Fault Lines: How Hidden Fractures Still Threaten the World Economy (37 page)

An anxious America is a cause of concern for the rest of the world, for it ultimately means a more inward-looking, fractious world. The world needs America to reform. The United States has always been able to remake itself in adversity, and there is no reason why it cannot do so again. It is in America’s past that we should see hope for its future. But what of the world itself? This is the question I turn to now.

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1714,
BERNARD MANDEVILLE,
a Dutchman living in England, wrote
The Fable of the Bees: Or Private Vices, Public Benefits.
Part verse, part prose, the tract was an indictment of the sharp practices, extravagance, and hypocrisy of the rich ruling class. For example, his portrait of lawyers in his fictitious beehive, a thinly disguised allegory for the England of his time, is one that should strike a chord with people in many countries today:

But after criticizing them, Mandeville went on to make an important economic point: the luxurious living of the rich and powerful, their changing fashions and tastes, had the one enormous benefit of providing work for the many. So

Indeed, when the voices of opposition grow loud enough in the beehive for Jove to put an end to the corruption and excessive consumption, the bee economy collapses. Mandeville thus makes the simple point that an economy full of thrifty savers cannot flourish for long because nobody can earn income if no one else spends money. We exalt frugality and excoriate borrowing, but in a vibrant economy, you cannot have one without the other.

In recent years, the world economy has come to resemble Mandeville’s beehive. The United States (and a few other rich industrial countries like Spain and the United Kingdom) have been spending more than they produce or earn and thus borrowing to finance the difference. Poorer countries like China or Vietnam have been doing the opposite.

Energy use is a good indicator of actual consumption of goods. Each person in the United States used 7.8 tons of oil in 2003, which was about twice the amount used per person in France, Germany, and Japan; about 7 times the amount used in China; and 15 times the amount used in India. Of course, per capita income in the United States is among the highest in the world, but its consumption is disproportionately high relative to other rich countries. And because its savings are commensurately low, the United States financed its spending in 2006 by borrowing 70 percent of the world’s excess savings.

This pattern of spending emerged, in part, because U.S. policies encouraged debt-fueled spending, both in normal times and as a way out of recessions, and because international financial markets were willing to accommodate the United States’ needs. Countries like Chile, China, Germany, Japan, Malaysia, Saudi Arabia, and South Korea supplied the United States by following a pattern of growth that emphasized exports and financed it by being willing to hold U.S. debt, much as the tradesmen held the IOUs of the spendthrift lords of Mandeville’s time. For many of these countries, supplying foreign needs was a more stable path to growth than creating their own.

This mutually beneficial but ultimately unsustainable equilibrium has been disrupted by the financial crisis and the subsequent downturn. Like many a developing country before it, the United States has come to recognize that the spending financed by a populist credit expansion is typically unproductive. Indebted U.S. households, weighed down by houses that are worth less than the mortgages they owe, have started saving more. To ensure that spending does not collapse, the U.S. government has stepped in to spend, but there are limits to how much it can do effectively. Consensus forecasts today suggest the United States will have to settle for a period of relatively slow growth. Forecasting is always difficult (especially about the future!), but if these forecasts are correct, sustained high unemployment will compound uncertainty for a middle class already hit by stagnant wages. They will have to face all this without the opiate of rising house prices and illusory wealth. Households in Spain and in the United Kingdom are in a similar situation, while smaller countries like Greece are on the verge of crisis.

Prudent macroeconomic management suggests that large-deficit countries should be more careful about spending and save more. If the world economy is not to slow considerably, the countries with trade surpluses will have to offset this shift by spending more. Ideally, the richer among them—Germany and Japan—should improve productivity in domestically oriented sectors like banking and retailing so that the added growth leads to greater incomes and more spending, while poorer but fast-growing developing countries like China and Vietnam should gradually reduce their emphasis on exports and promote domestic consumption.

There is even some hope that developing countries will start running large trade deficits once again and pull the industrial countries out of their growth slump, especially if multilateral lending institutions are reformed to be more supportive of borrowing. Such a hope is unrealistic and even dangerous, because developing countries have historically found it difficult to safely expand domestic demand financed with foreign borrowing. The problem is that domestic demand typically expands rapidly at times when the government has political aims or the financial sector has skewed incentives. In such situations, the fundamental allocation of resources is distorted. Anticipated financial support from multilateral organizations only increases wasteful spending before the inevitable crisis. Irresponsible foreign lenders get a larger subsidy, and the size of the hole that taxpayers eventually have to fill increases. There is, of course, some room for multilateral organizations to improve the availability of loans to countries with responsible policies, if nothing else so that countries do not run trade surpluses only to build up foreign exchange reserves. But in the foreseeable future, the response to the sustained reduction in industrial-country trade deficits should not be a commensurate sustained expansion of developing-country deficits and debts. Instead, it should require a narrowing of trade surpluses around the world, among both industrial and developing countries.

In practice, any such shift will be politically painful in the short term both for deficit and for surplus countries. Even as I write, the Federal Reserve is holding interest rates artificially low (especially in the housing market) in the hopes that households will start consuming more again—after all, household consumption has been the primary source of growth in recent years. China is actively intervening to stabilize the value of the renminbi against the dollar so that its exports do not suffer. These myopic actions will help entrench a longer-term pattern of behavior that will make it harder to move away from the current unsustainable equilibrium.

Of course, as Herbert Stein, the chairman of Richard Nixon’s Council of Economic Advisors, once said, “If something is unsustainable, it will stop.” Foreign investors have become increasingly wary about the amount of debt the U.S. government has had to issue to finance its deficits. With the majority of U.S. taxpayers believing they have benefited little from the boom years, the battle over who will bear the burden of additional taxes could turn ugly. Unlike the typical emerging-market country, the United States has not suffered a “sudden stop” of capital inflows during this crisis, because it has still been able to attract capital on easy terms from the rest of the world. However, if foreign investors fear that the United States will be unlikely to achieve the political consensus needed to set its government finances in order, they could start worrying that the government will follow the time-honored path of reducing the real value of its public debt through a bout of high inflation. If they take fright, they will sell their holdings of U.S. government bonds, causing the value of the dollar to slide more quickly. U.S. interest rates might have to go up substantially to retain foreign investor interest, thereby reducing U.S. growth even further than anticipated. That shift will bring down the U.S. trade deficit and spending, but in a way that maximizes pain all around.

Even if the status quo does persist for longer than we expect, there are longer-run consequences of maintaining the current pattern of imbalances. One is the issue of environmental sustainability around the world. Undoubtedly, as developing countries grown richer, their households will look to consume more. At current levels of technology, it is simply infeasible for the world to aspire to consume as much, and waste as much, as the average suburban American household does: as the former Indian finance minister Yashwant Sinha put it, we would then have no world to live in.
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No doubt technology will improve over time, making a unit of consumption progressively less destructive to the environment. Nevertheless, if sacrifices are to be evenly spread across the world, it makes sense for consumption growth to shift from rich deficit countries to developing ones.

It is also in the exporters’ long-run self-interest to alter their strategies. Although the reliance on exports has been very successful at both promoting rapid growth and ensuring stability, the Japanese experience raises questions about whether countries should follow it until they become rich—and risk subsequent stagnation—or turn to a more balanced path long before then. For a number of exporters, like China and Malaysia, the initial phase of building capabilities is long over. The challenge now is to broaden their sources of growth, withdrawing implicit and explicit subsidies to exporters gradually while extending the discipline of competition to the sectors focused on domestic production. Large countries like China may have no alternative but to wean themselves off dependence on global demand, because the world’s ability to absorb Chinese exports will be limited if China does not import more goods from them. Of course, the world’s political tolerance for buying Chinese goods may wear out long before its economic capacity to buy them does.

Change will therefore help global stability and sustainability and will be beneficial for each country in the long run. But change does upset the cozy status quo and the interests that benefit from it. For instance, the real estate lobby in the United States has no desire to see government support for housing diminish, even though the United States probably has far more housing stock than it can afford. Similarly, the export lobby in China has no interest in seeing the renminbi strengthen significantly. So we are caught between the rock of a financially and environmentally unsustainable pattern of global demand and a hard place of a politically difficult change in domestic policies.

These issues are not new. The political scientist Jeffry Frieden of Harvard University writes of the 1920s, when there was a macroeconomic imbalance between a great power running a sustained current-account deficit and a rising power that financed the deficits.
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The rising power was the United States, and the great power was Germany, which had borrowed heavily from abroad

As the Depression hit, each country looked inward, ignoring the consequences for other countries. The Smoot-Hawley Act passed by the U.S. Congress in June 1930 raised trade tariffs on imports in an attempt to protect U.S. jobs, making it still more difficult for debtor countries around the world to service debts. These countries either defaulted on their debt or overthrew governments that tried to adopt the austerity measures required to service it. Hitler was carried to power on the coattails of economic distress, and one of his first acts after taking power in January 1933 was to declare that Germany would not pay its foreign creditors. His message of hate and revenge fell on receptive ears in a Germany that felt ill-treated by the global economy.

The United States does not have the political weaknesses of the Weimar Republic, but the broader point is that without global economic cooperation when change is needed, countries could descend into opportunistic nationalism to the detriment of the global economy and the global political environment. Nationalism, coupled with great faith in the power of the government to enact domestic bargains between labor and capital, has been seen before: it was called fascism then. It is a development to be avoided at all costs.