States, the United Kingdom, Japan and some continental European economies saw deep downturns in output, and have to date experienced only weak recoveries that have left the level of output well below its previous trend and unemployment much higher than normal. In the United States in particular there is a very troubling increase in the duration of unemployment, which, with its likely atrophy of skills, does not bode well for future growth.
In Asia outside of Japan and in Latin America, economies have traced out the more classic ‘v-shaped’ path. In east Asia excluding Japan, the level of real GDP is well above its previous peak. It follows that most of these economies are likely to experience some moderation in the pace of growth, from something well above trend, to something more like trend. This is normal after a rapid recovery.
This difference in performance between large parts of the emerging world and the core of what we could call the ‘established’ world of industrialised economies leaves the global economy poised at a critical juncture. In Asia, capacity utilisation has more or less recovered and growth will moderate. Many of the old industrial countries, in contrast, still have large volumes of idle capacity and are searching, with increasing urgency, for ways to increasetheir growth. But they are having trouble increasing their own demand. So we face a slowdown of some degree in global growth at a time when substantial spare capacity remains in the global economy. The ‘global imbalances’, so called, have persisted, and have a new dimension: there is an imbalance in the location of spare capacity in the world.
What could be done to foster a better outcome for everyone?
There has been an increasing focus on exchange rates of late, with talk of ‘currency wars’ and so on. My view is that more flexibility of exchange rates in key emerging countries in Asia – including China, but not only China – would be part of a more balanced outcome.
But exchange rate flexibility alone isn't enough. Changes in exchange rates don't themselves create global growth, they only re-distribute it. Unless the exchange rate changes were accompanied by more expansion in demand globally, we would not have solved the problem of excess capacity, we would only have relocated it. The additional step needed is stronger domestic demand, compared with what would otherwise have occurred, in the countries whose currencies would appreciate in such circumstances.
Of course there should be room for this given that the higher exchange rate would, other things equal, help to dampen inflation. In principle, at least, this looks like a potential ‘win-win’ outcome. The appreciating countries could enjoy faster growth in living standards than otherwise, while the weaker countries whose currencies were moving lower would get some stimulus to aid their recovery.
There are, however, some complications. A number of Asian countries have been experiencing worrying increases in property prices. Low interest rates and easy financial conditions have contributed to this. Arguably domestic financial conditions in these cases need to be tighter, not looser. So it is not clear that monetary policy would be the best option to boost domestic demand. That said, allowing exchange rates to appreciate more quickly would probably help to dampen increases in asset prices.
What about more expansionary fiscal policies as the way of increasing domestic demand? Many, though not all, Asian countries would have some scope for that, given the long record of fiscal prudence and low public debt levels. But these countries are very unlikely to do things that would seriously impair their fiscal position in the long run. Hence my suspicion is that fiscal action, if it came, would be only modest.
Some argue that structural changes are needed to lower national saving rates in countries like China. Such changes could involve a shift in the distribution of national income away from state enterprises to households, who are thought more likely to spend it, a better developed social safety net, and so on. In all likelihood these sorts of changes will occur over time. But structural change is rarely a rapid process.
So I think we should be realistic about how much difference exchange rate flexibility would make to the unbalanced nature of growth in the global economy, at least over a time horizon of just a few years. It is definitely part of the answer (and it is surely in the interests of the countries with closely managed rates to accept more flexibility), but it is no panacea.
A full resolution of the imbalances will take time. It will involve more far-reaching changes to very deep-seated attitudes to saving, which remain very different across the regions of the world. As incomes in Asia continue to rise, saving rates will probably decline over time, but only gradually. Meanwhile, aggregate saving rates in America and Europe will have to rise over time, given the extent to which financial obligations have grown relative to likely future income, particularly on the public side. The key question is whether these two trends, in opposite directions, will occur at the same pace, or not.
Good policies can certainly help the world get to a better solution than might otherwise occur. But even with good policies, it is likely to be a slow grind out of the current difficulties for some countries. We probably have to accept that global growth was unsustainably fast in the few years prior to the crisis, that too much capacity of certain types was built up in the wrong places, that spending in some countries ran too far ahead of permanent income and that a period of adjustment and structural change cannot be avoided, even under ideal policy settings. If that is so, then, in all countries, an emphasis on accepting the need for adjustment generally – not just in exchange rates but in economic policies and structures across the board – is key.
Conclusion
Economies are not static machines. They are a complex and dynamic combination of actors, all continually seeking to adapt to changing conditions. That is one reason that economic outcomes are very hard to predict, and why I am circumspect about predicting ‘Australia to 2020’.
Looking to the long run, we probably can make a few very general observations, but not much more. Real income per head has generally been on an upward trend in industrial economies for the past 250 years, with occasional setbacks. Most likely that will continue (albeit that some major countries will take some time to recover their income levels of three years ago). As a broad observation, and definitely not as a precise forecast, we might expect that a decade from now Australia's per capita GDP will probably be roughly 15 per cent higher in real terms than it is now, give or take a few percentage points. The economic policy arguments, by the way, will all be about what policies might gain or lose those few percentage points.
In 2020, there will probably be, at a rough guess, an extra couple of million people working, compared with today's 11.3 million. But exactly how all those people working will earn their living and go about their work is considerably less predictable. A good proportion of those 13 million-plus jobs will be in firms that don't yet exist. Some will be in industries or occupations that barely exist as yet. And no one can give you a blueprint for which areas will succeed and which will not, any more than the pundits a decade ago, at the height of the ‘new economy’ fad, could foresee the shape of Australia's economy today.
Succeeding in the future won't ultimately be a result of forecasting. It will be a result of adapting to the way the world is changing and giving constant attention to the fundamentals of improving productivity. That adaptability is as important as ever, in the uncertain times that we face.
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