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Sent: Monday, September 26, 2005 11:28 AM
Subject: Roach: Global Economic Forum: Global - Globalization of the
Political Economy
>
>
> -----Original Message-----
> From: Love, Beverly (Equity Research) On Behalf Of Roach, Stephen
> (Equity Research)
> Sent: Monday, September 26, 2005 9:58 AM
> To: eranlsts; erassocs; Warrick, Judith (IBD); europeansales; emall;
> pwmall; coresales; e-fidcom; globalecon; econmail
> Subject: Global Economic Forum: Global - Globalization of the Political
> Economy
>
> Globalization of the Political Economy
>
> KEY POINTS
>
> * What's new
> Germany's post-election aftershocks are yet another example of one of
> the greatest tension points of globalization - resistance of the body
> politic to the structural reforms necessary for economic revitalization
> and cross-border integration. A globalized world must come up with a new
> model of the political economy.
>
> * Conclusions
> Two extremes frame the political context of globalization - the US with
> its minimal social contract and Old Europe with its deeply entrenched
> social welfare state. (1) On the surface, the US is the clear winner -
> with a decade of superior outperformance in terms of GDP growth and
> unemployment. (2) Beneath the surface, the verdict is less clear-cut -
> as a shortfall of US saving has generated massive current account
> deficits that lie at the core of global imbalances. (3) The excesses
> of US consumerism have pushed the consumption share of GDP to 71% - well
> in excess of the 58% share in Europe, the 55% portion in Japan, and the
> 42% share in China. (4) At the same time, worker compensation shares
> are lower in the US (65%) than they are in Europe (68%) and Japan (67%).
> (5) Sustainability of the US model remains open to debate.
>
> * Market implications
> The wealth effects of the Asset Economy are finessing the tension
> between America's smaller share of wage income and its record
> consumption share of GDP. This injection of newfound consumer
> purchasing power is being underpinned by ongoing monetary stimulus at
> the Fed, together with persistent foreign buying of Treasuries. The
> American consumer remains the weakest link in the chain.
>
> * Risks
> The longer the political economy of globalization remains on a collision
> course with the powerful trends driving cross-border economic and
> financial-market integration, the greater the likelihood of a hard
> landing in the not-so-distant future. I would still place about a 40%
> probability on such an outcome over the next 12-18 months.
>
> DETAILS
>
> Post-election Germany appears to be a political wasteland. This is yet
> another example of one of the greatest tension points of globalization -
> resistance of the body politic to the structural reforms necessary for
> economic revitalization and cross-border integration. It's hard to
> forge a new world order without breaking down the barriers that define
> the old way. Yet there is great debate over how to pull this off. The
> reforms of globalization shake the social contracts that bind nations
> together - leading to recurring clashes between capital, labor, and
> deeply entrenched political power structures. A globalized world must
> come up with a new model of the political economy. Germany is
> struggling mightily with just such a challenge. But it is hardly alone.
>
> Two extremes frame the choices - the United States with its minimal
> social contract and Old Europe with its deeply entrenched social welfare
> state. A couple of numbers say it all: Public sector social
> expenditures are currently running around 15% of GDP in the US - well
> below Europe's 24% share. Post-bubble Japan has been attempting to find
> a middle ground - effectively tearing up the lifetime employment
> contracts that were long at the core of its corporate welfare state;
> moreover, the Japanese electorate has now given Prime Minister Junichiro
> Koizumi a strong mandate to pursue further reforms. China has its own
> unique balancing act - pushing hard on several dimensions of the reform
> front but holding tightly to its all-important stability constraint.
> The contrasts between these approaches have turned globalization into
> something of a foot race. America has emerged as the "hare" whereas
> Europe seems unwilling or unable to shed its "tortoise-like" attributes.
> But globalization is a marathon - not a sprint. And it is not a
> clear-cut conclusion that the front-runner has the stamina to hold the
> lead. The increasingly chronic pitfalls of a saving-short US economy
> underscore the perils of the "shoestring" approach to globalization (see
> my 9 September essay, The Shoestring Economy). This raises the profound
> question as to whether the US approach is truly the gold standard of
> globalization that other nations should seek to emulate. Or, in more
> literary terms, forget about the tortoise - can the fabled hare actually
> make it to that ever-elusive finish line?
>
> On the surface, there's little reason to doubt the superior performance
> of the American way. Contrasts between the macro performance of the US
> and European economies are stark. Over the past decade, the US has
> turned in a decade of superior performance on most fronts. By our
> estimates, real GDP growth averaged 3.3% in America over the 1996 to
> 2005 interval - fully 65% faster than the 2% pace in Europe over the
> same timeframe. Similarly, the US unemployment rate has fallen from a
> peak of 7.4% in 1992 to 4.9% at present, while in Europe, the jobless
> rate has changed little from the 8% level of the early 1990s.
>
> A superficial assessment of the US model usually boils down to one word
> - flexibility. Americans are perceived to be risk-takers - unafraid to
> re-invent themselves or their institutions in response to changing
> circumstances. Possibly the best example of this trait is the painful
> restructuring of the 1980s - a direct outgrowth of the economic quagmire
> of the 1970s. President Ronald Reagan's willingness to go to the mat
> and break a strike by air traffic controllers in 1981 may well have been
> the tipping point - emblematic of the coming sea change in the social
> contract for American workers. Faced with unprecedented competitive
> pressures, over the first half of the 1980s, beleaguered factory workers
> opted for job security over wage rigidity. Collective bargaining
> contracts were subsequently re-opened and rollbacks of multi-year
> compensation packages became the norm. At the same time, deregulation
> became the mantra for a transition to "small government." The
> combination of wage flexibility and deregulation allowed the US to reap
> the benefits of the IT-enabled productivity revolution of the 1990s.
> The rest of the world stood by with its jaws wide open. The American
> model was on the ascendancy as never before.
>
> At the other end of the spectrum, a superficial take on the European
> model can also be boiled down to one word - in this case, rigidity.
> Europe's deeply ingrained social contract has forced labor market
> adjustments to occur through the quantity axis rather than through
> wages. Shifting political winds compounded this trend. Courtesy of
> German reunification in the early 1990s, Europe's largest economy was
> hit with a wage shock - a direct outgrowth of a politically-motivated
> exchange rate equalization between the West and the East. Despite much
> lower productivity of Eastern German workers, they were put on parity
> with high-productivity workers from the West. At the same time, the
> left-leaning body politic in both France and Germany opted for a
> mandated shortening of work schedules in an effort to spread employment
> over a larger number of workers. Unfortunately, these actions
> backfired. The combination of wage subsidies to low-productivity German
> workers, along with legislated constraints on the utilization of labor,
> resulted in unprecedented levels of unemployment that are still very
> much in evidence today.
>
> Beneath the surface, the contrasts between these two approaches are even
> starker. In particular, the American model has taken consumerism to an
> extreme, with private consumption having averaged 71% of GDP since early
> 2002. By contrast, the European consumption share is currently around
> 58%, whereas in Japan, it is only 55%; the Chinese consumption share
> trails the pack at 42%. Ironically, the excesses of US consumerism have
> been accompanied by a shift in the shares of national income away from
> labor and back toward capital. In the US, the worker compensation share
> fell to a 30-year low of 65% in 2005 whereas "economic corporate
> profits" currently stand at a near-record 11% share of GDP. By
> contrast, worker compensation shares are higher elsewhere in the
> advanced world - 67% in Japan and 68% in Europe. Not only does America
> slice the pie differently, it has a very different appetite for eating
> it as well.
>
> The American paradox of running a consumption-led growth model while
> tilting the rewards away from labor is a striking testament to the
> emergence of the Asset Economy. Courtesy of unusually low real interest
> rates and the wealth effects they have spawned, the US model is also
> characterized by a profound shortfall of domestic saving and an equally
> large current-account deficit. America's international creditors -
> especially Asian central banks - have elected to recycle their surplus
> saving into dollar-denominated assets. And that plays a key role in
> capping intermediate and longer-term US interest rates. That pretty
> much sums up the tactical objectives of the global body politic -
> providing subsidized interest rates that underwrite the free-wheeling
> ways of the saving-short, overly-indebted American consumer. "If you
> buy our goods," goes the logic, "we'll buy your Treasuries."
>
> While tactical gratification may work well for a time in today's world,
> beneath the surface, there are serious questions about sustainability.
> That's especially the case with a world economy that remains on an
> extraordinarily unbalanced growth path. As long as the global body
> politic fails to appreciate the perils of its imbalances, the more
> treacherous the endgame. Nor is it clear that the American model is the
> ideal that other nations or regions should aspire to emulate.
> Wealth-dependent consumption excesses leave the US exposed to the
> dark-side pressures of a debt overhang and a current account adjustment.
> And with post-Katrina aftershocks unmasking the long simmering problems
> of an impoverished underclass, the debate over America's social contract
> - or lack thereof - has now been re-opened. America's shoestring
> economy may wake up to find itself ill equipped to provide the enhanced
> safety net needed for a reordering of social and political priorities.
>
> So far, the breakthroughs of globalization have been confined to the
> real side of the global economy and the capital and information flows
> that drive world financial markets. The revolution has yet to spread to
> the political arena. Resistance from the body politic is evident in all
> major constituencies in the global village. That's true in the US,
> where China bashing and protectionist threats are on the ascendancy.
> It's true in a still relatively closed Japanese economy, where imports
> remain only 10% of GDP - well below America's 16% share. It's true in
> China, where currency flexibility exists in theory but not in practice.
> And, as its post-election political quagmire vividly demonstrates, it's
> very much in evidence in Germany - underscoring the risks that
> anti-reform politics could well spread to the rest of Europe. In all
> cases, governments remain captive of local constituencies - unwilling or
> unable to act with broader global interests in mind.
>
> Therein lies one of the biggest challenges for the rebalancing of an
> unbalanced world. This past weekend, another meeting of leading
> international policy makers has come and gone without any meaningful
> actions on the global policy front. Constrained by their own parochial
> agendas, there is little willingness to accept the shared
> responsibilities of rebalancing. That's not to say the major powers
> haven't been warned. The official institutions of globalization - the
> IMF, the World Bank, the BIS, and the OECD - have all sounded the alarm
> recently over the perils of mounting global imbalances. Those warnings
> have all gone largely unheeded - fairly typical of the denial that
> usually precedes a crisis. The longer the political economy of
> globalization remains at odds with the powerful trends driving
> cross-border economic and financial-market integration, the greater the
> likelihood of a hard landing in the not-so-distant future. I would
> still place about a 40% probability on such an outcome at some point
> during the next 12-18 months.
>
> Stephen Roach (New York)
> --------------------------------------------------------
>
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