Global: A Dysfunctional World
Stephen Roach (New York)
Morgan Stanley
In these headline-driven days of angst, financial markets have lost any sense of real purpose. One day
they’re up, the next day they’re down -- and with unprecedented vengeance. On Friday March 21, for
example, world equity prices surged by 2.1%, whereas on the following trading day they plunged by 3%.
That was one of the greatest two-day whipsaws on record. Notwithstanding the turbulent behavior of
financial markets, I believe the trials and tribulations of an increasingly dysfunctional global economy remain
pretty much the same. The war in Iraq changes little of that.
To me, the big global macro story is still one of mounting and unsustainable imbalances in a US-centric
world. It’s been a one-engine global economy since 1995. Growth in US domestic demand averaged 4%
over the ensuing seven years, double the 2% gains elsewhere in the world. Courtesy of bubble-induced
wealth effects, Americans have spent to excess. At the same time, reflecting deepening structural
constraints, demand has remained decidedly subpar in Japan and Europe. As a result, America has
accounted for literally 64% of the cumulative increase in world GDP over the 1995 to 2002 interval --
double its share in the global economy.
This dichotomy is hardly costless, or sustainable. A saving-short US economy has had to import surplus
saving from abroad -- mainly from Asia but also from Europe -- in order to sustain economic growth. And
the US has had to run a massive balance-of-payments deficit in order to attract that capital. America’s
current-account deficit surged to an annualized $548 billion in the fourth quarter of 2002, a record 5.2% of
GDP. The financing of such a shortfall requires $2.2 billion of capital inflows each business day -- hardly a
trivial consideration for a low-return, post-bubble US economy. Nor is this a stable situation. As
America’s federal budget goes deeper into deficit, the country’s net national saving rate -- consumers,
businesses, and the government sector, combined -- could easily plunge from a record low of 1.6% hit in
late 2002 toward “zero.” If that occurs, the US current-account deficit could approach 7% of GDP --
requiring about $3 billion of foreign financing each business day.
History is pretty clear on what happens next -- a classic current account adjustment. This will entail a very
different macro outcome for the United States -- namely, a weaker dollar, higher real interest rates, and a
slowdown in domestic demand. That’s precisely the scenario that a dysfunctional world is completely
unprepared for. A weaker dollar spells a higher yen and a stronger euro -- outcomes that would undermine
the externally-led growth that Japan and Europe have grown accustomed to. A slowdown in US domestic
demand growth would exacerbate that problem -- providing far less impetus to the world’s major source
of external demand. That would also spread the pain to the trade-dependent economies of Asia ex Japan.
As the one-engine global economy starts to sputter, the world will have no choice other than to come up
with a new recipe for global growth -- the essence of what I have called “global rebalancing.”
But can it? There are two key ingredients to global rebalancing. The first is a current-account adjustment
that forces the US economy to start living within its means again --- as those means are delineated by
domestic production and income generation. But equally important is for the rest of the world to press
ahead on the structural reforms that are required to unlock domestic demand. This could be the toughest
nut to crack. Japan has had little appetite for reform for over a decade. And Europe has deferred its
reforms for far too long. But now as the business cycle turns and unemployment rises, political constraints
could create new headwinds for reforms. Fighting for their own jobs, politicians can hardly be expected to
put voters out of work by embracing the noble pursuit of structural reform.
And so it may well be that a dysfunctional world remains stuck -- unwilling or unable to uncover new
sources of growth and, therefore, waiting by default for yet another kick-start from the now dormant US
growth engine. But that kick may be a long time in coming. Not only does America need slower domestic
demand in order to narrow its current-account deficit, but it also faces the negative wealth effects of a
post-bubble hangover. Consequently, a world that waits for another shot of US-centric growth may be in
for a rude awakening. In my view, the days of US-centric global growth are numbered. The time has come
for the rest of the world to wean itself from the American growth engine and draw on internal sources of
domestic demand. A failure to do so unmasks the true flaws of a dysfunctional world -- the inability to
generate self-sustaining economic growth. America has carried the world for long enough.
War -- and the peace that eventually follows -- changes none of this. The global economy had plenty on its
plate long before the assault on Iraq began, and I dare say the macro agenda won’t change much at all in
the postwar period. In fact, there’s the distinct possibility that the world’s macro conundrum might even be
exacerbated by the war. Two considerations come to mind -- the first being a war-related widening of
America’s already large federal budget deficit. President Bush’s request of $75 billion of emergency
spending authority is just a down-payment on the cost of this war. A prolonged combat effort -- to say
nothing of a multi-year commitment to postwar rebuilding -- could easily require several multiples of this
initial request. Those outlays, in conjunction with ill-timed proposals for costly tax reforms, could well take
the US budget deficit up to 5% of GDP -- the recipe for an ever-widening current-account deficit in a
saving-short US economy. The dollar would bear the brunt of this development -- and that would turn the
screws all the tighter on the rest of the world.
Secondly, the war in Iraq could well spell trouble for globalization. To the extent that this conflict
undermines the supra-national alliances that have long bound the world together, globalization will lack the
collectivism of political support that it needs for further success. That possibility, in conjunction with the
potential for trade frictions arising from a weaker dollar, a super-competitive Chinese economy, and the
outsourcing of white-collar jobs to nations such as India, spells tough times ahead for globalization.
Moreover, the war could well push an already weakened world economy into its second recession in three
years -- an outcome that would only make matters worse for globalization. In recession, nations look
inward to matters of self interest. By contrast, the look outward to collective interest that globalization
requires usually comes in good times.
Ironically, the feel-good case for a “victory recovery” that financial markets are craving could also
exacerbate the imbalances of a dysfunctional world. That would be especially the case if the US led the
way -- not just on the battlefield but also in a restarting of the US-centric global growth dynamic. Under
those circumstances, America’s current-account conundrum would only intensify. A resurgence of US
domestic demand would boost imports. That would provide yet another excuse for the rest of the world to
stay the course of externally-led growth and defer the reforms needed for an unlocking of domestic
demand. The last thing a dysfunctional world needs, in my view, is to go back to the well of US-centric
growth.
It has become conventional wisdom to believe that the war is the root cause of the perils now afflicting the
global economy. I don’t buy that. In my view, an unbalanced, US-centric global economy was in serious
trouble long before the war in Iraq commenced. Yes, the seemingly inevitable victory will undoubtedly
unleash a sigh of relief on the confidence front. But rest assured it won’t fix what ails a dysfunctional world.
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