So much is happening that it is quite hard to pick the signals out from the noise. There are, in essence, five huge economic stories running at the moment, or rather, five stories that have or will have huge economic consequences. The first two are glaringly obvious: the Japan earthquake and the unrest in North Africa and the Middle East. As a result the other three – European sovereign debt, China's uneven growth and the US recovery – have been rather pushed aside.
Taken together, though, how these five stories develop will determine the shape of global growth for the next five or so years. This matters directly to all of us in the UK because our recovery depends on global growth being sustained. Unlike in the previous (and much less serious) downturn in 2001, our fiscal position is too weak to give us any real headroom for independent action. Our Budget next week matters to us for obvious reasons but in world terms it is eclipsed by vastly bigger events.
You can catch a feeling for the amount of lost ground that has to be made up from the first graph. It shows the output gap for the different parts of the developed world, the gap between the sustainable long-term output and what is being produced. Why only the developed world? Because there is no output gap in the main emerging economies, which are running at or above their long-term trend output. The slack in the world economy is in our part, not theirs.
So what might derail the global recovery? It will not, short of some further catastrophe that does not bear thinking about, be Japan. It should be said again that this is first and foremost a human story rather than an economic one. However there are economic consequences and it is beginning to become possible to quantify those.
The normal economic response to natural disasters is that initially there is a loss of economic output but subsequently that is more than made up by reconstruction efforts. It is important to separate this loss of output from the loss of wealth, the hit to living standards. This is because resources going into reconstruction, putting things back, are resources not available for consumption. But in macro-economic terms the net impact to growth may well be positive.
You can see some estimates for this in the second graph. This shows some rough estimates, made by Barclays, for what might have happened to growth in Japan as it was, and now following the earthquake and tsunami. Net of everything, there is some hit to growth but it is not huge. As for the loss of wealth, Barclays estimates this as likely to be between 2.4 and 3.4 per cent of GDP. The lower figure would put it similar to that of the Kobe earthquake in 1995. I have seen higher estimates of up to 5 per cent of GDP and those are plausible too. But even the top end of these would not change the overall performance of the world economy.
Japanese debt? Much of the cost of reconstruction will be financed by additional government borrowing but again this is quite modest in the context of the economy as a whole. Japan might add debt equivalent to, say, 3 per cent of GDP. But debts are already more than 200 per cent of GDP so the additional burden is really pretty minimal. Japan's debt problem is really worrying, for even with very low interest rates, debt service is taking up 20 per cent of government revenues. But that is a long-term problem, not something for the next couple of years.
There are other issues, including the fall in share prices, the loss of confidence, the impact on the nuclear power industry worldwide and so on. But put all this together and it is still hard to see the Japanese disaster making more than a temporary dent on growth. The human cost is what matters; not the financial one.
I am more worried by Libya and Bahrain. Again we should always put people before numbers, though this is not the place to comment on the humanitarian aspects of these struggles. But I suppose the danger for the world is that the whole region becomes unstable: that what is happening in Bahrain becomes, so to speak, a proxy for what might happen in Saudi Arabia. The relationship is very close, for Bahrain is not just a pressure valve for Saudi people wanting a couple of days R&R in a more liberal environment. It is also a service hub for the region, not as important as Abu Dhabi or Dubai but still important.
It makes no sense to start trying to calculate what might happen to Middle East oil production given different political scenarios for the region. The danger is more that we are moving back towards the situation of the early 1970s, when the world had allowed itself to become massively dependent on Middle East oil and was accordingly devastated when Opec quadrupled the price. Were Saudi not to remain the reliable swing producer of Opec, the rest of us would be in a lot of trouble. It is unlikely that the oil price will reach $150 a barrel, its previous peak, but it should not be totally ruled out. So, yes, there is a real threat to the world economy.
And the other three matters? Well, they have been pushed aside here in this commentary by the more immediate events, as they have in the collective mind of the financial community. In any other circumstances we would all be focusing on the difficulties that the European fringe nations are having in funding themselves, whether the new package that has emerged from the eurozone leaders will restore confidence, what will happen to Portugal and so on. What seems to have happened is that peace has been bought for a few months but at the cost of pushing the problems further into the future. At the margin, though, sovereign defaults in Europe have been made less likely for the time being and that is good. A problem postponed is not a problem solved but better to have to cope with it at a later stage in the growth cycle.
On China, the remarkable news is that the country seems to have eliminated its trade surplus. The reason for that is partly higher import costs but also a slackening of demand. Its new five-year plan has cut the country's projected growth rate, which makes sense. What is very hard to gauge is how effective this will actually be. For several years China has been growing faster than projected. Now it may turn out that the events in Japan will slow growth – they appear to have slowed the Chinese nuclear power programme – but the transformation element in China's relationship with the rest of the world would be the elimination of the trade surplus. If that persists all sorts of consequences flow: a fall in purchases of US Treasury securities would be just one.
As for the US, the news is that the industrial recovery is picking up some pace. The data as always is conflicting: manufacturing is growing very strongly indeed but the housing market remains the most depressed for a generation. Of course one crucial imbalance remains: the fiscal deficit. But there is the tantalising possibility that as this cycle matures the US will grow faster and China more slowly. Were it not for Japan and the Middle East this might even be a time for modest confidence. Remember that.Reuse content