Global: two different worlds
. . . in sharp contrast with that of 1991, it's a US-centric world that is still picking up the pieces from the greatest bubble of them all. It's a world whose sole growth engine is now sputtering and coming to grips with an energy shock every bit as large as that which triggered recession in 1990-91. It's also a world that has utterly failed to uncover a new source of growth.
Global: Two Different Worlds
By Stephen Roach
On the surface, it smacks of classic déjà vu. As was the case in 1990-91, war looms between America and Iraq. Once again, it's Saddam Hussein versus George Bush first the father, now the son. And once again, it's the economy that's also at risk. As was the case over a decade ago, world energy prices have run up dramatically in anticipation of the seemingly inevitable conflict. A sagging global economy is now trembling in response just as it did a dozen years ago. Yet there's hope in this extraordinary replay. After all, the Gulf War of 1991 was a springboard for financial market nirvana and eventual economic recovery. Is this precedent a portent of a similar outcome in 2003-04?
The world economy has changed a lot since 1990-91. Perhaps the most significant change has been the emergence of a lopsided, US-centric global growth dynamic. In the late 1980s, there was much greater balance to the global economy than there was in the late 1990s. Back in the earlier period, the industrial world was drawing support from three engines the US (3.4% average GDP growth over the 1985-90 interval), Japan (4.8%), and even Europe (3.0%). The developing world was benefiting from the East Asian "miracle"(8.1% average growth over the six-year period ending in 1990) as well as from moderate growth in Latin America (2.9%). Drawing its sustenance from multiple sources of growth, the world had more legs to stand on in the event of a shock. Nor was the global economy of the late 1980s plagued by serious external imbalances. In 1990, for example, current-account deficits (and surpluses) in the broad global economy amounted to only about 0.5% of world GDP.
That was then. The world has now become a one-engine economy. Over the seven years from 1995 to 2002, our calculations suggest that the United States accounted for 64% of the cumulative increase in world GDP (at market exchange rates). That's essentially double America's share in the global economy. Over the same period, domestic demand growth averaged about 4% in the US, double the anemic 2% gains elsewhere in the world. Japan has been mired in a post-bubble malaise (+0.1% average annual growth over 2001-02) and the Euro zone growth dynamic has taken on a new sluggishness (+1.2% over the same two-year period). Growth in Asia ex Japan has remained brisk (+4.8%) but well below the heady gains of the late 1980s; meanwhile, Latin America has fallen victim to yet another in a long string of crises (contracting by 0.3%, on average, over the 2001-02 period). Unfortunately, this one-engine world has spawned massive external imbalances; that's underscored by America's record 5% current-account deficit in 2002 and matched by Asia's and, to a lesser extent, Europe's current-account surpluses. In fact, never before has the modern-day world economy been saddled with such extraordinary disparities between outsize current-account deficits and surpluses. In retrospect, the balanced global economy of the late 1980s was well positioned to withstand the pressures of a shock. By comparison, today's unbalanced world is at a distinct disadvantage in coping with such a disturbance.
That's especially the case if such an unbalanced world can no longer rely on the impetus of its main growth engine. Not only has the world slowed, but so has the US (expanding at just a 1.4% average annual rate over the 2001-02 interval). And that frames the central issue: Like it or not, the prognosis for a US-centric world economy has a decided US-centric spin. In my view, the debate over the US outlook continues to hinge on two critical issues the deflationary perils of America's post-bubble excesses and the US economy's ability (or inability) to overcome those excesses by getting traction from monetary and fiscal stimulus. While the jury is out, I remain very much of the view that the risks on both counts remain on the downside. But even if I'm wrong, there can be no mistaking the sharp contrast in the state of today's US economy when compared with that of prewar period in 1990. America has just gone through its most devastating asset bubble in modern times. That's not to say there weren't stresses and strains in the earlier period a savings-and-loan crisis comes to mind. But those travails pale in comparison to the post-bubble aftershocks that still dominate America's economic landscape. That contrast bears critically on the key issue of resilience whether the US economy, and a US-centric world, will be as capable of withstanding the blow of war today as it was in 1990-91.
In that vein, I continue to believe that my simplistic "recession model" could well hold the key. Recession vulnerability, in my view, has long been determined by the confluence of two macro factors pre-recession momentum (or lack thereof) and an exogenous shock. If the economy is cruising ahead comfortably above its potential growth rate, then it is quite capable of warding off the impacts of all too frequent shocks. If, on the other hand, the economy is limping along below its growth potential close to what can be called its "stall speed" then it's a different matter altogether. Since a stalling economy simply lacks the cyclical immunities needed to cushion it from unexpected blows, recessions can easily ensue in the aftermath of a shock. In retrospect, that latter depiction held the key to the recession of 1990-91 and could well be most pertinent for the 2003 prognosis.
As seen in the context of this recession model, the comparison between these two periods is striking. By mid-1990, annualized real GDP growth in the US had slowed to 0.9% on a sequential quarterly basis (or 1.6% on a year-over-year basis). By year-end 2002, annualized real GDP growth had slowed to just 0.7% (2.7% on a year-over-year basis but only 2.0% over the final three quarters of last year). Significantly, the current pace of US economic activity is probably a good deal further below today's potential growth rate (3% to 3.5%) than was the case in the summer of 1990, when the potential growth norm was closer to 2%. In other words, just as we now know the US economy was operating at its stall speed in the summer of 1990, a similar conclusion seems evident today. Moreover, the two oil shocks are also comparable a 67% increase in crude oil prices in 1990 (from $22.50 to $37.50 per barrel on a WTI basis) and a 75% increase so far in the current period (from $20.00 in early 2002 to $35.00 at the close on 8 February 2003). According to the two-step recession model, the damage may have already been done not just to the United States but by default, also to a US-centric global economy.
Consequently, I am left with the uncomfortable conclusion that the world economy is in a far more precarious state today than it was some 12 years ago. While the analytics of recession vulnerability flash a warning in 2003 that is quite comparable to that of 1990-91, the inherent imbalances of today's post-bubble US centric world are far more disconcerting. But there's an intangible aspect of this vulnerability that may be even more troubling: The combination of globalization and mounting geopolitical pressures has introduced an added set of tensions in the world that may be inherently destabilizing for a weakened global economy. For example, the industrial world is having difficulty coping with the asymmetries of China's globalization, with deflationary impacts on the supply side initially overwhelming any impetus from the demand side. Meanwhile, Japan is getting more and more isolated in the industrial-world community, and new frictions economic as well as political have emerged between Europe and the United States.
I find the wedge between America and Europe especially worrisome. Examples are numerous not just trade frictions (i.e., steel, farm products, and a host of services) but also disagreements over anti-competitive principles (the GE-Honeywell merger, agricultural subsidies, and export tax subsidies). Most troubling, however, is the mounting dispute over foreign policy as underscored by French and German objections to America's intentions in Iraq; Russia's concerns only compound the differences. America and Europe no longer seem to see global issues through the same lens. As Robert Kagan puts it in a provocative little book, Europe increasingly views America as unilateral and aggressive in direct contrast to a US that that now sees its once staunchest allies as weak and less ideologically committed (see Kagan's Of Paradise and Power: America and Europe in the New World Order, Alfred A. Knopf, 2003). I saw this contrast first hand at the recent World Economic Forum. US Secretary of State Colin Powell had come to Davos to make the case against Iraq in front of the international community. Americans left the speech filled with pride and confidence, convinced that Powell had made an ironclad case. Yet the rest of the world not just Europeans but also Asians didn't see it that way at all. In Kagan's words, it's as if "... Americans are from Mars and Europeans are from Venus." The grand alliance not only came together to win the two world wars of the 20th century but also collectively wrote the rules of globalization. And now it grows uncomfortably apart.
Frictions between America and Europe be they economic or geopolitical add yet another dimension of vulnerability to an already shaky global economy. All this paints a picture of a world that stands in sharp contrast with that of 1991. It's a US-centric world that is still picking up the pieces from the greatest bubble of them all. It's a world whose sole growth engine is now sputtering and coming to grips with an energy shock every bit as large as that which triggered recession in 1990-91. It's also a world that has utterly failed to uncover a new source of growth. As such, it's a world that remains underpinned by an American psyche that remains fragile in the aftermath of the terrorist attacks of September 2001. Sadly, all this speaks poorly of the collective efforts that a struggling world needs to get to the other side in sharp contrast to the broad multilateral coalition that came together to deal with the Gulf War. With the drumbeat of war growing louder, the postwar euphoria of 1991 seems painfully distant. It's a tale of two very different worlds.
add a comment on this article