While he believes the global recession may be technically over, Nobel-prize winning economist Paul Krugman is not entirely clear what it will take to achieve full recovery.
“We need a source of demand — a driver — which is very hard to find,” he told attendees at a recent conference at the Centre for International Governance Innovation (CIGI), the Jim Balsillie-founded think tank, in Waterloo.
“Consumers can’t do it and export-led growth is not going to work because this is a global crisis. It should be a surge in business investment. But where is that going to come from? Government spending can prop us up but it looks like that it will not be big enough.” He then turned his attention to Canada, acknowledging that the country’s national employment performance has been better than that of the U.S. and banks were
insulated from the severity of the financial crisis. However, Krugman notes that Canada’s economic future direction will follow the American economy.
“Canada is closer to the U.S. economically than it is to itself,” he says. “Canada can’t have a full recovery until the U.S. does which, unfortunately, is very far away.”
A possible solution may be innovation. “It would be really helpful if someone could invent something like the Internet or the railroad about now because that is what we need for our recovery,” he says. “I have this slightly hopeful thought that climate change policy could unleash a wave of business investment in anticipation of carbon pricing.”
The seeds for that transformation may be found in draft legislation currently before the U.S. Senate. In Krugman’s mind, the American Clean Energy and Security Act is better than many believe because its cap-and-trade provisions offer incentives to large utilities to become more efficient, which will reduce emissions and then pass on part of the savings to consumers. If the law is passed, he believes that the world’s advanced economies, including Canada, will all soon follow with similar legislation.
Nevertheless, the economy is still in the dumps. “The recession may be over. But if you are looking for a job it isn’t,” says Harvard University economics professor Kenneth Rogoff. “The latest U.S. unemployment figures were 9.8 per cent. That understates the true picture because many people have given up looking for work.”
Like many other observers, Rogoff sees China as the crouching tiger in today’s world economy. “There is growth in China, especially in plant and equipment that will eventually be targeted at keeping their export machine going,” he says.
But Rogoff also detects a flaw in the plan. “China is using its resources to grow (exports). But if the U.S.consumer does not come back the same way, there could be problems down the road, toward the end of next year.”
The problem, as he sees it, is that although Chinese exports continue growing, the rest of the world just can’t keep absorbing the goods. Rogoff proposes that China refocus it priorities on meeting internal market demand.
That switchover may already be underway. According to Alicia Garcia-Herrero, Hong Kong-based chief economist for emerging markets for the Spanish bank, BBVA, “Since the Chinese government has changed the social safety net for health care and retirement benefits, people are now starting to buy medical insurance. The government has also introduced a three-pillar retirement plan in major cities and is also increasing financial education so consumers can buy proper coverage.”
Another untapped source of domestic demand is China’s housing market. Currently there is a low level of home ownership with little participation from the middle class. The shift to more domestic consumer spending need not be great. Currently the figure is about 35 per cent of total annual GDP. In Garcia-Herrero’s opinion, bumping it up to around 40 per cent would make a big difference. And it would follow in the earlier economic footsteps of Japan, Taiwan and Korea.
As Chinese consumers save less and spend more it will benefit domestic Chinese producers but not necessarily foreign exporters. “It will be good for commodity producers and makers of luxury goods,” says Garcia-Herrero. “But it will be tough for machinery exporters in Germany to sell there because of import substitution. China has started to make more of its own precision production equipment.”
Besides the voracious appetite of its huge consumer market, China’s other ace in the hole is its estimated reserve of US$2 trillion in American government debt. That amount places great pressure on global financial and currency markets. The first concern is its potential impact on the American dollar’s role as the global reserve currency.
According to a recent Bank of International Settlement survey, 87 per cent of all global trade transactions are denominated in U.S. dollars at one end of the deal or the other.
The consensus among session speakers is that while no other currency is about to knock the dollar off its perch, many countries, especially emerging economies, are now thinking seriously of alternatives. For example, Chinese business leaders are seeking a greater role for special drawing rights (SDRs) — an artificial IMF currency based on the value of a basket of world currencies.
“Recently, there have been more issues of SDR-denominated IMF bonds reaching a level of about 5 per cent of the total,” says the Balsillie School of International Affairs’ economist Eric Helleiner. “In the late 70’s, it was closer to 9 per cent.
“The same discussions about the U.S. dollar were around in the 1960s. Earlier in the current crisis, the euro appeared to be a credible alternative. But more recently, it is looking less stable because of growing concerns over a possible bailout for Greece and the impact of problems in Eastern European economies.”
Another future candidate may be the renminbi — China’s currency. “That might happen in 10 to 15 years,” says York University politics Professor Gregory Chin.
China needs to build investor confidence to get foreigners to hold renminbi, Chin says. He believes that the Chinese government is looking to Hong Kong’s securities and financial markets to help internationalize the renminbi, which is currently a controlled currency.
Krugman cited the example of Japanese corporations during the 1980s. He points out that they bought things like New York City’s Rockefeller Center and various Hollywood movie studios.
Other emerging markets, such as Brazil, have become bolder in seeking to make their voices heard in the continuing multilateral trade and finance talks. “In the discussions about the kind of tomorrow we are looking for, this is the first time that Brazil is not part of the problem, but at least a significant part of the solution,” says Marcel Bioto, policy advisor, Office of the President of Brazil.
Such newfound confidence reflects Brazil’s recent successes, including having its second-largest city, Rio de Janeiro, chosen as the host for the 2016 Olympic Summer Games and its purchase of US$10 billion in IMF bonds in June. The latter signifies a remarkable economic turnaround since Brazil received US$45 billion in IMF bailout loans in 2001-2002 to deal with a financial crisis.
Bioto attributes Brazil’s successful bootstrapping to the government’s introduction of major institutional experimentation, which led to a wider distribution of resources that helped develop the domestic economy. “Prosperity came as a result of maximizing our strengths and developing synergies, not just our size,” he says.
“As an emerging economy, we have found a certain niche and are now looking at how to become a responsible stakeholder at the main table of international discussions. To be true to our priorities, we want to do it on our own terms.”
From the Indian perspective, its trade relations are more focused on regional and emerging market players than developed markets in Europe and North America. According to Manmohar Agarwal, CIGI senior fellow, India’s financial sector was insulated from the global crisis because of tighter regulation.However, the country lacked the means to introduce a strong stimulus package because of high existing government deficits.
“Brazil and India each have about 1 per cent of total global GDP,” he says. “That makes us too small to be engines of growth.”
During a global recession, protectionism trumps free trade. According to Andrew Rose, University of California Business School, since the November 2008 G20 meeting in Washington D.C., there have been new trade protectionist measures introduced every three days.
Among the causes is the lack of world leadership. In the United States, “President (Barack) Obama is a lukewarm supporter of free trade,” he says. “During the debate over the stimulus package in Congress, he never threatened to veto it. And despite NAFTA, he has also prevented Mexican trucking firms from entering the United States.”
Closer to home, the ‘Buy American’ clause in the U.S. stimulus bill has stymied attempts by Canadian exporters to supply goods to government infrastructure projects. Krugman, a noted free trader, offers little comfort to Canadian companies. “In free trade terms, we
should not be doing that,” he says.
“But we’re in the middle of a severe slump. So when stimulus spending stimulates someone else’s economy, that is a real problem.
“I don’t think that you can get too worked up about the U.S. Congress putting in those provisions. If fact, they have very little bite. So, it is more symbolic than anything else.”
Ultimately, Krugman suggests that more government stimulus money financed by public debt could pull the economy out recession. For the U.S., that would amount to about 3 per cent of GDP, which he believes is not likely to happen, certainly not in one big lump.
“The Chinese, who do not operate under the same political restraints as we do, have been able to use a great deal of public money in a very short time,” he says. “And it has worked. We all know how to do this.
“The problems are fundamentally political, not economic.”
This article appeared in the November 2009 issue of The Bottom Line.