If stock market and interest-rate spreads are to be believed, the US economy has seen the worst and may be on its way to a slow recovery. But the troubles for the world economy are just starting. If globalization does not get the fix it needs, economic prospects will be dim for rich and poor countries alike.
The worst that could happen is a return to the 1930s, when countries put up high trade barriers and retreated into isolationism to the detriment of all. Fortunately, this is a remote scenario today. But the next worst thing is to assume that a minor patch-up will be enough to render globalization healthy and sustainable. It will take real effort and creativity to repair the deep cracks in globalization revealed by the financial crisis.
First, the good news. The global response to the crisis may not have been stellar, but neither has it been the free-for-all that might have been feared.
The G20 could not agree on coordinated fiscal stimulus or concrete steps towards banking reform. But it did coalesce behind the IMF and provided it with additional resources. Despite scores of new protectionist measures around the world since the onset of the financial crisis, the vast majority are nothing to lose sleep over. Globalization has not received a mortal blow — at least not yet.
The real test is yet to come. The problem is that none of globalization’s underlying weaknesses is likely to be adequately addressed under the current agenda. Financial regulation and supervision will surely be strengthened, but they will remain national in character, with little safeguard against cross-border spillover and regulatory arbitrage.
Moreover, the WTO’s agenda will remain irrelevant and, in any case, deadlocked. China has yet to discover and adopt an alternative growth strategy that does not rely on a large trade surplus. Trade and immigration (legal and illegal), if left unchecked, will continue to exert downward pressure on rich countries’ labor markets. The financial crisis has not helped improve the image of globalization, which has long been deeply unpopular among ordinary voters in most of the world’s advanced countries.
As a result, globalization’s tendency to produce macroeconomic imbalances and financial fragility, its adverse impact on equality and social peace in many countries and its weak political legitimacy will continue to generate tension and periodic crises.
Two other developments will greatly aggravate these weaknesses. The first is that the US and other advanced countries are unlikely to recover their previous economic dynamism even after financial stability is restored. Rich-country households have suffered a momentous loss of wealth (amounting to tens of trillions of US dollars). This implies that consumption growth will remain muted for some time.
With public debt rising rapidly, and in some countries projected to exceed 100 percent of GDP, governments will not be in a position to take up the slack. The restructuring of economies away from finance will necessarily take some time. Stagnation rather than growth will be the name of the game.
Second, global leadership is likely to remain in very short supply. The US will be crippled by its high debt, underperforming economy and discredited economic model. The EU will be preoccupied with its own internal integration process. And China, where income per person is one-eighth the level of the US (adjusted for purchasing power parity), is simply too poor to become the new hegemony.
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