t sound like the words of a Secretary of State. But of course I should have realised it was a wikileaks comment. To help people find the original quote, it is actually “How do you deal toughly with your banker?”.

2. Surely the relevant figure is not what percentage of US GDP relates to consumption, but what percentage of world consumption relates to the US? I would imagine around 30% but it would be interesting to confirm that.

4. Europe’s countries together actually constitute the largest economy in the world, not the second largest. Although if you only include the eurozone (which I think is what you intend) then it is indeed smaller than the US.

6. In principle it doesn’t matter whether big companies save or invest; provided that there’s a route for their savings to be channeled into productive investment by someone else. Perhaps big companies genuinely don’t have good internal investment opportunities – in which case it would be quite appropriate, indeed optimal, for them to save in order that someone else can invest instead.

The problem seems to be (though it’s unclear as this is a difficult area to study systematically) that private investors in general are not able to find enough good investment opportunities anywhere. Partly this is related to capital controls and institutional weaknesses preventing developed-world investors from investing effectively in other countries. Partly it is a self-fulfilling prophesy based on expected low growth in the Western economies which means that business plans don’t look positive and borrowers don’t seem creditworthy. The property market affects this too, as entrepreneurs who would previously have borrowed against their house are less likely now to have equity available to do so.

I suspect to resolve this there needs to be an increase in willingness to provide (and accept) equity funding instead of debt; risk aversion is one reason this hasn’t happened, but in a subtle way: investors are too risk averse (preferring to own debt than equity), but entrepreneurs are risk-seeking (therefore they also prefer to incur debt than to sell equity).

9. Economics is intrinsically linked with psychology – after all, any economic action originates in a decision of some person. Behavioural economics simply attempts to understand these decisions better, rather than assuming a specific (rational) view of psychology which is not in accordance with scientific observation. As a practitioner in the field, I don’t perceive any tendency of behavioural economists to be apologists for austerity or to object to growth.

I guess the happiness literature is the main exception to that, but it does not represent the mainstream of behavioural or cognitive economics. Having said that, given that we know many limitations of GDP as a measure, why not try to make it more accurate with some kind of hedonic adjustments? Hopefully without abandoning GDP as a measure altogether; happiness alone is too little understood, too vague and slippery to be a primary economic measure.

This comment turned out longer than I intended – I guess your post must have made me think about things a bit.

20 12 2010
Rob Killick

Thanks Leigh, for the sake of trying to pack in as much as possible I had curtailed some of the references, which are now corrected.

I would also have liked to spent more time looking at the reasons for the ‘investment strike’, another day I think, although i agree with some of your points.

Rob

22 12 2010
Articles of note - danielbenami.com

[…] Ten key aspects of developed economies, post recession, UK After The Recession blog, by Rob Killick. […]

30 12 2010
Neil Craig

The subtext of G20 is that a number of EU countries within the 20 top economies have been excluded from membership. Nominally this is because the EU itself is a member but it also means that as these economies fall further they will not suffer the embarrassment of having their seats removed. This is forward planning – EU style.

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