Why the world economy is having a bumpy ride

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Why the world economy is having a bumpy ride

Terrorism, refugee crisis and despotic leaders adding to global woes

By David Dapice

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Published: Tue 12 Apr 2016, 12:00 AM

Last updated: Tue 12 Apr 2016, 11:05 AM

The world economy has slowed substantially, and monetary stimulus is losing its punch. Several countries are employing negative interest rates to weaken their currencies and discourage capital inflows, even though these rates do little to boost real economic growth. Terrorist attacks in Europe and the refugee crisis emerging out of the Middle East add to the negative sentiment of the global economy.
Support for free trade will continue to falter unless countries enact reforms, managing exports and domestic production to encourage full employment and prevent stagnation. Preventing destabilizing terrorist attacks is a longer-term task.
On the economic front China, among others, is using increasingly strict measures to curb capital outflows - Chinese officials fear that excessive devaluations would reward speculators and spark capital outflows, but do not want to raise interest rates as that would further weaken China's highly indebted firms and shaky banks.
Only the United States seems willing to exercise its own monetary tightening, using caution, while allowing the dollar to appreciate. Yet this stance hurts exporters and manufacturing. Its low share of manufacturing relative to services gives it a little room to maneuver.
China has excess capacity in many industries, such as steel and aluminum, and is exporting products at low prices. Such trade imbalances contribute to demonstrations in Europe by workers facing layoffs and increasing anti-dumping cases in several countries. In general, trade and currency wars are a byproduct of inadequate global demand. In the past, a commodity boom fueled by China's growth patterns from 1990 to 2012 allowed many commodity exporters to grow rapidly. Now that has been thrown into reverse, and major emerging markets that export iron ore, soy, oil and other commodities such as Brazil, Argentina, Russia and South Africa are in or near recession. From 2012 to 2015, the share of global trade to world GDP has been basically flat, reversing a decades-long trend that had survived even the global financial crisis - the ratio was higher in 2011 than in 2008. It is too soon to say that the tide has turned, but exports may no longer be an engine of growth.
An often forgotten part of trade theory suggests that if there are significant unemployed resources, it may be better to use them to produce for domestic consumption than to import and pay unemployment compensation. Free trade thrives when there is growth and full employment. Support for free trade is falling in the US because workers perceive it is destroying their "good" jobs without creating adequate alternatives. Technology may be a more important factor, but trade has surely contributed to the sharp decline in manufacturing jobs. Fluctuating exchange rates also create insecurity as firms have to move production to other countries to remain competitive. This combination of insecurity and instability may be creating a powerful coalition against free trade.
A combination of insecurity and instability may be creating a powerful global coalition against free trade.
Along with diminished support for free trade, growing capital controls and negative interest rates, other challenges add resistance toward globalization. In Europe, large-scale terrorist attacks like the ones in Paris and Brussels along with increasingly unsustainable flows of migrants from violent, poorly governed and impoverished countries add to the challenge. Germany and Sweden have tried to be welcoming, but realize that they alone cannot absorb the millions who would come, and other nations are not lining up to help. The result is walls going up and passport-free travel being curbed, often with the added fear of terrorist infiltration.
Right-wing parties reflect popular angst that societies cannot or do not want to absorb vast numbers of migrants. The United States has a similar, though smaller problem with migration from Mexico and Central America. Australia, too, has taken harsh action against migrants, putting them on remote islands. The walls are going up not just for goods, capital and people. The very flow of information is being Balkanized. It's not surprising that authoritarian regimes such as Russia and China wish to control the flow of information. Worries about free trade and capital controls including negative interest rates add resistance toward globalization. The internet could become regional rather than global. The world faced similar challenges in 1929 when crashing stock markets and economies led to walled gardens rather than an open field for trade and capital flows. The United States had already restricted migration in the 1920s but trade had been open and collapsed in the face of rising tariffs worldwide.
As Mark Twain is reputed to have remarked, history does not repeat itself but it rhymes. Most of the productivity gains have been concentrated in the top 10th or less of the population. Some mix of technology, globalization, politics and migration have caused such inequality, but the outcome is a deficit in demand and periodic credit bubbles as easy money leads to credit growth well above income growth which in turn leads to financial crises. These crises decrease trust in the advantages of the existing global system and increase sentiments to blame instability on openness. The diagnosis may be partly right, but the prescription that will work does not rely on closed borders - though that may be the instinctual response to attacks like the ones in Brussels.
David Dapice is the economist of the Vietnam Program at Harvard University's Kennedy School of Government. YaleGlobal and the MacMillan Center


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