international analysis and commentary

Tackling global imbalances: a matter of fresh economic thinking


As the cyclical picture of the world economy now appears to be broadly improving (despite some concerns and exceptions) we have to ask ourselves about the structural picture. What were the underlying causes and consequences of the crisis and to what extent will they continue to impede the recovery, resulting in secular stagnation?

The good news is that the “new normal” if we look at the world economy as a whole, is not actually that different from the old normal. The average growth of the world economy in the 20 years before the crisis (from 1988-2007, IMF Purchasing Power Parity) was 3.6%. According to the IMF forecast in 2014 the growth of the world economy as a whole will be 3.6% – exactly the same.

The composition of that figure, though, is interesting. The developed countries have slowed down and the IMF expects 2.2% growth this year as opposed to an average of 2.8% before the crisis. In the emerging economies growth is projected at 4.9% this year and it was 4.9% before the crisis. In other words, the average growth remains the same, as half the world has slowed down and the other half is doing the same: the arithmetic because is due to the base effect.

The emerging economies are now a much larger part of the world than the developed economies and because they are structurally growing at a faster rate the average can improve. So that is the good news about the world economy. Even with the slowdown of China, whose growth is slowing to 7%, rather than 10%, we know that it is now growing at 7% off a base of around $10 trillion. When it was growing at 10% it was growing off a base of only $2 trillion. Thus China, even as it slows down, contributes more and more to global economic demand.

Now the bad news about the causes and consequences of the global financial crisis. Is the slowdown since 2008 in both developed and emerging economies a supply or demand phenomenon? I think it is a demand phenomenon, because it is hard to argue that technology and productivity have fundamentally weakened. If anything the pace of technological progress is probably accelerating again. There was a view until recently that energy and resource constraints were going to be an overwhelming problem from the world economy, but that no longer seems to be the case. As the global economic cycle has accelerated, attention has begun to shift from what seemed like structural obstacles, for example “peak oil” in 2011 or the slowdown in technical change identified in 2012 by the US economist Robert Gordon, to structural opportunities, for example shale oil, robotics and driverless vehicles. This positive reassessment of supply-side opportunities will surely continue if cyclical conditions continue improving, which seems almost certain now in the US and Britain and quite probable in Europe and Japan.

Unfortunately on the demand side of the world economy, we can see some real problems that are closely connected to the growth of debt and leverage that led up to the crisis and to a large extent caused it. Specifically I would identify three imbalances – social, geographical and demographic – that caused the huge buildup of debt before the crisis and still pose a major challenge to the sustainability of the global system.

First of all, the social imbalance. The widening of income distribution is an issue that everyone has now started to talk about. But in addition to the obvious political and social concerns, there is a very important macroeconomic dimension which has attracted less attention and really goes back to under-consumption theories of Karl Marx and even earlier writers of the 18th and 19th centuries. If more and more of the world’s income goes to a small portion of the population at the top of the income distribution, this inevitably creates crises of under-consumption and overproduction of the kind that Marx and Engels described in Das Kapital and that Keynes analysed more thoroughly in the 1930s. Since the widening of income gaps seems to be caused by an almost inexorable dynamic of modern technology, globalization and politics, this social imbalance is a very intractable problem to which I have not heard credible solutions in the post-crisis years.

The second imbalance is geographical. Before the crisis there was widespread concern about the “global imbalances” between the US on the one hand and China and Japan on the other. Those imbalance have largely been removed, but now we have a more localized and equally troubling imbalance between Germany and the rest of Europe – in fact between Germany and the rest of the world. Germany’s current account surplus today is around 7 per cent of GDP, larger and more persistent than were the Japanese or Chinese surpluses before the crisis. Yet on the global stage Germany is not subjected to the same sort of pressures. And within the Eurozone, because of the fiscal compact and the political dominance of Angela Merkel, Germany is immune to the kind of pressures that were applied to China and Japan, ultimately successfully, to reduce these imbalances.

The third imbalance is demographic. Proponents of “secular stagnation” have drawn attention to the downward pressure from demographics on underlying supply growth. But there is an equally important pressure from demographic imbalance on economic demand. All over the world we have seen social and labor market policies that redistribute both incomes and economic opportunities from younger to older generations. Government support for older people’s pension and healthcare “entitlements” have been protected or even increased since the crisis, in contrast to the sharp spending reductions on in-work welfare, education, family policies and child support. This preferential treatment of older voters has shifted income away from young people and to make matters worse, it has also deprived the younger generation of economic opportunities. For example, employment protection for the older generation has been prioritized, especially in Europe, over employment flexibility and job creation policies that would favor new entrants to the labour force. This demographic imbalance in politics has had a big macroeconomic demand impact, contributing to the global pressures of under-consumption, because the ageing Baby Boom generation is already richer than their children and grandchildren and therefore tends to save more and spend less.  

These are a whole host of new problems and there is a need for new solutions, which must surely start with a better understanding of the fundamental problems and how they are intertwined. If the sustainability of global economic recovery is still in question, this is not just because of financial greed or imprudence or boom-bust banking cycles or errors in financial or macro policies. To understand the real problems we don’t just need a reassessment of banking policy or macroeconomics or monetary policy – we need a new understanding of economics. We have to get away from the economics that assumes equilibria, self-stabilising financial markets and automatic processes of return to full employment, as well as the policies that these assumptions led to, such as central bank mandates that focus exclusively on inflation targets and arbitrary fiscal rules such as the Stability and Growth Pact. We need instead to replace inflation targeting at the central bank level by the sort of control engineering approach that Fed Chairman Janet Yellen has spoken about. We have to allow more flexibility and pragmatism in fiscal policy. And we need to show more respect again for income distribution as an important objective of economic policy, look more closely at industrial policies and have a deeper understanding of global trade. It is time, not just for new economic policies, but for new economic thinking.