An Answer to the Change

The world has always turned in accordance with the greatest global powers of a time period, complying with their financial strategies and emulating their precedents.  If money is power, then the financial centers of the world hold the reigns.  Prior to the 2007 financial crisis, there were three major engines that fueled the world economy: the United States, Europe, and China.  Each power possessed its own unique advantages, but they drove the world economy with comparable strength, subjecting each other to a system of checks and balances.  Evolving conditions have caused these great trends to change completely, forcing some out of the driver’s seat entirely.  In spite of the recent slowdown, China has seized the reigns and now comprises about one third of world growth, the US around ten percent, while Europe’s contribution amounts to zero or perhaps negative values.  Even if there are signs of a European recovery, it is difficult to forecast significant changes in the future roles of these major players.

The consequences of the economic crisis not only changed the protagonists, but their fuel sources as well.  The three big engines of the world run at a different speed today, and rely on a completely different array of resources.  In China, the main fuel has been investment.  Never in history has such a large country worked on an investment rate higher than 50% of its GDP for such a long period of time.  The US operated mainly on private consumption encouraged by a credit-propelled buster.  Europe worked thanks to the EU’s enlargement and exports (mainly German but also Italian and French).  Following the crisis, Chinese and American ammunition did not change, but Europe has simply run out of gas: there is no consumption and no private or public investment.  In the meantime, the interdependence of the world economy has increased as never before in previous history.  Suffice it to think about the way supply chains have evolved in the last few decades and how the trade of intermediate goods has increased.  Due to the different characters of the three giants (even without taking note of the productivity rate, labor costs, and other variables) the consequence has been the creation of a high degree of interdependence, albeit a heavily unbalanced interdependence.  Although it has decreased in recent years, China still experiences a huge and enduring surplus.  The US, on the other hand, has an enormous, permanent deficit—a large extent of which is covered by Chinese money.  Europe may be balanced, but the cost of this equilibrium is a lower and lower rate of growth.

Now we have to answer the basic question: can this unbalanced situation continue for a long time?  Recent history has demonstrated that this is impossible.  The cost of these prolonged imbalances can only be a corresponding prolonged global crisis; any intermediate recovery in this framework will be followed by a new crisis.  However, there are two possible outcomes for this critical situation.  The first is that, due to the difficulty in achieving a new equilibrium, the world will proceed in the direction of breaking up this interdependence.  This is not totally implausible because protectionist temptations are strong and increasing everywhere.  Inside Europe, the high degree of unemployment (especially among the young) is feeding new nationalists forces and pushing for more protectionism.  Nationalistic movements are targeting American monetary policies and Chinese competition accused of not adhering to coherent market rules.  Europe is, of course, accused of impeding the global economy due to its internal divisions and total lack of direction.  Many complaints fuel the protectionist trend, but it is clear that we cannot afford this unregulated competition in a period of total redistribution of global GDP.  A more mild conception of protectionism, based on the creation of regional trade areas, leads to the same conclusion.  Moreover, any type of protectionist strategy will bring the same result: lower income and higher unemployment.  We must therefore work toward a SECOND alternative outcome, which is to say an innovative development based on a shared effort to harmonize national and international economic interests.

The big players’ efforts must converge in the direction of correcting their own imbalances with the clear understanding that this will help global growth and, more importantly, that this is the only instrument with which to avoid a new worldwide economic crisis.  The pillars of change must be targeted in order to avoid the consequences of previous mistakes, and must be compatible with internal policy goals of the main countries.  From a theoretical point of view, the solution is both possible and feasible.  In short, the occasion necessitates the following: China must put into action its declared goal of increasing consumption via instrumental policies of a new welfare state, focusing on the main issues of health, education and pensions.  This would not only be a social and political achievement, but also a necessary condition to increase the propensity to consume.  On the US side, reduced private debt and less fancy finance is needed.  In theory this is an easy goal, but it is our understanding that very few changes are occurring within the American financial system.  Despite some minor technical adjustments, the message after the crisis is “business as usual.”  In Europe it appears very difficult to empower a new shared continental strategy aimed at not only to achieving harmonized budgets but also to promote growth: an impossible tasks with policies of severe austerity adopted over the last five years.

When the architecture of international institutions was elaborated after the 1929 economic crisis and World War II, the world was a completely different place.  Taking into account the consequences of the current economic crisis, it is time to draft new strategies.  The world needs a set of long-lasting relationships among the big regional blocks.  The basic goal for the foreseeable future is to guarantee freedom of trade and crossed investments, based on a set of basic shared rules.  Specifically, reviving WTO negotiations after the stalemate, dropping the impossible ambition of managing all the details, and taking into account the increased role of developing nations.  Not out of generosity, but self-interest: the future expansion of the global economy is largely in the hands of the developing world.  Another urgent aspect of this rule set is building a common environmental policy: this will be the new source of our common development in the future.  When members of the European Union insisted on the Kyoto protocol, it was a fantasy.  Now, it is a shared need.  Doing the homework is not enough: it is necessary to foster cooperation between trading blocks, and to develop common rules that respect the needs of developed and developing countries.