Friday, November 1, 2002
A doomsday scenario
JOSEPH E STIGLITZ
As America debates whether or not to invade Iraq, fears that the country's economic recovery will stall are beginning to creep into the discussion; with that, worries about the health of the global economy are growing, too.
A consensus is emerging that the gap between the US economy's growth potential and its actual performance will remain large for some time to come. Can the situation get worse? Yes, it can: much worse.
A number of worrying factors about the US economy have been around for a long time:
* huge trade deficits have persisted since Ronald Reagan's misguided tax cuts of 1981 converted America from the world's largest creditor into the world's largest debtor. Today, these deficits set new records by the month;
* America's appallingly low savings rate. When American wealth seemed to be growing year after year as the stock market boomed, this was understandable; individual Americans were becoming richer without savings, so why bother?
Today's savings rate, while it has increased slightly, still finds America at the bottom of the world's savings league tables;
* lax accounting standards. The Arthur Andersen, Enron, and WorldCom scandals didn't emerge out of thin air, but had their origins in the mid-1990s, when the US Treasury actually intervened to stop attempts by the supposedly independent accounting standards board to improve matters.
Bad accounting contributed to the recent stock market bubble; bad information led to stock prices that did not reflect underlying realities; and these in turn provided incentives for the excess investment in telecoms that caused today's excess capacity.
To this old brew, new ingredients have been added, notably the most rapid change in a nation's fiscal posture the world has probably ever seen. In a "now you see it, now you don't" move only a magician should love, the $3 trillion, ten year (non social security) US budget surplus was - in a matter of months - converted into a gaping deficit of $2 trillion dollars.
Of course, excuses are at hand: the magnitude of the economic downturn was not anticipated and the increased expenditures to fight terrorism could not be foretold. Excuses, excuses. As the old saying goes: don't count your chickens before they hatch. The Bush administration not only counted its chickens, it sold them forward!
To anyone with decent eyesight, it was clear that the rosy budget projections of two years ago were nonsense. Clear, too, was the fact that, in promoting its tax cuts, the Bush administration was engaging (on a multi-billion dollar scale) in dishonest, Enron-like accounting.
So if things are so bad now, how can they get worse? Here's a plausible scenario.
To finance its trade deficit, America must borrow from abroad over a billion dollars a day. When America was the only safe haven for global investors, this was easy.
But America today appears less safe. The combination of lack of confidence in US corporate accounts, lack of confidence in America's economic policy management (compounded by the mounting deficits), and America's soft underlying economic fundamentals, has dented the US economy's global reputation.
As foreigners start pulling their money out of a country they suspect, the dollar will weaken. As the dollar weakens, America looks even less safe. So a rush to the door begins.
While a weak dollar may be good for exports, a falling dollar will be accompanied by stock market losses and greater declines in confidence. Eventually, even the almighty American consumer will be shaken and realise that he is poorer today than three years ago and that he better start putting money away for his retirement, especially given Bush's proposed risky experiments with the social security system.
At that point, Americans will join the stampede out of their economy. Why shouldn't they? They're free to choose where to put their money. Europe's stock markets will begin to look like an attractive alternative.
But this scenario offers no happy ending for Europe. A weakening US economy and the strengthening euro will dampen European exports. The European Central Bank, fixated on inflation, will be slow to lower interest rates, and the European Stability Pact will make it impossible for fiscal policy to offset these weaknesses.
Europe will join America in a downturn, reinforcing America's decline and setting in motion a global downward spiral.
I am not predicting that this will happen. I hope that the Bush administration will enact policies to strengthen the US economy: a tax cut that might have made minimal sense when it seemed that the US had a multi-trillion dollar surplus no longer makes any sense at all.
The Bush administration should admit this, and redesign a tax programme to strengthen the economy by making the country live within its means.
President Bush could even stabilise the economy, offering better unemployment benefits to provide the needed stimulus if the downturn continues.
America is strong, and the global economy is strong. Should the disastrous events contemplated here occur, a new global economy will eventually emerge from the ashes.
Downturns, of course, can never be fully prevented. We can, however, decrease their frequency; we can make them shallower; we can ensure that fewer people are hurt and that those that get hurt are better protected.
Sadly, we are doing less than is possible to prevent things from getting worse and doing less than necessary to protect ourselves from the consequences.
(The author is Professor of Economics and Finance at Columbia University and the winner of the 2001 Nobel Prize in Economics)
(C): Project Syndicate, October 2002
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