GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
How the U.S. can emerge from the global slump
, May 28, 2011
The policy response to the global financial crisis, especially in its country of origin, the United States, is beginning to look like bad “old” world optimism. Generated by the excesses of the finance industry, the GFC took hold of the world economy in the third quarter of 2007. Within a year, it threatened to tear apart the world economy.
Policy elites began looking, not for cause and solution, but for someone to blame. They overlooked perpetrators in favour of victims.
US economic thinking retreated into orthodoxy. Unlike Humpty Dumpty falling off the wall, it would somehow put itself together again.
US Nobel prize-winning economist Paul Krugman is among the dissenters, saying this can’t happen. Left unattended, the patient will get worse. Effectively treated, however, the US economy can make a full recovery.
The data remind us that the US is still bouncing along in the trough of a prolonged, deep recession. Consumer spending, on which the US economy is 70 per cent dependent, remains flat. The official unemployment rate is conceded to be 10 per cent; the real number without full time jobs work is significantly higher.
And while this heavy cloud looms over the job market, consumer spending will not recover — all the more so while excessive debt, a hangover from the previous boom in spending, burdens so many households.
For the moment, a kind of political and economic paralysis seems to have settled over the US. The ruling elite maintains its blind faith in pure market-based solutions, and in the policy prescriptions that flow from them, not withstanding the fact that they are not working.
Some of the fundamental international regulatory bodies, such as the International Monetary Fund, are, however, having a re-think. The IMF’s previous faith in the recuperative powers of purely market-based economics has certainly been shaken.
Recent pronouncements by the IMF have acknowledged that high and stable employment levels and equitable economic outcomes are essential foundations for long-term economic and political stability.
However, this view is at variance with current policy thinking in Washington, London and much of the European Union.
While this impasse continues, the chance of the US economy being brought back to rude health is impaired and, in the opinion of this writer, so are the prospects for world economic stability.
All the more is this so, given that one of the supposedly most important stabilising elements, the European Union, continues to stumble along, seemingly in financial and organisational disarray.
It is tempting to assume that other generators of world growth are waiting in the wings. The US and Europe, so the thinking goes, are less important; and the moment is coming when, for example, we can anticipate emerging giants, China, India and even Brazil, taking up the slack.
Those who believe this point to the fact that China is the world’s fastest growing economy, that it is now second on the economic-leadership table, and fast overtaking the US.
True as this might be, there is a need to keep it in perspective — and to remember history. In the last 300 years, for example, economically powerful nations have emerged by climbing over those previously more powerful whose leaders believed in their respective countries’ invulnerability.
Britain, on the way up, did it to continental Europe. The US, in turn, did it to Britain. In each case, the transformation came about because the nation on the rise put its own interest first.
We can observe that the China push towards economic and political pre-eminence is driven by the same imperatives.
The Chinese Communist Party knows this. It also knows that, if it is to retain power, it must keep growing. Success, in this context, means the creation of jobs for its vast underemployed population moving off the land.
Britain and the US began their road to economic and political might with one important advantage over China. Their relatively small populations grew alongside their economies’ industrialisation. This helped them help the world.
China started its growth spurt with a huge population for which work had to be found. It could not have succeeded thus far, and cannot advance further, without more or less unrestrained access to the US, with its vastly larger market and much smaller population. It had no interest in accepting Western exports in return and in the West’s commitment to free trade.
Consider, by comparison, how the US got the better of Britain. Britain believed that, by adopting free trade policies, it could import cheap food from the US and flood an emerging and prosperous US market with the output of its factories.
The US had other ideas. It decided to protect its emerging industries from British imports to the point where US growth and prosperity allowed it to keep its agricultural export trade and dominate manufacturing as well.
In the aftermath, the US followed the same misguided path as Britain. Once on top, it came to the belief that free trade could serve its long-term interests best, and has promoted it vigorously to its own disadvantage.
It began by opening its market, initially to Germany and Japan — admittedly, at the time, largely driven by the geopolitical imperatives of the Cold War. Curiously, something of this approach was also used towards China. There was a fond hope that China would be brought into the capitalist camp by this approach.
There is no evidence that the Chinese Communist Party ever thought this way. An obliging hand from the US generously exporting US jobs and output to China has provided the springboard for sustained Chinese growth.
An incidental benefit, which China may or may not have anticipated, was the fact that Chinese exports sapped the strength from the US economy to the point where the export surpluses gained by China actually are taking over US businesses and helping fund US deficits.
An unintended consequence has been to destabilise the trading system and to create a divide between saving and spending nations. China is now the major savings economy and holds a disproportionate percentage of world currency reserves. By contrast, the US is the biggest consumer.
The global financial crisis, ushered into the world by the US, has been driven by the above considerations and the largely unsuccessful measures taken to offset the harm done to US manufacturing and jobs by the free trade push.
China has prospered by taking shelter under the US ideological umbrella of free trade without believing a word of it.
This is the basis on which Chinese economic and political influence has been increased to the detriment of the US and the West, and it cannot continue.
Chinese exports to the US will not be restored to pre-GFC levels for a number of reasons. First, household debt overhang is seriously reducing the US consumer’s capacity to spend. Surplus consumer income is being used to liquidate debt.
Second, the purchasing power of consumers has been further curtailed, by rising unemployment. The numbers of recorded unemployed has risen from 5 per cent to 10 per cent since the GFC. And this official data probably understates the real unemployment figures.
Uncertainty about future employment prospects, even among those currently in jobs, also acts a disincentive to spending.
The state of the US economy is another consideration.
For purposes of funding improvements in infrastructure and other necessary outlays, the US will have to begin saving more and spending less. It has no option but to shift the emphasis of the economy away from consumption expenditure and towards saving.
It must also begin making more of what it uses at home and have a greater emphasis on exporting. Rebuilding its manufacturing industry will be absolutely essential.
Given the part the US has played since the end of World War II in generating growth in the world economy, first with Europe, second with Japan and, more recently, with China and East Asia, any such change will reverberate around the world.
Whatever else the US may or may not wish to do, the simple fact is that it has to start paying its way.
It is not known how precisely it can manage this. Among other things, it will certainly be necessary to arrest and reverse the drift of US manufactures to cheap labour offshore locations —including China. A consequence of that will be some form of border protection against import competition, along with all that implies for the US commitment to free trade.
The US must close the gap between import outlays and export returns. More well-paid jobs will result, income tax collections will increase and welfare outlays will diminish. All are necessary if the US economy is to be restored to better health.
Stimulating the re-growth of US manufacturing industry will be an essential part of any such plan. It is unclear how the US can make this necessary transition, but economic recovery depends upon it. We must assume that necessity, as always, will be the driver of change.
One thing can be said for certain. If the US does what it must, there will be adverse consequences for China’s economy. At the very least, its growth will be curtailed to the extent that its access to the US market for Chinese manufactures is restricted.
In that event, the Chinese economic miracle can only continue to the extent that Chinese domestic demand takes up the slack. It is by no means certain, given the size of its job-creation problem, that China can do that.
What happens if it fails is a matter for concern; but too much is at stake —especially for the West — for the US to be distracted from the task of rebuilding its own economy.
Given its dependence on China, Australia’s economy can’t be sheltered from the consequences of what the US might do; but that is a subject for another time.
Colin Teese is a former deputy secretary of the Department of Trade.