I don't like it, everyone seems so confident
Sunday 06 October 1996
Everyone who was in Washington last week for the annual meetings of the International Monetary Fund and World Bank - everyone that is from the US Treasury secretary Robert Rubin downwards - was asking themselves this question. The answer, at least as far as Mr Rubin was concerned, was that there must be something out there because it was always just at the moment when the world economy seemed to be going very well that one should start to worry. But, chatting to journalists, he said he really could not see what it might be.
For many people here, the idea that everything is going wonderfully might seem a bit over the top. The UK is managing a decent recovery, consumption is whizzing up, and inflation is quiescent, but in many people's minds the scars of the last recession remain. On the Continent, the recovery has been less vigorous, while in Japan it has only just begun. In the US, by contrast, the Holy Grail of low inflationary growth seems to have been achieved.
You can see the difference by looking at the snapshot of recession and recovery shown in the graph - how the US is running above its long-term growth trend, whereas everyone else still seems to have some slack in the economy. Still for two reasons the rosy US view of the world, if it continues, is relevant to the rest of us. First, the US economic model of flexible labour markets and a cheapish currency is a useful guide for the rest of the world. Of the other G7 economies, the UK is probably closest to the US in policy and is so far sustaining a more impressive recovery than the rest. And second, the US is still the largest economy in the world: success there helps the rest of us.
In any case, even on fairly cautious assumptions there will surely be some recovery in growth in Europe and Japan in the next 18 months. The forecasts certainly look encouraging. So let's take a reasonably cheerful outlook as a starting point and go back to the question: what can go wrong? Here, in no particular order, are three candidates.
One would be a commodity price shock. If the world economy grows solidly during the next two years (and remember that the developing countries are growing much faster than the developed) that will put pressure on commodity prices. The very long-term trend of commodity prices has been downward over the last 100 years, but that has not stopped there being sizeable shocks on the way.
Signs now? Nothing alarming just yet, but the oil market has tightened in recent months as anyone who fills up their car may have noticed, and world food prices are under some pressure. The key here is perhaps not so much demand from the developed world but from the developing, in particular China, whose growth will put increasing pressure on the supply of a whole range of commodities, including oil, in the years ahead.
A second threat comes from the imbalance in fiscal policy. Governments have been running unsustainable deficits, which only now are being corrected. In some cases (for example, Belgium this week, Italy last) they are being corrected more by creative accounting than by cuts in spending and rises in taxation. So the world faces a decade or more of fiscal squeeze. There may be some cases in small, open economies where such a tightening might actually stimulate the economy because of its effect on confidence - Ireland may be a case in point. But the more likely effect in the short-term at least will be to depress the economy. On the continent of Europe, there is a danger that such tightening by so many countries will have a cumulative downward effect. It has to be done, to be sure. But I think better 'twere not done too quickly.
There is an argument that if deficits are cut too fast, the whole path to fiscal balance will be undermined: it will be just too unpleasant. Governments will be tempted to inflate away their debts, rather than pay them back. Of course bond holders will cotton on to this and demand higher returns, so the exercise will ultimately be self-defeating. But the voters and the politicians will not know that to start with and will accordingly condemn the world to a long period of even higher real interest rates.
The third threat comes from the markets, in particular equities and in particular Wall Street. The experience of the whole post-war period is that the real economy is pretty robust when struck by sudden collapses. We have weathered not just the crash of October 1987, but also the grave pressure on the banks from excessive lending on property and to the Third World. So even if there is a sudden fall on Wall Street (and sooner or later that is bound to occur) this need not destroy the real economy in the way that share-price and bank collapses did in the 1930s. But it would be silly to deny that this is a concern.
Of the three, my own greatest worry is the second. The experience of the commodity markets suggests that sooner or later there will be another shock, but it is hard to see a really serious one in the next two to three years. The experience of the markets is that there will be a shock and there is surely a very good chance of that happening in the next year, maybe the next two to three months. But unless that blow is combined with something else going wrong, it is hard to see that demolishing world growth. But getting a balance back into fiscal policy is going to be very, very difficult. It is not just a question of meeting Maastricht targets, the current preoccupation of most EU members. The problem is almost as great for the US and Japan, the US because of the low level of savings, Japan because of extremely adverse demographic trends.
It is quite hard to think through the consequences of the European fiscal squeeze because it has become bound up with the single currency and as a result so politicised. But it is even harder to gauge how European (and to a lesser extent American and Japanese) voters will react to years of a combination of higher taxation and cuts in public spending - a period of perhaps a generation where living standards fail to rise very much, if at all.
The Americans already have some experience of this - some 20 years where, though GDP per head has risen sharply, actual living standards for most people has risen very little. The more successful the economy is, the less the pain - hence the sense of self-confidence evident in the US at the moment. The fact that the US has had some six years of solid growth has finally stilled the voices of people who have lost out from the painful structural changes the economy has made.
Now Europe, and in a rather different way, Japan, also need a similar period of economic success to reduce the pain of the fiscal adjustment they have to make. Good growth and all the numbers begin to look manageable; little growth and they look ghastly.
There is a giant gap between "what might go wrong?" and "what will go wrong?". None of the above should be taken as a forecast of economic disaster. In any case, in the world of economics everything always seems to take longer than it ought to; so maybe the end of the present global expansion comes in 1998 or 1999 rather than 1997. Meanwhile, we muddle through. But whenever finance ministers congratulate themselves, beware - and I fear they are a touch too chipper at the moment for comfort.
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