Obstacles to Economic Growth

09.02.14 Publication:

If you are an international investor, everything has changed in the world economy since 2014 began. If you are a young unemployed person in Italy, Britain or even America, or a family whose income has been unchanged or declining for the past five years, nothing has changed. The big question for 2014 is whether these two paths will converge.

For investors the change is dramatic, even if on reflection it should not be surprising. For unemployed youth and for ordinary families, however it is the lack of change that is disappointing. But for them the really big disappointment in many countries—especially Italy—is the apparent lack of action by government or politicians to do anything about it. If the Five Star Movement remains steady in the opinion polls and if anti-establishment parties like the Dutch Freedom Party, France’s Front National or the UK Independence Party prosper in May’s elections for the European Parliament, that will be the reason.

The change for investors ought, nevertheless, to bring some hope, at least for an eventual end to the disappointment. That hope is stronger in America and Britain than it is in Italy or the rest of the euro zone, but it could reach there too, ultimately. If, that is, events in Asia and in other emerging-economies do not block or destabilise it.

What is the change? The change is that instead of constantly calculating how weak the American, British, Japanese and northern European economies are, investors and indeed central bankers are now having to calculate how strong they are. Recoveries from financial crashes, especially ones as violent as those of 2008-09, will always be slow. Banks take time to be cleaned up, companies take time to cut their debts, confidence is shattered. But eventually confidence returns and companies start to invest again and to hire workers again.

That is clearly what is happening now in America and Britain. The revival of business investment remains slow, but it is under way. Fewer new jobs were created in America in January than economists had hoped, but bad weather was probably largely responsible. The Federal Reserve has felt confident enough about the recovery to begin tightening its monetary policy by gradually reducing the amount of bonds it buys from the market each month—the so-called “quantitative easing”.

Britain’s strengthening growth owes more to the property market and household consumption than America’s does, which might make it less sustainable in future years. But there too unemployment is falling and incomes are, tentatively, beginning to rise. For that reason, the Bank of England is likely to start tightening its own monetary policy later this year in order to prevent growth producing a new surge in inflation.

In the Eurozone the worry is different: rather than inflation, what the European Central Bank needs to worry about is deflation, or falling prices, for such a trend would make the already huge public debt burdens even costlier, and could hurt companies too. But last wek the ECB won an important victory at the German Constitutional Court when the court decided it could not block Mario Draghi’s existing measures to support the financial system. This makes it likelier that to combat inflation the ECB will now be able to introduce its own policy of “quantitative easing”, pumping money into the euro zone economies in just the way the Fed has done in America.

So change is either here or on its way, on both sides of the Atlantic. But as always, there is a shadow hanging over it, or rather two shadows. In Europe, the big shadow is politics – the danger that those European elections in May might turn the natural disappointment of ordinary voters into a big rebellion against the European Union, against international co-operation, and against the austerity policies associated with the euro and with Angela Merkel’s Germany.

In the world, however, the shadow is a different one, albeit that there too it has a political component. The shadow over the world comes from new turmoil in what for the past five years have been the saviours of the global economy: the emerging economies.

Partly, this is a result of the change of policy at the Federal Reserve, since American quantitative easing has in recent years sent money flooding not just around the USA but also around the world. But also, a lot of emerging economies kept themselves growing fast amid the global recession by creating a lot of new credit themselves, encouraging their own private companies to borrow. That process was supported by rising prices for natural resources and energy, which made investment in African, Asian and Latin American resource-producing economies look like a one-way bet. But now commodity prices have been falling, making the gamble more risky.

It is in many ways a return to the East Asian and emerging-market financial crisis of 1997-98. Countries that had accumulated big private debts and big balance of payments deficits were hit hard in that crisis. So were oil producers such as Russia, as the oil price slumped. Now, the most fragile economies are again those with big deficits, such as Turkey, South Africa, India and Indonesia, but also again Russia.

The emerging-market turmoil is only just beginning, so it is too soon to judge whether it will be just a ripple in the ocean or a new tsunami. There is also a further complication: China. The world’s second biggest economy is not fragile and nor does it have a deficit. But other countries depend on exports to it, especially of natural resources and half-finished manufactures. And its economy is slowing sharply, thanks to its own domestic credit bubble and official efforts to contain it.

The likeliest bet is that the emerging-market turmoil will this time prove containable, and that China’s slowdown will be moderate. That would allow western economic recoveries to gather strength, as the year goes on. Yet we must always remember that politics has the power to disrupt even the most confident of predictions, and that financial markets panic like herds of wildebeest being chased by lions. And we must finally remember that the point of the whole exercise is not the GDP figures or the investors’ incomes, but the future of those young unemployed and the family incomes. If they do not feel better by the end of 2014, then nothing good will have happened.