Paper to Wellington South Rotary; 22 March, 2017

Thankyou for the invitation to talk about contemporary world economy. I am not going to give a blow-by-blow account of the challenges New Zealand currently faces; instead I am going to place them in a broad context. What I am arguing – I am uncertain, of course – is that the world economy is entering a new phase.

Because my time is limited I am going to confine myself to four themes about how the world is changing from the one we grew up in.

First, I shall argue that the US is no longer the international hegemon it once was. That issue is so important that I shall stray into the wider issue of what follows.

Second, the process of economic globalisation seems to be changing, with less emphasis on the growth of merchandise trade, more on digital-based trade and greater population mobility.

Third, the rich economies may be in a period of long-term stagnation.

Fourth, the grumbling populace seem to be becoming relatively more politically powerful. I’ll focus on the implications for international trade policy.

 

1. The US is No Longer ‘The’ International Hegemon

An international hegemon is a state with political, economic and military predominance or control over all others. There have been only two global hegemons. One was Britain in the nineteenth century but its power began to wane in the early twentieth century to be totally replaced by the US from about 1940. It was not just that the US military and economic power was the key to winning the Second World War. After there was a dollar shortage, because the reconstructing rest needed US goods and services but had little to offer in return.

Now a hegemon may be dominant but it can act with generosity as the US did with the Marshall Plan which provided dollars to Europe to help with its reconstruction following the war. One could list other areas – such as human rights – where the US sacrificed its immediate interests to what it judged to be the interests of the world.

That dominance is coming to an end. A key point in international trade was the failure to conclude the Doha (Development) Round in 2008. No longer was the US able to lead the world into a new multilateral trade deal. Instead it shifted to plurilateral deals such as the Trans Pacific Partnership and the Transatlantic Trade and Investment Partnership. For a number of reasons, including the loss of hegemonic power by the US, both have fallen through. Intriguingly, President Trump is saying that in future the US will only do bilateral trade deals – which may indicate his assessment of the limitations of US economic power.

It is happening on other dimensions. A year or so back the London-based Economist argued that the US economy may no longer be strong enough to be the banker of the world. It fears that come the next financial crisis (I don’t think the Economist expects one soon), the US, the IMF, Old Uncle Tom Cobley and All will not be able to bail the system out, even if the US policy response is more coherent than Congress would currently allow. Trump also seems to argue that the US is no longer strong enough to carry the military burden it once did.

What will replace US hegemony? Because over the last two centuries the world has had a hegemonic leader, it is natural to look for a successor to the US – perhaps following the sort of difficult transition we saw as dominance shifted from Britain to the US in the early part of the twentieth century.

Many will jump to the conclusion that the next hegemon will be China – and contemplate such a shift with anxiety. I do not think that is going to happen. Rather, the likely scenario is there will be no future hegemon but five, say, major economic powers – the China, EU, India, Japan, the US – will struggle for dominance; yet none able to dominate the others. It seems likely that such a future world order will be very disorderly. It is a world to be much more anxious about than if there was a new hegemon.

 

2. The Nature of Economic Globalisation Seems to Be Changing

The second disruption is that the nature of economic globalisation seems to be changing. We have taken it as a norm that international trade should grow faster than production. Between 1985 and 2007 global merchandise trade volumes grew at around twice the rate of global GDP. However since 2012 the rate of growth of trade in goods has barely kept pace with production.

There seems to be three main reasons for this. First, the rapid growth of merchandise exports and imports could not go on forever; if it did, countries would eventually be exporting more than then they produced.

Second, a major driver of this trade has been the falling costs of distance – transport and the related costs of shipping things around. We may have exhausted the productivity gains from, say, containerisation. It is instructive that in the interwar period the costs of distance did not fall as fast as costs of production, and the growth of international trade stalled.

The third reason is that the growth of merchandise trade has been enhanced by reductions in border protection, but a few commodities aside – sadly that includes our food exports – protection levels are now near zero.

I have been careful to emphasise this slowdown is only evident in merchandise trade. It may well be that the digital revolution, which reduces the cost of transporting information, has not exhausted international commercial opportunities and we may see a continued rise in the global trade in services.

One place where this is particularly important is the financial services industry, but that is a separate issue for another occasion. More pertinent for today’s presentation is that the cost of moving people has come down stunningly. The nominal cost of air travel is much the same today as it was forty years ago, despite major consumer inflation. Consequently, migration is increasingly common, leading to rising social and political tensions. That raises the future of the nationhood – again a topic which has to be left to another day.

 

3 The Rich Economies May Be in a Period of Long-term Stagnation.

There are a number of economists – including the eminent Larry Summers – who think that the rich world economies may be in a period of secular stagnation and that GDP per capita will not grow much in the long term. Why?

The most likely explanation sees economic growth arising from technological innovation. The American economist who has studied this best is Robert Gordon. He does not think that current innovations are nearly as significant as those which happened a century ago, He cites, for instance, the consequences of the introduction of electricity with any of today’s innovation.

There may be a slightly different explanation as to why Gordon cannot find the productivity gains in recent years that he found a centruy ago. Recall that there is no business case for many ICT applications (that is, the owners cannot figure out how to make sufficient cash flow from the businesses) which provide services which are, however, highly valued by users. There are some huge web-based corporations that have never made a profit. In such cases their value may not appear in the productivity and growth statistics.

It is this profitability issue which worries Summers and all. Low productivity growth and profitability means there have been fewer opportunities to invest, with the consequences that interest rates (and hence profits) are driven down. Perhaps today’s low real interest rates are not just a part of the cyclical adjustment to the Global Financial Crisis but arise from the fundamental consequences of long term technological change which cannot be easily accommodated by private market transactions.

That does not mean there will be no growth in material wellbeing and choice; rather it will be different. Moreover, many poorer economies may be expected to experience rising standards of living as they catch-up by implementing the known technologies already available in rich economies. But there will be limitations; instructively the Chinese economy continues to grow as it catches up, but the rate of economic growth is slowing down from the double digit rates of the past to about half of that.

It also does not mean that commerce will stop. Some businesses will grow, many will stagnate, more will fail; the plodding disciplines of good business practice will remain necessary. As I have said, business profitability seems likely to decline from past levels This could well mean a dramatic change to the nature of the world economy – to capitalism. It would, for instance, invalidate Thomas Picketty’s predictions of increasing inequality in the long run. But generally such low profit economies are new territory and we cannot readily predict what exactly will happen.

 

4. The Grumbling Populace Seem to Becoming More Politically Powerful.

Examples of the unexpected arising from secular stagnation may be the election of Donald Trump as the US president and the British vote for Brexit. In both cases particular circumstances enabled large chunks of the populace to express their displeasure with the ruling elite – in the one case it was social media, in the other it was a referendum. Looking forward, the issue is why there were, and are, so many grumblers in the US, in Britain and, indeed, elsewhere in Europe. Are they a new phenomenon?

One factor seems to be an xenophobia towards migrants, which – you will recall from the second theme about globalisation – is an increasing international phenomenon. Typically, the immigrants that are grumbled about come from poor economies and are delighted to seize the opportunity the richer economy offers and the resulting rise in their material standard of living.

On the other hand, the grumblers seem not to have had a rise in their material standard of living for some time. In the case of some groups of Americans there appears to have been no increase for two and more decades. They blame their income stagnation on the arrival of migrants, although the research evidence does not support that inference; the grumblers have made the classic mistake of thinking that correlation is the same thing as causation.

The issue of opening up an economy to international trade draws a similar conclusion from them, although the research evidence is a little more complex. Economic theory does not say that everyone is better off under free trade, despite the rhetorical claims of the advocates. What the theory says, is that everyone could be made better off if the winners compensated the losers. But generally they do not.

We got away with this lack of compensation when real incomes were otherwise rising, so that most losers were, even so, experiencing a rise in material prosperity. Under secular stagnation there are no such overall rises, even if the dominate rhetoric bangs on otherwise. Incomes may well be rising for the advocates and their retinue, but by depressing the incomes of the rest; that is where the rising income inequality comes from.

It seems likely that the grumbling is increasing. There were always grumblers but they seem more vocal, possibly because of the secular stagnation – possibly there are more of them. And they appear more vocal, probably because there are more channels to express their discontents. concerns.

Will the grumblers become even more politically influential? Undoubtedly with Brexit, Trump and some of the things going on in Europe the elites feel badly wrong-footed – I include the Republican elite. History reports that the elites in Western democracies have proved remarkably adaptable to such challenges – which is why they are still democracies. How they will adapt this time and whether they will adapt quickly enough remains to be seen. In the past – during the interwar years – the transition sometimes involved authoritarian populist movements – fascism. There are those who discern the rise of fascism in some of democracies.

 

To Conclude

The point about the contextual approach of this presentation is that it places some recent upsets in a context. Trump, Brexit, the attacks on immigrants and the losing of enthusiasm for free trade are not isolated events but are responses to underlying changes, to whit:

1. US is no longer the international hegemon it once was.
2. The process of economic globalisation seems to be changing

3 Rich economies may be in a period of long-term stagnation.

4. The grumbling populace seem to becoming relatively more powerful compared to the elite.

The subtext, especially to the last point, is that elite thinking has not incorporated these changes into its thinking. It is still largely complacent, expecting things to continue much as they have over the last decades – or even earlier as it was when they grew up.

That is what justifies such presentations as this. It will not be exactly right – even if it has avoided predictions – but it is likely to be more right than the mindless conventional wisdom. If it has shaken some of us out of that complacency, it will have achieved its purpose.