Global: The Pendulum of Global Leadership
Stephen Roach (New York)
Financial markets are abuzz about the possibility of yet another spurt of US-centric global economic growth. Irrespective of the current-account deficit and external debt implications of this outcome, America’s growth dynamic is the magic to which the rest of a growth-starved world has become addicted. In the minds of investors and policymakers alike, there’s no breaking this habit for the conceivable future.
Yet history cautions us against taking world economic leadership for granted. Look back no further than the late 1980s: America was widely thought to be “over,” and Japan and Germany -- the two defeated great powers of World War II -- were viewed as on the ascendancy to the pinnacle of global economic leadership. US companies were introducing Japanese-like quality circles into corporate cultures, and Germany’s unique style of worker-owner co-determination (“Mitbestimmung”) was viewed as the new wave of corporate governance practices for the future. Oh, how the once mighty have since fallen.
The long history of global economic leadership is replete with countless other examples of the demise of the powerful -- a pattern well documented and analyzed by Yale historian Paul Kennedy (see The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000, Random House, New York, 1987). Starting 500 years ago with a world dominated by Ming China, the Ottoman Empire, India’s Mogul Empire, Moscovy, Tokugawa Japan, and the great nation-states of western Europe, Kennedy posits a simple but elegant thesis as to why these and the other strains of global leadership that were to follow were destined to fail. In almost all these cases, he argues, the global projection of military power ultimately outstripped the nation’s domestic economic base. Countless other examples in history fit this script to a tee -- from the Hapsburg Empire and Napoleonic France to the Spanish and British Empires and Imperial Prussia-Germany. Remember the Soviet Union?
Kennedy’s book was quite the rage when it was first published in 1987. The US stock market crashed late that year, conjuring up dark memories of the 1930s. The Cold War was still raging, and under President Ronald Reagan, US defense spending had risen from 4.7% of GDP in 1979 to 6.2% in 1986; meanwhile, America’s current-account deficit was headed to a then unheard of 3.4% of GDP. America seemed over-extended and down on itself. Would it be the next in a long line of great powers to succumb to the historical tendency of over-reach? Those concerns resonated deeply in the US body politic in the late 1980s and the early 1990s -- underscoring a sense of malaise and concern that a young governor from Arkansas turned into a stepping stone to the White House in 1992.
Ironically, of course, it was communism that was first to topple -- a power failure right out of the mold of Paul Kennedy. For the United States, however, it was precisely the opposite story. Far from over-extended, America was on the cusp of the Roaring 1990s -- a decade that ended with US supremacy in geopolitical, military, and economic terms. That accomplishment even gave Kennedy pause for thought. Writing in the Financial Times in the aftermath of 9/11, he noted that the US “…now spends more each year on the military than the next nine largest national defence budgets combined. Nothing has ever existed like this disparity of power” (see Paul Kennedy, “The Eagle Has Landed,” Financial Times, 3 February 2002).
Conceptualists often tend to be early in anticipating actual events. At least, that’s the hope. I hear that constantly from my own sympathizers. “Hang in there,” they urge me, “one of these days US deficits and global imbalances will matter.” In retrospect, Kennedy’s timing couldn’t have been worse: Far from “over,” America was, in fact, entering a new era of supremacy. But was Kennedy simply wrong or just early in applying his historical framework to the US experience?
On the surface, a strict application of the Kennedy model suggests little reason to worry. Courtesy of the peace dividend arising out of the end of the Cold War, US defense spending plunged to a post-World War II low of just 3.0% of GDP over the 1999 to 2001 period -- about half the share of the late 1980s and less than one-third the peak rate of 9.5% hit at the height of the Vietnam build-up in 1968. America’s post-9/11 response has reversed only a small portion of the post-Cold War decline. By 2004, defense outlays had risen to just 3.9% of GDP (4.1% including homeland security) -- up considerably from the lows of 2001 but well below the shares hit in the late 1980s when Kennedy’s warnings were first taken seriously. Nevertheless, with the US having fought two wars in the last three years and now facing a costly and potentially open-ended occupation in Iraq, to say nothing of threats in Iran and North Korea, the question of over-reach can hardly be dismissed out of hand.
I suspect there is a good deal more to the economics of over-reach than simply the defense-spending share of GDP. Should a nation’s defense commitment be scaled by its actual GDP or by the factors that ultimately determine potential output growth in the future? In my view, the key is the wherewithal of any nation to fund its leadership role. Two factors will ultimately be decisive in that regard: national saving and productivity growth. On both counts, there are grounds for concern -- the US is either in trouble right now (saving) or possibly headed for a rude awakening (productivity). The national saving rate is critical because it determines what a nation can plow back into investment in new technologies and other forms of plant and equipment -- the forces that ultimately drive (or constrain) productivity growth. There can be no mistaking the warning from this metric: America’s net national saving rate -- the combined saving of households, businesses, and the government sector (adjusted for depreciation) -- has averaged a record low of just 1.5% of GDP since early 2002. That’s far short of the post-World War II (1947 to 2003) average of 7.8% and well below the 5% level prevailing in 1987 when the Kennedy thesis was first in vogue.
During periods of excess, it always becomes fashionable to discredit concerns that challenge the status quo. New theories arise that explain away the excesses. Remember the “new paradigm” of 1999 and early 2000? Well, it’s back -- this time in the form of a dismissal of the significance of America’s low national saving rate and the massive current account deficit it has spawned. Globalization and its concomitant arbitrage between the providers and users of capital make the United States special, goes the argument. If America doesn’t save, it doesn’t matter. This new paradigm allows for the seamless flow of saving from abroad to close the gap -- generating massive US current-account and trade deficits along the way in order to attract the external capital. In such a newly symbiotic world, other countries are more than willing to finance America’s hegemonic role as the sole surviving superpower. In the context of the Kennedy framework, a saving-short United States need not worry about military over-reach for as long as it remains the magnet for external capital.
And that’s where productivity enters the equation. America’s role as a magnet of international capital also is tied to the superior productivity performance of the US economy. With productivity growth having accelerated to a 3% trend rate since 1995, foreign investors have become increasingly eager to invest in the world’s highest-return markets. Such external funding, however, could be quick to dry up in the event of a slowdown in US productivity growth. In my view, just such a possibility could now be in the cards (see my 4 February dispatch, “The Great Productivity Fade”).
US productivity growth faded appreciably in the second half of 2004 -- a 1.3% average annual rate (that could be revised up to 1.5%) versus 4.4% in the prior 13 quarters and the 3% post-1995 trend. While there is undoubtedly a long overdue cyclical element to this recent slowing, it may also signal the return of more sluggish productivity growth in the years ahead. Four factors underscore just such a possibility: IT saturation of corporate spending budgets and a related flattening out of “capital deepening,” the end of slash-and-burn cost cutting, the physical limits of extended work schedules, and the above-noted shortfall of domestic saving, which could finally become a serious constraint on investment when foreign providers of capital start hedging their portfolio risks and/or begin investing in their own economies. Just like global leadership, the lessons from history are clear in this realm as well: Never say never on the productivity call.
I strongly suspect that a test is looming for America’s global leadership. On the surface, this leadership seems secure -- especially now, as a lopsided world economy salivates over the possibility of another spurt of US-centric growth. Yet Paul Kennedy’s historical perspective urges caution in presuming that little can disturb Pax Americana. An unprecedented shortfall of national saving is a clear warning of an unsustainable economic leadership model, in my view. As are the responses to this saving shortfall -- freely available foreign funding, artificially depressed real interest rates, and a profusion of asset bubbles that have given rise to asset-dependent saving and consumption behavior. Equally disconcerting is the related possibility that America may be nearing the end of its great run on the productivity front. World financial markets have barely paid lip-service to these possibilities -- or to the related risk of a test to the US-centric global growth model. I continue to believe that the dollar and US real interest rates are especially vulnerable in the event of such a test.
In the end, globalization is about the diffusion of economic power -- and the technologies, worker skills, and capital that underpin such power. Courtesy of the Internet, that process of diffusion now occurs at hyper-speed. The emergence of the Chinas and Indias of the world, to say nothing of the urgency for the once mighty (i.e., Germany and Japan) to regain their economic prowess, speaks more to global convergence than to hegemonic dominance of one superpower. With US economic leadership on an increasingly shaky foundation, don’t be surprised at yet another swing of the ever-fickle pendulum of global leadership. History teaches us that’s long been the rule -- not the exception.
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