The uncertain outlook for the global economy
Speech originally delivered June 18, 2002 at KfW Bank, Berlin, Germany
By Robert E. Rubin, Citigroup director and former Secretary of the Treasury
Thank you for the kind introduction. I enormously appreciate the invitation by Hans Eichel, Germany's highly regarded Minister of Finance, to speak with you today, at this annual meeting organized for the Ministry of Finance by KfW. KfW has made an immensely important contribution to the economic well being of Germany - especially in financing for reunification and, under the leadership of its dynamic Chief Executive Officer, Hans Reich, in financing for small and medium-sized enterprises - and I am deeply honored to be part of today's program.
I have spent my whole career dealing with uncertainty and trying to reduce that uncertainty to probabilities about future events, to provide a basis for action. That is the essence of the arbitrage activities where I began my career, and of what we did at Treasury, under President Clinton's leadership, in everything from the critically important decisions to work to reestablish fiscal discipline in the United States to excruciatingly difficult judgments about responding to financial crisis in Mexico and then later in Asia, Latin America and Russia.
Applying that probabilistic approach is how I think about the outlook for the global economy - the subject I was asked to address today - and how I think about making sound policy decisions. At the end of my remarks, I am going to focus on one particular policy challenge that I think is absolutely central to all of us in today's highly interconnected world, where every country - including my own - is highly vulnerable to being affected by the difficulties and disruptions in other parts of the world. The tragic attack of September 11 was a horrible reminder of that reality. I welcome the opportunity for this policy discussion, because you are an extraordinarily influential group in the economic and political system of Germany, and thus have the ability to affect European and global response to this policy challenge. However, before proceeding to policy, let me begin with the discussion of my outlook with respect to the global economy. I will focus predominantly on the United States, since what happens in the United States is probably key to what happens globally.
The American economy had a remarkable period from roughly 1993 through the first half of 2000. My purpose today is not to discuss the reasons for this, but I think it is useful as we think about economic conditions going forward, to note that public policy played an important role. As central examples, the restoration of fiscal discipline promoted lower interest rates and increased confidence, relatively open trading markets created competitive pressure for increased productivity, and relatively flexible labor markets and a culture that embraces change encouraged investment to achieve increased productivity. Unfortunately, we also have many economically important, policy deficiencies, such as a troubled public school system and inadequate programs to equip the poor to enter the economic mainstream.
In any case, the extended period of growth was accompanied by the increasing development of excesses and imbalances - a phenomenon that seems to be inevitable whenever economic conditions are favorable for a considerable time.
These unbalances included corporate and consumer debt at very high levels of GDP, a very low personal savings rate, a stock market that was high by any conventional standard, a current account deficit that was high and rising, and over-investment. These imbalances led - I thought at the time predictably - to difficulties in both economic conditions and the markets, beginning in the middle of 2000. Briefly looking at how forecasters reacted to the slowdown seems to me useful in thinking about the current outlook.
Once the slowdown began, most forecasters predicted that strong action by the Federal Reserve Board to lower interest rates would relatively quickly restore healthy growth. That certainly was a real possibility, and the Federal Reserve Board is certainly an important factor in our economy, but the Federal Reserve Board is only one factor and not an all powerful answer to all problems, and I felt that forecasters throughout this period overstated the force of this factor and greatly underweighted the impact of the excesses and imbalances. And, in fact, conditions did remain difficult, right up to the terrible attack of September 11, which added a new set of competing considerations affecting the economy. On the one hand, confidence was adversely affected and security, trade and transportation costs increased; on the other hand, government spending increased in response to September 11 increased, to provide fiscal stimulus.
Today, the great preponderance of Wall Street forecasters have for some time been projecting favorable economic conditions at least this year and next. Their theory is that previous rate cuts of the Federal Reserve Board, combined with the stimulus from government spending in response to September 11 and from the small portion of the tax cut enacted in 2001 that occurs this year and next, plus favorable changes with respect to inventory accumulation and, very importantly, continued productivity improvement, will result in maintaining healthy growth in consumer demand and renewed growth in investment demand. My own view is that the current situation is similar to the situation with respect to forecasts and the outlook at the time the slowdown began in mid-2000. The positive forecast could well turn out to be right, but there are also many uncertainties and concerns that could produce an extended period of more difficult conditions. Since the positives have received the bulk of the attention in most forecasts, and since I've already mentioned them, let me now elaborate on the concern.
To begin, the excesses and imbalances, which I discussed a few moments ago, that developed over the eight remarkable years, have not fully unwound. More specifically, consumer and corporate debt have continued to be very high, excess capacity has diminished - except in telecommunications - but is still significant and the current account deficit has worsened. The stock market has fallen considerably, but views are mixed as to whether current market levels are undervalued, about right or still overvalued on a fundamental basis, and current market psychology is clearly affected by accounting and corporate behavior issues and by terrorism and geopolitical concerns. How much the decline so far will affect consumption and investment, if at all, and how much impact any further decline would have, is an important uncertainty. So far, rapidly increasing housing prices have maintained consumer net worth, but could housing prices be vulnerable? Stock market analysts have relatively favorable expectations about future profits - a key to renewed investment - while most business people are highly uncertain about profit prospects. More generally, most economic forecasters are relatively optimistic, and most business people are far more concerned.
This list of concerns and uncertainties about factors that could affect consumption or investment and thus the economy, could go on, but let me mention just three more. First, the projected fiscal position of the United States government has deteriorated enormously over the past year. In May of 2001, the bi-partisan Congressional Budget Office had projected a 10-year surplus of 5.7 trillion dollars. Today, a realistic estimate of the 10-year fiscal position would be that at the least almost the entire 5.7 trillion dollars has been dissipated, with significant likely effects on interest rates and confidence over the long run and probably some effect even now. Secondly, global trade and capital markets integration and the spread of market-based economics throughout the world, which have contributed so much - though unevenly - to global economic well being, are now subject to a powerful and growing backlash which threatens not only to prevent further progress but even to reverse direction in these areas, with adverse effects in the future and perhaps even now on trade, capital flows, and business investment and hiring. And, thirdly and most importantly, future terrorist acts, or political instability and conflict in important areas around the world, certainly seem a realistic possibility. Interestingly, if you read Wall Street economic forecasts, remarkably little is said about these geopolitical risks. On the other hand, the many people I know who have been in national security jobs in prior administrations are all deeply concerned about these risks.
When you put all this together - the positive and negative competing considerations and all of the effects they could have on each other and ultimately on consumption and investment - my conclusion is that the most realistic and useful way to look at the outlook is not as a single point forecast - which is what almost all forecasters provide - but rather as a wide range of possibilities. In that context, I think there is a significant probability of either favorable or unfavorable conditions occurring, and I don't think it is possible to estimate the respective likelihood of either other than to say, as I just did, that the likelihood of either is significant. I recognize that that kind of "on the one hand, on the other hand" type of view is what economists - and I am not an economist - are often criticized for, but, in this instance, I think it provides the most realistic perspective on the time ahead. I think the most sensible way to cope with this high degree of uncertainty for a large corporate enterprise is to be aggressive strategically, so as to move ahead if conditions turn out to be favorable, but at the same time to be highly disciplined about expenses and to have a strong balance sheet and strong liquidity position, to weather sustained difficult conditions should those occur.
Just to expand on this for a moment, my own view is that at this time, building liquidity is critical, and the cost of doing so ought not to be a deterrent, because there is no way of knowing how much creditor risk aversion might accompany difficult conditions if they occur, and the risk of being short of cash in a risk-averse environment is not, in my view, worth taking. In the United States, today, corporate debt issuance is at very high levels, for this very reason, and corporate debt pricing in the markets is very sensitive to liquidity status. I would also add that I think investors should seek some similar balance between equity exposure to realize the benefit of favorable times if that should occur, and an overall portfolio that can comfortably weather adversity should that occur.
Let me now turn very briefly from the U.S. economy to the two other major areas in the global economy.
Japan is viewed by many as likely to experience some cyclical upturn, assuming that the global economic conditions are reasonable, but the enormously complicated structural and fiscal problems Japan faces have in large measure not yet been effectively addressed. My personal view is that a nation and a culture that had the remarkable economic success experienced in post-World War II Japan, is very likely to once again do what is needed to get on a successful economic track. However, that will require exceedingly difficult actions on banking, trade restrictions, labor laws, regulations, informal rigidities, and a severe fiscal and government debt problem made all the more serious by Japan's rapidly aging population. Addressing these issues will itself create economic difficulty during an extended adjustment period, and thus the prospect of a robust Japanese economy lending strength to the global economy - though I believe a distinct possibility in the long run - is not a shorter-term prospect.
As to Europe, which you obviously know far better than I, I would make only a few observations. Firstly, I think the Euro is proving to be a real success and a real contributor to European economic well being. On the other hand, I remember when I was at Treasury being concerned that the intense European focus on creating the Euro might well be absorbing political energy that could otherwise have gone to the structural reforms needed to increase European productivity growth.
One of the lessons I took from my six and a half years in Washington is that the politics are as important as the policy, because if the politics doesn't work, the policy decisions - however good - will not be put in place. It seems to me that one of the great challenges for Europe - in order to realize the productivity potential from today's immense technological developments and from globalization - is to develop an approach to reducing rigidities and increasing trade openness, that can win broad-based public support, and therefore political support. And, I might add, we have the same problem in the United States. Although our markets are relatively open, and our labor laws are relatively flexible, trade is always a very difficult issue politically - as evidenced by our recent steel tariff decisions, and the large new agricultural subsidies just enacted.
Having now completed a brief tour of the global economic outlook, let me turn to the policy issue I referred to at the beginning of my remarks, and that is global poverty.
I believe that in today's closely interconnected world, global poverty will profoundly and unavoidably impact economic, national security, and social conditions in the industrial nations, including the United States, and that effectively combating global poverty is imperatively in our self-interest. The relationship between poverty and terrorism is hotly debated, but at the least, poverty can breed resentment, anger, alienation and hopelessness, and so an environment hospitable to terrorists and susceptible to political instability and conflict. Moreover, the effects of global poverty on the industrial nations go way beyond geopolitical matters.
With today's vast movement of goods and people across borders, illegal immigration by the desperately poor has greatly increased, as Europe is now experiencing and the United States has for a long time. Public health hazards have spread more rapidly from countries that simply cannot afford even modest healthcare for most of their people. And cross-border environmental dangers - such as industrial pollution or destruction of rain forests - comes from countries where most people's daily struggle for existence simply precludes any real focus on the environment.
I firmly believe that the whole world - including the United States - may be at something of a junction, between improved economic, environmental, social and national security conditions on the one hand, and far greater difficulty and even danger in each of these areas on the other hand. And a favorable outcome at this junction requires that the industrial nations provide committed leadership to combating global poverty, to promoting broad-based participation in global growth, to addressing economic and cultural dislocation that inevitably accompanies globalization and to helping create functioning societies in failed states. These are very complicated matters, especially in the critical area of encouraging sound policy, effective government and integrity in government, in countries receiving assistance. But much has been accomplished - such as the eradication of river blindness in Africa or the increase in GDP per capita in Korea from $100 in 1960 to $9,000 today.
Aid effectiveness can and must be improved, but, having been deeply involved in these matters while I was at Treasury, in my view, the evidence of accomplishment is more than sufficient to warrant the greatly increased commitment requisite to making real headway against poverty. Foreign assistance is roughly 0.35 of 1 percent of GDP in Europe, and roughly 0.13 of 1 percent in the United States, and both - especially, that of the U.S. - that must be greatly increased. Moreover, of comparable importance to aid is opening markets, in Europe, Japan and the United States, to the goods that emerging market nations produce. And that means especially textiles and agricultural products, both very difficult areas politically.
The business communities of both Europe and United States can make a great contribution to their own well being, and the well being of all by providing political support for foreign aid and for market opening to combat poverty, and by promoting public understanding of that imperative self-interest in combating global poverty.
Let me conclude by thanking you once again for inviting me to be with you today. I believe that the United States and Europe have an immense community of interests in a robust economic relationship, including on-going reduction of barriers to trade, and in a robust geopolitical partnership, and I think the two region's business communities can contribute greatly to these purposes by supporting good policy and mutual endeavor in both Europe and the United States. I am happy to have had the opportunity to share a few views with you today, and I look forward to all of us continuing to work together in a healthy and mutually successful relationship between our two parts of the world in the years to come. Thank you. |
