Editor’s Note: Dr. Matthias M. Matthijs is Assistant Professor of International Politics at American University and a Professorial Lecturer at Johns Hopkins University’s School of Advanced International Studies (SAIS) in Washington, DC. Neil K. Shenai is doctoral candidate in International Political Economy at SAIS, writing his dissertation on the global financial crisis.
By Matthias M. Matthijs and Neil K. Shenai - Special to CNN
As world leaders prepare for another much-anticipated G-20 summit in Cannes, France in early November, the future of the global economy remains highly uncertain. The spirit of cooperation and solidarity that marked the London Summit in the spring of 2009 seems long gone. It has been replaced with dissonance, finger-pointing and beggar-thy-neighbor policies.
For all of the confusion and missteps in the aftermath of the global financial crisis, it is worth remembering that the origins of the ongoing economic malaise stem from the divergence in policy preferences between countries that borrowed their way into the crisis, like the United States and the European Mediterranean (Portugal, Italy, Greece, and Spain), and the countries that lent to them, like China and Germany.
According to IMF data, Germany’s trade surplus increased steadily from a scant 0.02% of GDP in 2001 to 5.4% in 2010, while China’s trade surplus grew from just 1.3% of GDP in 2001 to 6.2% in 2010. Not surprisingly, both countries saw a drop in consumption and increase in savings during this same period. The figures for the United States are the opposite, with a current account deficit that was consistently between 4 and 6% of GDP between 2001 and 2008, and consumption increasing from an already high 83% in 2000 to 87% of GDP in 2008. In other words, China and Germany used their excess savings to finance the debtor countries’ trade deficits.
The ongoing debates in the global economy reflect this fundamental, underlying tension between debtor and creditor countries over what caused the crisis and how to solve it. The creditors, like Germany and China, see the crisis as a problem of profligate spending and irresponsible borrowing in the debtor countries, while debtors, like Greece and the United States, see the crisis as a problem of unfair competitive practices on behalf of their lenders.
Both the global financial crisis and Europe’s sovereign debt crisis exposed the limits of this arrangement between borrowers and lenders. While the Chinese were enjoying robust export growth from 1990 to 2007, the United States experienced a series of asset price bubbles and rising consumer leverage. In Europe, converging German and Greek interest rates masked the structural weaknesses of Greece’s tax collection and unsustainable public pensions systems. In both cases, each debtor country’s borrowers are tapped out, and can no longer continue to binge consume on low interest rates provided by lender countries.
Of course, both creditors and lenders are to blame for the current slowdown. German (and French) policies of enthusiastic peripheral Eurozone lending and low wage growth, together with fixed exchange rates helped it become the export power that it is today. China’s nominal exchange rate and lack of social safety nets encouraged private savings that enabled it to lend to the United States, fueling its export boom by relying on the voracious appetite of U.S. consumers.
The path forward is theoretically simple but practically difficult. In short, creditor countries have to consume more and save less, while debtor countries have to consume less and save more. But it is hard to execute this rebalancing act when the debtor countries are virtually bankrupt. While the United States government is in no immediate danger of bankruptcy, despite Congress’ best efforts, both the sovereign government in Greece and the U.S. household mortgage sector had reached points where their debts were no longer sustainable. This debt overhang helps explain the sluggish economic growth and stubbornly high unemployment rates that continue today.
During ‘normal’ times, the process of macroeconomic adjustment is smooth and quasi automatic, and does not warrant the careful management or coordination of multiple countries. But these are not normal times. World economic growth has slowed across the advanced-industrial world because demographics, debt and political deadlock prevent the interstate cooperation necessary to rebalance the world economy. In a sense, the evolution of the global economy has outpaced the evolution of the interstate system. Although the world economy is now global, with free trade in goods, services and capital across borders, economic regulation remains the domain of nation-states. Democracy can impede the cross-border cooperation necessary to rebalance the world economy, since domestic populations do not see the fairness in sacrificing for some hypothetical, technocratic benefit down the road.
The challenge now is not to repeat the mistakes of the past, where every country fends for itself and tries to pass the buck of macroeconomic adjustment to their partners. Today, world leaders need to spread the costs of adjustment in an equitable way across their populations, which is hard to do with income distributions that have become much more skewed in favor of the relatively well off. The challenge today is for democracies – sensitive as they are to the will of their publics – to understand the need to sacrifice for others. This challenge of adjustment manifests itself in different ways, from the Occupy Wall Street movement to Greek public sector riots and Spain’s Indignados. All cases are symptomatic of the broader difficulties of spreading the pain of the hangover after a long and debt-fueled consumption party.
The path forward requires three C’s: cooperation, co-optation, and conviction. Every country in the world needs to cooperate with each other if they want to avoid the chaos of the 1930s, when the liberal world trade and financial system collapsed under the weight of global depression. This cooperation depends on the co-optation of understandably reluctant domestic populations, who need to be made to feel as if the prevailing economic technocrats of their country are treating them fairly. Finally, such a tough sell requires good leaders with conviction who can lead from above and actually change voter preferences for the common public good. This is an ingredient that has been sorely lacking across the advanced-industrial world and unfortunately is something for which there are no quick “technical” fixes.
China vis-à-vis the United States, just like Germany in Europe, will need to respond to fiscal austerity abroad with an accommodating demand stimulus at home, and allow other countries to rebalance their economies through greater exports. The current state of the global economy is a “catastrophic equilibrium” at best. The task is difficult but not impossible. World leaders need to craft a new global economic consensus for a truly multipolar economic world. That consensus needs to balance the demands and sensitivities of domestic constituencies for growth and prosperity as well as take into account the need for external equilibrium, i.e. a rebalancing between debtor and creditor nations. Time will tell if world leaders are up to the challenge. Let’s hope they will take the lessons of the 20th century to heart.
The views expressed in this article are solely those of Matthias M. Matthijs and Neil K. Shenai.