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  • Dani Rodrik on 'Premature Deindustrialization' in Developing Economies

    At Project Syndicate , Dani Rodrik tries to make sense of "an unexpectedly large gap in productivity between large firms and small firms," in Mexico and other developing economies. This isn't what is supposed to happen. At least it doesn't follow the industrialization model of the last century and a half. "When economies develop the productivity gap between the traditional and modern parts of the economy shrinks, and dualism gradually diminishes, Rodrik writes. Today, the picture is very different. Even in countries that are doing well, industrialization is running out of steam much faster than it did in previous episodes of catch-up growth – a phenomenon that I have called premature deindustrialization. Though young people are still flocking to the cities from the countryside, they end up not in factories but mostly in informal, low-productivity services. Indeed, structural change has become increasingly perverse: from manufacturing to services (prematurely), tradable to non-tradable activities, organized sectors to informality, modern to traditional firms, and medium-size and large firms to small firms. Quantitative studies show that such patterns of structural change are exerting a substantial drag on economic growth in Latin America, Africa, and in many Asian countries. There are two ways to close the gap between leading and lagging parts of the economy. One is to enable small and microenterprises to grow, enter the formal economy, and become more productive, all of which requires removing many barriers. The informal and traditional parts of the economy are typically not well served by government services and infrastructure, for example, and they are cut off from global markets, have little access to finance, and are filled by workers and managers with low skills and education. Even though many governments exert considerable effort to empower their small enterprises, successful cases are rare. Support for small enterprises often serves social-policy goals – sustaining the incomes of the economy’s poorest and most excluded workers – instead of stimulating output and productivity growth. The second strategy is to enlarge opportunities for modern, well-established firms so that they can expand and employ the workers that would otherwise end up in less productive parts of the economy. This may well be the more effective path. Read The Growing Divide Within Developing Economies here .
  • Nouriel Roubini's Top Six Risks for Global Markets

    At Project Syndicate , Nouriel Roubini writes that the major risks to global markets have shifted. The leading risks from the last two years, while not quite resolved, are not as predominant. But there is plenty to be concerned about. Namely: For starters, there is the risk of a hard landing in China. The rebalancing of growth away from fixed investment and toward private consumption is occurring too slowly, because every time annual GDP growth slows toward 7%, the authorities panic and double down on another round of credit-fueled capital investment. This then leads to more bad assets and non-performing loans, more excessive investment in real estate, infrastructure, and industrial capacity, and more public and private debt. By next year, there may be no road left down which to kick the can. There is also the risk of policy mistakes by the US Federal Reserve as it exits monetary easing. Last year, the Fed’s mere announcement that it would gradually wind down its monthly purchases of long-term financial assets triggered a “taper” tantrum in global financial markets and emerging markets. This year, tapering is priced in, but uncertainty about the timing and speed of the Fed’s efforts to normalize policy interest rates is creating volatility. Some investors and governments now worry that the Fed may raise rates too soon and too fast, causing economic and financial shockwaves. Third, the Fed may actually exit zero rates too late and too slowly (its current plan would normalize rates to 4% only by 2018), thus causing another asset-price boom – and an eventual bust. Indeed, unconventional monetary policies in the US and other advanced economies have already led to massive asset-price reflation, which in due course could cause bubbles in real estate, credit, and equity markets. Fourth, the crises in some fragile emerging markets may worsen. Emerging markets are facing headwinds (owing to a fall in commodity prices and the risks associated with China’s structural transformation and the Fed’s monetary-policy shift) at a time when their own macroeconomic policies are still too loose and the lack of structural reforms has undermined potential growth. Moreover many of these emerging markets face political and electoral risks. Fifth, there is a serious risk that the current conflict in Ukraine will lead to Cold War II – and possibly even a hot war if Russia invades the east of the country. The economic consequences of such an outcome – owing to its impact on energy supplies and investment flows, in addition to the destruction of lives and physical capital – would be immense. Finally, there is a similar risk that Asia’s terrestrial and maritime territorial disagreements (starting with the disputes between China and Japan) could escalate into outright military conflict. Such geopolitical risks – were they to materialize – would have a systemic economic and financial impact. Read The Changing Face of Global Risk here .
  • Shiller on Narratives and the Psychology of the Global Economy

    "We seem to be at the mercy of our narratives," writes Robert Shiller at Project Syndicate . On a speaking tour in Japan, Shiller was struck by how people there responded to the "positive change" in Prime Minister Shinzo Abe's economic reforms. A "comprehensive" and seemingly effective plan led to greater optimism, and then a narrowing of the gap between actual GDP and potential GDP. Shiller says our collective optimism was up in the early 2000s (to our detriment, as it turned out). We kept the real estate bubble going because we wanted to believe it could last forever. Then the financial crisis erupted, scaring the entire world. A story of opportunity and riches turned into one of corrupt mortgage lenders, overleveraged financial institutions, dimwitted experts, and captured regulators. The economy was careening like a rudderless ship, and the sharp operators who had duped us into getting on board – call them the 1% – were slipping away in the only lifeboats. By early 2009, the plunge in stock markets around the world reached its nadir, and fear of a deep depression, according to the University of Michigan Consumer Sentiment Survey, was at its highest level since the second oil crisis in the early 1980’s. Stories of the Great Depression of the 1930’s were recalled from our dimmest memories – or from our parents’ and grandparents’ memories – and retold. To understand why economic recovery (if not that of the stock market) has remained so weak since 2009, we need to identify which stories have been affecting popular psychology. One example is the rapid advance in smartphones and tablet computers. Apple’s iPhone was launched in 2007, and Google’s Android phones in 2008, just as the crisis was beginning, but most of their growth has been since then. Apple’s iPad was launched in 2010. Since then, these products have entered almost everyone’s consciousness; we see people using them everywhere – on the street and in hotel lobbies, restaurants, and airports. This ought to be a confidence-boosting story: amazing technologies are emerging, sales are booming, and entrepreneurship is alive and very well. But the confidence-boosting effect of the earlier real-estate boom was far more powerful, because it resonated directly with many more people. This time, in fact, the smartphone/tablet story is associated with a sense of foreboding, for the wealth that these devices generate seems to be concentrated among a tiny number of tech entrepreneurs who probably live in a faraway country. These stories awaken our fears of being overtaken by others on the economic ladder. And now that our phones talk to us (Apple launched Siri, the artificial voice that answers your spoken questions, on its iPhones in 2010), they fuel dread that they can replace us, just as earlier waves of automation rendered much human capital obsolete. Read The Global Economy's Tale Risks here .
  • Crimea Crisis: The Economic Costs to Russia

    War is costly on all levels. And Russia's involvement in Ukraine is going to be costly economically, not only for all Ukrainians, but for the Russian economy. How costly? Very costly, argues Sergei Guriev , a professor of economics and former Rector at the New Economic School in Moscow who is currently a visiting professor at Sciences Po . At Project Syndicate Guriev writes "The economic damage to Russia will be vast." First, there are the direct costs of military operations and of supporting the Crimean regime and its woefully inefficient economy (which has been heavily subsidized by Ukraine’s government for years.) Given the uncertainty surrounding Crimea’s future status, these costs are difficult to estimate, though they are most likely to total several billion dollars per year. A direct cost of this magnitude amounts to less than 0.5% of Russia’s GDP. While not trivial, Russia can afford it. Russia just spent $50 billion dollars on the Sochi Olympics and plans to spend even more for the 2018 World Cup. It was prepared to lend $15 billion to former Ukrainian President Viktor Yanukovych’s government and to provide $8 billion annually in gas subsidies. Then there are the costs related to the impact of sanctions on trade and investment. Though the scope of the sanctions remains uncertain, the effect could be enormous. Annual inward foreign direct investment is estimated to have reached $80 billion in 2013. A significant decline in FDI – which brings not only money but also modern technology and managerial skills – would hit Russia’s long-term economic growth hard. And denying Russian banks and firms access to the US (and possibly European) banking system – the harshest sanction applied to Iran – would have a devastating impact. In the short run, however, it is trade that matters much more than investment. Russia’s annual exports (mostly oil, gas, and other commodities) are worth almost $600 billion, while annual imports total almost $500 billion. Any non-trivial trade sanctions (including sanctions on Russian financial institutions) would be much more painful than the direct cost of subsidizing Crimea. Of course, sanctions would hurt Russia’s trading partners, too. But Russia’s dependence on trade with the West is certainly much larger than vice versa. Moreover, the most important source of potential damage to Russia’s economy lies elsewhere. Russian and foreign businesses have always been worried about the unpredictability of the country’s political leadership. Lack of confidence in Russian policymaking is the main reason for capital flight, low domestic asset prices, declining investment, and an economic slowdown that the Crimea crisis will almost certainly cause to accelerate. Read Putin's Imperial Road to Ruin here .
  • Rogoff on Potential Blocks to Sustained Economic Progress

    When you look at the collective rise in the quality of living for most people over the last century, it is easy to understand why Warren Buffett says he will continue to bet on economic prosperity. But, writing at Project Syndicate , Kenneth Rogoff warns that "past growth performance is no guarantee that a broadly similar trajectory can be maintained throughout this century." And he lays out four problems to consider: The first set of issues includes slow-burn problems involving externalities, the leading example being environmental degradation. When property rights are ill-defined, as in the case of air and water, government must step in to provide appropriate regulation. I do not envy future generations for having to address the possible ramifications of global warming and fresh-water depletion. A second set of problems concerns the need to ensure that the economic system is perceived as fundamentally fair, which is the key to its political sustainability. This perception can no longer be taken for granted, as the interaction of technology and globalization has exacerbated income and wealth inequality within countries, even as cross-country gaps have narrowed. Until now, our societies have proved remarkably adept at adjusting to disruptive technologies; but the pace of change in recent decades has caused tremendous strains, reflected in huge income disparities within countries, with near-record gaps between the wealthiest and the rest. Inequality can corrupt and paralyze a country’s political system – and economic growth along with it. The third problem is that of aging populations, an issue that would pose tough challenges even for the best-designed political system. How will resources be allocated to care for the elderly, especially in slow-growing economies where existing public pension schemes and old-age health plans are patently unsustainable? Soaring public debts surely exacerbate the problem, because future generations are being asked both to service our debt and to pay for our retirements. The final challenge concerns a wide array of issues that require regulation of rapidly evolving technologies by governments that do not necessarily have the competence or resources to do so effectively. We have already seen where poor regulation of rapidly evolving financial markets can lead. There are parallel shortcomings in many other markets. Read Malthus, Marx, and Modern Growth here .
  • Kemal Derviş Sees 'Vulnerability' in Emerging Market Private Sector Balance Sheets

    There has been a fair bit of pessimism about the fate of emerging market economies this year. At Project Syndicate , Kermal Derviş writes that, with the Federal Reserve expected to begin tapering off its quantitative easing programs, "the emergent market bears are ascendant once again." In gauging whether countries like Brazil, India, Indonesia, South Africa, and Turkey are in trouble, Davis urges us to pay a little less attention to public deficits and look more at private sector balance sheets. To be sure, the weakest-looking emerging countries have large current-account deficits and low net central-bank reserves after deducting short-term debt from gross reserves. But one could argue that if there is a capital-flow reversal, the exchange rate would depreciate, causing exports of goods and services to increase and imports to decline; the resulting current-account adjustment would quickly reduce the need for capital inflows. Given fiscal space and solid banks, a new equilibrium would quickly be established. Unfortunately, the real vulnerability of some countries is rooted in private-sector balance sheets, with high leverage accumulating in both the household sector and among non-financial firms. Moreover, in many cases, the corporate sector, having grown accustomed to taking advantage of cheap funds from abroad to finance domestic activities, has significant foreign-currency exposure. Where that is the case, steep currency depreciation would bring with it serious balance-sheet problems, which, if large enough, would undermine the banking sector, despite strong capital cushions. Banking-sector problems would, in turn, require state intervention, causing the public-debt burden to rise. In an extreme case, a “Spanish” scenario could unfold (though without the constraint of a fixed exchange rate, as in the eurozone). It is this danger that sets a practical and political limit to flexible exchange rates. Some depreciation can be managed by most of the deficit countries; but a vicious circle could be triggered if the domestic currency loses too much value too quickly. Private-sector balance-sheet problems would weaken the financial sector, and the resulting pressure on public finances would compel austerity, thereby constraining consumer demand – and causing further damage to firms’ balance sheets. To prevent such a crisis, therefore, the exchange rate has to be managed – and in a manner that depends on a country’s specific circumstances. Large net central-bank reserves can help ease the process. Otherwise, a significant rise in interest rates must be used to retain short-term capital and allow more gradual real-sector adjustment. Higher interest rates will of course lead to slower growth and lower employment, but such costs are likely to be smaller than those of a full-blown crisis. Read Tailspin or Turbulence? here .
  • Feldstein on Steadily Improving Standard of Living

    Looking for some cheery economic analysis? Then Martin Feldstein is your man. Stop fretting over the slow rate of growth. Looking beyond 2014, Feldstein makes the case that slow, steady growth will bring significant improvement in the standard of living. From Project Syndicate : The Congressional Budget Office (CBO) projects that real per capita GDP growth will slow from an annual rate of 2.1% in the 40 years before the start of the recent recession to just 1.6% between 2023 and 2088. The primary reason for the projected slowdown is the decrease in employment relative to the population, which reflects the aging of American society, a lower birth rate, and a decelerating rise in women’s participation in the labor force. While the number of persons working increased by 1.6% per year, on average, from 1970 to 2010, the CBO forecasts that the rate of annual employment growth will fall to just 0.4% in the coming decades. A drop in annual growth of real per capita GDP from 2.1% to 1.6% looks like a substantial decline. But even if these figures are taken at face value as an indication of future living standards, they do not support the common worry that the children of today’s generation will not be as well off as their parents. An annual per capita growth rate of 1.6% means that a child born today will have a real income that, on average, is 60% higher at age 30 than his or her parents had at the same age. Of course, not everyone will experience the average rate of growth. Some will outperform the average 60% rise over the next three decades, and some will not reach that level. But a 30-year-old in 2044 who experiences only half the average growth rate will still have a real income that is nearly 30% higher than the average in 2014. But things are even better than those numbers imply. Although government statisticians do their best to gauge the rise in real GDP through time, there are two problems that are very difficult to overcome in measuring real incomes: increases in the quality of goods and services, and the introduction of new ones. I believe that both of these problems cause the official measure of real GDP growth to understate the true growth of the standard of living that real GDP is supposed to indicate. Read The Future of American Growth here .
  • The Challenge Ahead for Commodity-Price Dependent Latin American Economies

    Andrés Velasco , former finance minister of Chile, is not exactly bullish on growth in his country and across the region. At Project Syndicate , he lays out the challenge ahead. If Latin American economies do not diversify sufficiently, then maintaining anything close to the recent rate of growth will be difficult. Velasco: It is pretty clear by now that an extraordinarily benevolent external environment, not a revolutionary policy shift, underpinned Latin America’s rapid growth in the years following the 2008-2009 global economic crisis. As long as the price of soy, wheat, copper, oil, and other raw materials remained stratospheric, commodity-rich countries like Brazil, Chile, and Peru got a tremendous boost; even Argentina grew rapidly, despite terrible economic policies. But now “secular stagnation” – the concept du jour in US policy debates since former Treasury Secretary Larry Summers argued last November that the US (and perhaps other advanced economies) has entered a long period of anemic GDP growth – may also be coming to Latin America. The argument goes like this: high consumer debt, slowing population growth, and rising income inequality have weakened consumer demand and stimulated savings, while slowing growth in productivity and output itself has discouraged investment. So the “natural” rate of interest – the rate at which the demand for investment equals the supply of savings – has fallen, and arguably has become negative. But, because real interest rates cannot be strongly negative unless inflation is high (which it is not), there is a savings glut. With consumption and investment lagging, the US economy is bound to stagnate. But how could such a situation apply to Latin America, where GDP growth is faster, interest rates are higher, and domestic demand is stronger than in the US? Consider the region’s history. Until the recent commodity-driven boomlet, growth in Latin America was mediocre. The 1980’s are known as the “lost decade,” owing to a debt crisis and massive recessions, while the market-based reforms of the 1990’s did little to reignite short-run growth. From 1960 to 2007, only four countries in Latin America and the Caribbean – Brazil, Chile, the Dominican Republic, and Panama – grew faster than the US. So meager growth in the coming years would be a return to Latin America’s historical pattern, not a deviation from it. Read Secular Stagnation Heads South here .
  • Eichengreen: Lessons Learned From the Decade of Concern Over Global Imbalance

    At Project Syndicate , Barry Eichengreen declares the "era of imbalances is over." Ten years ago, Eichengreen notes, leading economies had rising current-account deficits--the U.S.'s rose to 5.8% of GDP--or current-account surpluses--China's hit 10% of GDP. But now, those surpluses and deficits are mostly under control. Eichengreen tries to sort out some lessons from the decade. Back in 2004, there were two schools of thought on global imbalances. The Dr. Pangloss school dismissed them as benign – a mere reflection of emerging economies’ demand for dollar reserves, which only the US could provide, and American consumers’ insatiable appetite for cheap merchandise imports. Trading safe assets for cheap merchandise was the best of all worlds. It was a happy equilibrium that could last indefinitely. By contrast, adherents of the Dr. Doom school warned that global imbalances were an accident waiting to happen. At some point, emerging-market demand for US assets would be sated. Worse, emerging markets would conclude that US assets were no longer safe. Financing for America’s current-account deficit would dry up. The dollar would crash. Financial institutions would be caught wrong-footed, and a crisis would result. We now know that both views were wrong. Global imbalances did not continue indefinitely. As China satisfied its demand for safe assets, it turned to riskier foreign investments. It began rebalancing its economy from saving to consumption and from exports to domestic demand. The US, meanwhile, acknowledged the dangers of excessive debt and leverage. It began taking steps to reduce its indebtedness and increase its savings. To accommodate this change in spending patterns, the dollar weakened, enabling the US to export more. The renminbi, meanwhile, strengthened, reflecting Chinese residents’ increased desire to consume. There was a crisis, to be sure, but it was not a crisis of global imbalances. Although the US had plenty of financial problems, financing its external deficit was not one of them. On the contrary, the dollar was one of the few clear beneficiaries of the crisis, as foreign investors, desperate for liquidity, piled into US Treasury bonds. Read A Requiem for Global Imbalances here .
  • Stiglitz Offers Up Prescription for EU Woes

    Writing at Project Syndicate , Joseph Stiglitz warns us not to celebrate Europe's exit of a double dip recession, given that there are EU states "with per capita GDP still below pre-2008 levels, unemployment rates above 20%, and youth unemployment at more than 50%." He is calling for "fundamental reform," in the euro zone. He does not chalk up the EU's economic woes to the euro zone itself being a bad idea. Rather, the design was the problem. Stiglitz: Much of the euro’s design reflects the neoliberal economic doctrines that prevailed when the single currency was conceived. It was thought that keeping inflation low was necessary and almost sufficient for growth and stability; that making central banks independent was the only way to ensure confidence in the monetary system; that low debt and deficits would ensure economic convergence among member countries; and that a single market, with money and people flowing freely, would ensure efficiency and stability. Each of these doctrines has proved to be wrong. The independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility. Likewise, Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. The crisis caused the deficits and high debt, not the other way around, and the fiscal constraints that Europe has agreed will neither facilitate rapid recovery from this crisis nor prevent the next one. Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialized), has been hollowing out the weaker economies. It can also result in a misallocation of labor. Internal devaluation – lowering domestic wages and prices – is no substitute for exchange-rate flexibility. Indeed, there is increasing worry about deflation, which increases leverage and the burden of debt levels that are already too high. If internal devaluation were a good substitute, the gold standard would not have been a problem in the Great Depression, and Argentina could have managed to keep the peso’s peg to the dollar when its debt crisis erupted a decade ago. Read An Agenda to Save the Euro here .
  • Frankel on the Resilient Dollar

    During the Great Recession, we were starting to come to terms with a weakening U.S. global economic position. And we saw the dollar lose ground (though it remained the chosen global currency). Well, the currency seems to be regaining that ground. At Project Syndicate , Jeffrey Frankel writes that the dollar will likely be replaced as the top currency someday. "But today is not that day." The International Monetary Fund’s most recent statistics suggest, unexpectedly, another pause in the dollar’s long-term decline. According to the IMF, the dollar’s share in foreign-exchange reserves stopped falling in 2010 and has been flat since then. If anything, the share is up slightly thus far in 2013. Similarly, the Bank for International Settlements (BIS) reported in its recent triennial survey that the dollar’s share in the world’s foreign-exchange trades rose from 85% in 2010 to 87% in 2013. Given dysfunctional US fiscal policy, the dollar’s resilience is surprising. Or maybe we should no longer be surprised. After all, when the global financial crisis erupted in 2008 from the bowels of the American subprime-mortgage market, global investors responded by fleeing to the US, not from it. They obviously still regard US Treasury bills as a safe haven and the In particular, the euro has its own all-too-obvious problems. Indeed, the euro’s share in reserve holdings and foreign-exchange transactions have both declined by several percentage points in the most recent statistics. At the same time, the IMF’s data indicate that the vaunted renminbi is not yet among the top seven currencies in terms of central-bank reserve holdings. And, according to the BIS, while the renminbi has finally broken into the top ten currencies in foreign-exchange markets, it still accounts for only 2.2% of all transactions, just behind the Mexican peso’s 2.5% share. Despite recent moves by the Chinese government, the renminbi still has a long way to go. To try to explain the recent stabilization of the dollar’s status, one might note something that the last three years have in common with the previous period of temporary reversal from 1992 to 2000: striking improvements in the US budget deficit. By the end of the 1990’s, the record deficits of the 1980’s had been transformed into record surpluses; today, the federal deficit is less than half its 2010 level. Read The Dollar and Its Rivals here .
  • The Tenuous 'Quasi-Dominant Policymaking Position' of Central Banks

    Central banks have risen to positions of great power and responsibility in large developed economies. So much so that we watch their every move as if it has the potential to change everything. They not have planned on acquiring this "quasi-dominant policymaking position," as Mohamed El-Erian puts it, but this is where they are thanks to the global economic crisis. However, as El-Erian argues in a piece at Project Syndicate , they may lose their power quickly and with dangerous consequences if other policy making institutions (namely, elected leaders) don't stop relying on central banks to prop up economies, Comforted by the notion of a “central-bank put,” many investors have been willing to “look through” countries’ unbalanced economic policies, as well as the severe political polarization that now prevails in some of them. The result is financial risk-taking that exceeds what would be warranted strictly by underlying fundamentals – a phenomenon that has been turbocharged by the short-term nature of incentive structures and the lucrative market opportunities afforded until now by central banks’ assurance of generous liquidity conditions. By contrast, non-financial companies seem to take a more nuanced approach to central banks’ role. Central banks’ mystique, enigmatic policy instruments, and virtually unconstrained access to the printing press undoubtedly captivate some. Others, particularly large corporates, appear more skeptical. Doubting the multi-year sustainability of current economic policy, they are holding back on long-term investments and, instead, opting for higher self-insurance. Of course, all problems would quickly disappear if central banks were to succeed in delivering a durable economic recovery: sustained rapid growth, strong job creation, stable financial conditions, and more inclusive prosperity. But central banks cannot do it alone. Their inevitably imperfect measures need to be supplemented by more timely and comprehensive responses by other policymaking entities – and that, in turn, requires much more constructive national, regional, and global political paradigms. Having been pushed into an abnormal position of policy supremacy, central banks – and those who have become dependent on their ultra-activist policymaking – would be well advised to consider what may lie ahead and what to do now to minimize related risks. Based on current trends, central banks’ reputation increasingly will be in the hands of outsiders – feuding politicians, other (less-responsive) policymaking entities, and markets that have over-estimated the monetary authorities’ power. Read The Uncertain Future of Central Bank Supremacy here .
  • The EU's Need to Focus on Growth

    Jean Pisani-Ferry thinks it is time for Europe's leaders to put growth at the top of the to-do list. The last six years have been brutal for GDP across the EU. Several member-states are now looking at GDP per capita that is well below where it was before the Great Recession, and even the model economy, Germany, has seen only anemic" growth in GDP. Writing at Project Syndicate , Pisani-Ferry argues that EU policymakers first need to make growth a priority, and then they need to come together to build a cohesive plan: In the eurozone, the hope is that calmer sovereign-debt markets, slower fiscal adjustment, and supportive monetary policy by the European Central Bank will help trigger a sustained recovery. This may be the case, but the recovery that is now expected will not suffice to offset the adverse consequences of the last six years. The productivity gains that failed to materialize during this period are lost forever: many people who have experienced long-term unemployment or have left the labor force are unlikely to return to work, and Europe will be lucky if productivity growth accelerates somewhat and approaches pre-crisis trends – better than nothing, but hardly satisfactory. Things are completely different in the United States, where growth is on everyone’s agenda: the Federal Reserve is targeting an employment rate below 6.5%, and companies have used the recession as an opportunity to reorganize and become more efficient. The lasting adverse effects of the 2008 shock are likely to be much smaller there than in Europe. So, why is Europe not doing more to return to growth? European leaders would probably say, first, that they have been forced to address more urgent matters since the Greek crisis erupted in 2010. But, while it is true that much policy attention has been devoted to fighting financial fires, this is not a sufficient answer: since the summer of 2012, when ECB President Mario Draghi convinced markets that the eurozone would not break up, Europe has had enough breathing space to address the growth imperative, but has barely done so. The second explanation is that there is agreement on the goal but not on the means. Again, there is some truth to this. Keynesians argue that Europe would grow if only policy were focused on generating aggregate demand; they blame precipitous fiscal consolidation and insufficiently aggressive monetary easing for the loss of momentum. Their opponents, by contrast, see structural weaknesses and internal imbalances as the major impediment to growth; for supply-siders, it is the slow pace of economic and social reforms that is to blame. This lack of consensus on the nature of the problem arguably hinders agreement on a solution. But, again, this is not an entirely convincing explanation. Disagreements such as this have arisen before – and not only in Europe. Given sufficient will, there could be ample room for compromise. As the Nobel laureate economist Paul Samuelson famously said, the reason we have two eyes is to keep one on supply and the other on demand. Read Europe’s Elusive Growth Consensus here .
  • Stephen Roach: U.S. Government Shutdown as China's 'Wake-up Call'

    At Project Syndicate , Stephen Roach writes about the debt-fueled China and U.S. co-dependence. While "China buys Treasuries because they suit its currency policy and the export-led growth that it has relied on over the past 33 year," the U.S. "runs chronic current-account deficits and relies on foreign investors to fill [its] funding void." It is a relationship that Roach sees as unsustainable. And The fights in Washington over the debt ceiling may serve as a "wake-up call." For more than 20 years, this mutually beneficial codependency has served both countries well in compensating for their inherent saving imbalances while satisfying their respective growth agendas. But here the past should not be viewed as prologue. A seismic shift is at hand, and America’s recent fiscal follies may well be the tipping point. China has made a conscious strategic decision to alter its growth strategy. Its 12th Five-Year Plan, enacted in March 2011, lays out a broad framework for a more balanced growth model that relies increasingly on domestic private consumption. These plans are about to be put into action. An important meeting in November – the Third Plenum of the Central Committee of the 18th Chinese Communist Party Congress – will provide a major test of the new leadership team’s commitment to a detailed agenda of reforms and policies that will be required to achieve this shift. The debt-ceiling debacle has sent a clear message to China – and comes in conjunction with other warning signs. Post-crisis sluggishness in US aggregate demand – especially consumer demand – is likely to persist, denying Chinese exporters the support they need from their largest foreign market. US-led China bashing – a bipartisan blame game that reached new heights in the 2012 political cycle – remains a real threat. And now the safety and security of US debt are at risk. Economic alarms rarely ring so loudly. The time has come for China to respond with equal clarity. Rebalancing is China’s only option. Several internal factors – excess resource consumption, environmental degradation, and mounting income inequalities – are calling the old model into question, while a broad constellation of US-centric external forces also attests to the urgent need for realignment. Read China’s Wake-Up Call from Washington here .
  • Kenneth Rogoff on Potential Economic Cost of Incivility in Washington

    Nobody is arguing that the shutdown of the U.S. federal government is not hurting the dollar and U.S. business, but it has yet to spell economic disaster. "At least for now," Kenneth Rogoff writes at Project Syndicate , "the rest of the world seemingly has unbounded confidence." But that is unlikely to last, Rogoff notes. Consider what happened when the Federal Reserve misplayed its hand with premature talk of “tapering” its long-term asset purchases. After months of market volatility, combined with a reassessment of the politics and the economic fundamentals, the Fed backed down. But serious damage was done, especially in emerging economies. If the mere suggestion of monetary tightening roils international markets to such an extent, what would a US debt default do to the global economy? Much of the press coverage has focused on various short-term dislocations from counterproductive sequestration measures, but the real risk is more profound. Yes, the dollar would remain the world’s main reserve currency even after a gratuitous bout of default; there is simply no good alternative yet – certainly not today’s euro. But even if the US keeps its reserve-currency franchise, its value could be deeply compromised. The privilege of issuing the global reserve currency confers enormous advantages on the US, lowering not just the interest rates that the US government pays, but reducing all interest rates that Americans pay. Most calculations show that the advantage to the US is in excess of $100 billion per year. There was a time, during the 1800’s, when the United Kingdom enjoyed this “exorbitant privilege” (as Valéry Giscard d’Estaing once famously called it when he served as French President Charles de Gaulle’s finance minister). But, as foreign capital markets developed, much of the UK’s advantage faded, and had almost disappeared entirely by the start of World War I. CommentsView/Create comment on this paragraphThe same, of course, will ultimately happen to the dollar, especially as Asian capital markets grow and deepen. Even if the dollar long remains king, it will not always be such a powerful monarch. But an unforced debt default now could dramatically accelerate the process, costing Americans hundreds of billions of dollars in higher interest payments on public and private debt over the coming decades. Read America's Endless Budget Battle here .
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