A Looming Global Crisis?

Recently in Paris for meetings between the OECD Economic Department and TUAC (the Trade Union Advisory Committee to the OECD), I found my trade union colleagues concerned about the “downside” risks of an increasingly gloomy economic outlook.

The OECD Economics Department believes that there will be a pronounced slowdown in the US – driven by the housing downturn. However, it expects effects on global growth will be cushioned to a significant degree by continued growth in Asia, and a modest recovery in Europe.

Trade union economists, by contrast, pointed to growing possibilities of a much worse outlook. (What follows is my own take on the union perspective on key points).

• The housing downturn in the US may have much larger than expected negative impacts on US consumer spending, given that recent household spending has – in a context of flat employment growth and stagnant median wages – been highly leveraged to debt. The downside of the huge and growing inequality in US earnings is that growth in mass consumption has been debt-financed. High household debt and higher interest rates are already having a negative impact on US growth.

• The knock-on effects of a US slowdown on Asia region growth would be considerable. Rapid Chinese export growth has been the fastest-growing flip-side of the huge US trade and current account deficit. This export growth has depressed US wages and employment, but also supported the recent recovery in Japan, Korea, Taiwan, etc. These countries have met the lion’s share of growth in Chinese demand for capital goods, and have successfully re-structured their own manufacturing sectors to exploit supply-chain complementaries with relatively cheap Chinese labour.

• Asia as a whole makes up the financial and real economy flip-side of the huge and still-growing US trade deficit. The US now imports close to $2 of goods and services for every $1 of exports, adding up to a continuing balance of payments deficit of 5% of GDP. Chinese manufactured imports are displacing domestic production of an increasingly wide-range of goods, including more sophisticated final goods. Asian central banks have been content to this point to pile up those surpluses in US dollar denominated low-interest foreign exchange reserves (partly to cushion themselves against another financial crisis and IMF intervention).

• The key questions are: will Asian central banks continue to bankroll US deficits, or – at some point – will they begin to shift to other assets, and precipitate a sharp fall in the US dollar? A shift out of the dollar is most likely to take place if the dollar falls precipitously due to speculation, activities of hedge-funds.

• As the saying goes, “if something can’t go in forever, it won’t”. The US-Asia imbalance has to be resolved by some combination of US export growth to meet more domestically-driven demand in Asia (which would help maintain global growth) and a sharp deceleration of US imports (which would in turn precipitate a sharp deceleration of Asian exports and Asian growth).
• Currently, the odds are against more domestic demand driven growth in China and “soft landing” for the global economy. Ultimately this requires a sharp turn from the current model of wage and domestic consumption repression, and the lack of a social safety net which results in very high household savings. (Strikingly, about 50% of Chinese national income is saved. While 40% of GDP goes to investment, there is still 10% of national income flowing into foreign savings).

• Urban industrial wages in China are rising (to a current level of about $1 per hour) and industrial disputes are on the rise, but huge labour reserves in rural areas and in the state-owned industrial sector will continue to dampen real wage growth in line with rising productivity in fast-growing modern industrial sectors.

• The odds are also against US export-led growth. Manufacturing capacity in the US has shrunk (manufactured goods account for more than two-thirds of the trade deficit but only 12% of US GDP) and it is hard to contemplate how a sharp acceleration in exports could be produced even if the US dollar were allowed to fall by much more against Asian currencies.

• Europe – which broadly-speaking balances trade with Asia at a much lower overall level than the US – is largely a side-story to the main “Global Imbalances” issue. And Europe – which has been experiencing a very modest export-led recovery – is unlikely to add much to global demand as it addresses major public finance deficits/aging society issues (Germany just hiked its VAT tax very significantly by three percentage points, and the European Central bank is prone to excessively tight monetary policy). The odds on expansionary European fiscal and monetary policy are very low.

• Add it all up, and the odds of a “hard landing” for the global economy are growing.

It could come suddenly – in a financial flight from the US dollar precipitating a sharp rise in US interest rates, public spending cuts, and a major recession – or more gradually – in a US slowdown caused by a squeeze on public spending in the context of very weak household spending and weak business investment, and interest rates held high enough to support the dollar.

• The benign way out of this looming crisis would be to somehow twin an expansion of Asian (mainly Chinese) internal demand to an expansion of North American manufacturing capacity and exports. That is far more likely to result from a political engagement than from the workings of the so-called “free market”. (Unfortunately, financial markets are likely to precipitate the crisis of the real economy which will demand a political response, after rather than before the fact).

• Alternatively, the way out could yet arise from internal developments within China. Even in Chinese national terms, the current hyper export growth model is problematic, resulting in huge increases in inequality between urban and rural areas and urban and migrant workers, environmental devastation, and potentially huge over-investment in productive capacity (which could result in major financial problems).