The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy. This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.
MALLABY: Are we live? In fact, can we be heard? You can hear me?
So let’s get going. Welcome to the Council on Foreign Relations World Economic Update with, on my right, Susan Lund, partner at McKinsey Global Institute; in the middle, Adam Posen, president of the Peterson Institute for International Economics; and on the far right, Doug Rediker, a nonresident fellow at Brookings and also executive chairman of International Capital Strategies.
I am Sebastian Mallaby. I’m a senior fellow here at the Council on Foreign Relations, and I’ll be presiding, and I want to welcome those who are joining us from around the country, around the world via live stream.
So I guess the framing context here for the world economy is that, on the one hand, we had a February which was tumultuous in financial markets, but on the other hand, right before that tumult, the IMF came out with an update which essentially said that this is the best balanced, most promising economy since 2010. And the forecast—the consensus forecast for 2018-2019 are, if anything, a tad stronger than the 3.7 percent growth recorded in 2017. So it feels as if the real economy is in great shape—we’ll get to that—but I think first, since markets have been on people’s minds, I want to ask Doug whether we’ve seen the back of this latest bout of Wall Street falling out of bed. Now do—are you hearing from people in the markets that there’s more to come, or is that it for now?
REDIKER: It used to be I shunned any question where I had to speak for the markets, but then it became a choice between either speaking for the markets or explaining the Trump administration, so I now embrace speaking for the markets as a much easier, digestible thing to pontificate about.
Look, I think you’ve got all of the positive wins that you suggested in your question, Sebastian. I’m not going to quibble with the IMF’s forecast. I think you are seeing global growth across the world, you know, basically all moving in the same direction. You’ve got the general uncertainties of the policy apparatus here in Washington, and by extension, everywhere else. That is the big, looming question mark.
So if you assume that—we’ve talked about this in the past—the policy choices that are being made that could impact this general tailwinds-are-all-moving-in-the-right-direction kind of momentum—if you assume that there’s a lot more bark than bite, which has been the case thus far for the most part, and where there has been bite—action—it has been pro-cyclical. So you’ve got a stimulative tax plan, you’ve got a budget that is spending more, all of which might long term be a negative, but in the short term, it’s considered to be a positive. If you discount the policy uncertainty, then markets are basically still in the “buy the dip” mindset.
The question is when does uncertainty become something more tangible that it can be latched on to as political risk where you can quantify it. So if you were to say the Trump administration and by extension policy uncertainty globally is so big that we can either ignore it or get so scared we take our money off the table. Everybody is ignoring it, which means “buy the dip” prevails.
If you narrow it to trade disputes with China that could spiral out of control, withdrawing from NAFTA—another trade thing—you know, some of the other issues that I think we’ll get into this morning, once you hone in on them, then they’re very, very serious risks. But for now they are—they continue to be largely discounted by the markets, which—so far so good.
MALLABY: OK, so Adam, we’ve had therefore really an inflation of scare, not a growth scare in the markets, so interest rates have moved up at the long end, but equities had a dip and then sort of recovered quite a lot of it.
So that raises this question that Doug was alluding to: we’ve had pro-cyclical shocks—
MALLABY: —from the political system, and the question is when demand is being expanded that much on the fiscal side—I think the estimates are 0.3 for the tax cut, 0.3 percent of GDP; another 0.3 or so from the budget deal. So you’ve got a big fiscal boost at a time when the central bank, because of its starting position, is very loose, both in terms of conventional policy with negative policy rates, and in terms of QE because, although QE is being unwound, if it’s a stock effect, not a flow effect, there’s a lot of stock out there still, right, and the balance sheet is still big.
So you’ve got both a monetary stimulus and a fiscal stimulus at the same time. Can the supply side respond without untoward effects?
POSEN: Yeah. So let me try, Sebastian, to give you a bit of baseline on that. The bottom line is that people are prematurely worrying about inflation, and they’re certainly prematurely worrying about rapidly accelerating or large inflation.
Just to pick up on something you and Doug said, I think the growth prospects are even better than people have been saying. The—my colleagues at Peterson Institute and I have been saying for a couple of years now that people are not appreciating the strength of recovery in Western Europe, in China, in Japan, and that’s indeed what we are seeing.
As my favorite factoid from the IMF is, there are I think 192 members in the IMF? All but six of them are forecast to grow this year. This isn’t just the best nominally since 2010; this is arguably the broadest based, most solid recovery we’ve seen in decades. And so that is a very big deal, and almost nothing else you do on policy—even some of the very scary risks that Doug rightly points to—is likely to counteract that.
So then comes the question about inflation, as you say. And so a couple of facts on that point: first, that on average—we’ve sort of forgotten this over the last ten years—but on average the U.S. economy has 2 ½ to three times as many years in recovery as it does in recession, if you look at the last hundred years. So we have a lot of experience of the U.S. economy and other advanced economies growing above what’s supposedly potential, growing at high—at low unemployment rates without inflations spiraling out of control. So there seems to be the sense occasionally in markets—market—that, you know, we’re on a knife’s edge, that the Fed’s behind the curve and suddenly inflation is going to spike up. And if anything, the evidence is you can run an economy hot for quite a while without getting a spike in inflation, and that inflation is actually a very inertial process, and this is what we’ve seen in Japan and in Germany; this isn’t just a U.S. phenomenon.
In Germany they’ve been running lower unemployment rates than anybody expected, even proponents of reform, for years now, and you’re not seeing inflation. So there’s a lot of fundamental things there. It’s not to say we won’t eventually get inflation, but it’s just really ridiculous to assume we get massive inflation.
The second thing is just to say—and this is not something that people seem to want to recognize—is the share of profit, the share of economic income going to profit, going to capital over the last 20 years has kept going up, up, up—true throughout most of the rich world; especially true in the U.S. It is possible—not that it will be allowed to happen probably—but it is possible you could see the profit rate go down a bit, a little more money go to workers, and that’s not necessarily inflationary because that’s redistributing the pool of money, the huge amounts of cash that the corporations are sitting on. Instead of it going to dividends and share buybacks, it goes to workers.
Now it’s in the interest of companies to say to the Fed, oh, my god, that’s inflationary. We can’t do that, we’ll lose competition, you have to raise rates immediately. But historically that’s not unprecedented either. So there is a lot of room for inflation to pick up without—excuse me, for growth to continue without inflation picking up.
MALLABY: So, Susan, let’s continue on that line. So one way in which you could have rising wages, enticing more of the discouraged workers back into the workforce without triggering inflation is what Adam says, namely you take some of the historically unusually high profits, you redistribute those to workers so that wages rise without triggering inflation.
The other way, of course, is a productivity acceleration. McKinsey has done a lot of work on productivity. Tell us how you see both the causes of the slowdown in productivity gains and the prospects for an acceleration.
LUND: Yeah. So we’ve looked at the slowdown in productivity in the U.S. and Europe so it’s an advanced economy view. But as most of you in this room probably realize, we’ve seen a very sharp deceleration over the last, say, five years compared to what we were experiencing in the last 1990s or early 2000s, and it’s a broad-based deceleration. You see it across countries, most countries in Europe and the U.S. You see it across sectors.
And so it’s been a bit of a puzzle why is it slowing down, and in a new report we’re releasing we boil it down to three factors, basically. The first and most important is the after effects of the financial crisis. So we still have been in a period of weak demand, and against weak demand companies have invested the least in physical capital that they have at any point since 1900s since the Data Series started.
So we are in this unprecedented period. Despite all the talk about robots and automation, the data just don’t show that companies are investing and a lot of that is just the hangover from the recession and uncertainty about when demand was going to pick up.
Second factor is the fact that we, you know, had this boom in productivity, especially here in the U.S., in the 1990s with the adoption of ICT technology, so computers and the internet within companies, and that revamped supply chains and really transformed how companies operate. But those gains have been exhausted and we haven’t yet started to see the impact of the next wave of automation and artificial intelligence and some of the new technologies that we’re hearing about.
So we’re sort of—we rode that wave and now we’re down. But both of those factors, when we look forward, we would think will ease. So, because of the strong growth we’re seeing, company investment is picking up. It’s picking up, very importantly, in Europe, which is one of the things helping their recovery.
So we’ll see firms spending more on giving each worker more tools and capital to work with. That should raise productivity growth. And we’re hopeful that the next big wave of technology—so the Internet of Things, big data analytics, AI—is starting to be adopted in—throughout companies and that that will in fact raise their productivity as well. So, overall, we can’t quantify, you know, how fast productivity could grow but we do think that it will in fact accelerate in the coming years.
MALLABY: I think, Adam, you were saying that you’re optimistic about most things in the world economy but not necessarily about productivity.
POSEN: Yeah. I’m afraid I have a different view. I’ve seen an initial version of the report that Susan and her MGI colleagues have and, as always, they have this great sectoral and micro knowledge that’s very compelling.
The opposite interpretation, for the sake of argument, is that the lack of investment isn’t the cause of the low productivity growth or isn’t just the cause. It’s also the reflection—that there is by revealed preference, despite very loose financial conditions, ample cash, rebuilding of balance sheets, global growth.
Companies aren’t wanting to invest, which is an indication that they don’t see this as profitable, and that goes with the kinds of explanations said by people ranging from Robert Gordon, who I know has spoken here at the Council, to investors like Peter Thiel that there is no next big thing. And so it’s—you know, you have to decide what mental frame you're looking at the data. The one way of looking at the data is saying we have this next revolution yet to come, which the McKinsey team is arguing. Another way of looking at the data is to say, well, this is not happening because it’s not going to pay off or at least people perceive it as not paying off.
The other point I would raise—again, it’s just a different view—is that there are studies, which with Susan’s familiar, which suggest that the slowdown in productivity growth actually started in 2004, before the crisis, or as close as we can date it. It’s somewhere around 2004, clearly, before the crisis. So it’s not—it was certainly made worse by the crisis—there were certainly effects—but that there was something more fundamental going on as well. And, again, if that’s the case, then it’s sort of more worrisome that there’s something on the supply side that’s just not working.
MALLABY: Do you want to—
LUND: I’d like to respond.
MALLABY: Yeah. Sure.
LUND: I would say the slowdown that began in 2004 was the petering out of the 1990s ICT adoption boom and you saw it in retail, which had had tremendously high productivity growth. You saw it in semiconductors, which had tremendously high productivity growth, and when you get a few large sectors—semiconductors are not but retail is—when you get a few large sectors like we saw in the 1990s with rapid productivity growth, that’s sort of what moves the aggregate needle. But then that sort of played out only—
POSEN: We don’t disagree. I mean, the question is, is there something—where we disagree is the next thing.
LUND: Is there something—
POSEN: Is there a next big thing, but also just—you had said in your initial remarks that the last five years you haven’t seen stuff and I want to emphasize that there is some serious argument that it’s much longer than that.
MALLABY: I want to ask Doug about Europe in a second. But one last question on the U.S. for Adam, which is—which is to push you again on this question about whether the amount of stimulus, both fiscal and monetary, could be troubling. It just seems to me that, you know, right now, a worrier like I am—I will put my hand up and admit to being a worry wart—would say, well, if I look at financial markets—
MALLABY: —I don’t see any obvious problem. It’s kind of healthy that volatility is back up in equities. Bond market is correcting. That’s good. Even silly things like cryptocurrency, you know, which, down from 17,000 (dollars) for bitcoin to 11,000 (dollars)—it’s probably maybe still 11,000 (dollars) too much, but still—(laughter)—we’ve run the experiment and it doesn’t seem like it affects anything real.
So I will confess to not seeing obvious places where financial excess is really troubling. But I would say that if one says, look, this is an unprecedented amount of fiscal stimulus, this is a Fed balance sheet and, again, it’s the stock that matters—a Fed balance sheet which remains very, very large, and a tightening pace, which is slow, and in the context of gradually rising inflation—very gradually, but still—the real effect of that is somewhat reduced. It feels like so much stimulus that somewhere in some dark corner—
MALLABY: —which we haven’t thought about a problem might emerge. Do you discount that?
POSEN: Right. So I take it seriously, not just by congenitally being even more of a worrier than you are, but it’s a serious argument. But I do discount it in two ways. The first is just it is a known pattern across as the price booms and busts and bubbles even that most of them come and go without hurting the real economy very much. ’87 is the classic example where you had a major stock market correction. Of course, you had a Fed response. Nothing much happened.
Now, everybody’s chastened about saying that because there were people who came out in 2007, 2008 and said, oh, well, it’s just financial—don’t worry about it. It, obviously, wasn’t. So, I mean, that’s fair. But if you go one step more detailed, basically, when financial market swings affect the real economy in the big macro sense is usually when there’s lots of leverage and when real estate is involved. And leverage is slightly rising but it’s nothing to compare to 15 years ago by any measure I’m aware of. And real estate, again, there are specific markets that are mispriced but it’s not the kind of enormous real estate imbalances we saw in the U.S. in 2005, 2006.
So, on that score, as much as I’m humbled, like I think most people should be by the experience of the last 10 years, if we’re allowed to make any generalizations it doesn’t seem like this should be having big real effects right now.
The second thing is you’re absolutely right, Sebastian. I completely agree with you about the stimulus, in particular on the fiscal side. So you said numbers of we’re going to get 0.3 this year, say, on the fiscal and then the additional package of the budget deal. My personal estimates are much higher than that. I think we might even get 0.6 out of the big tax cuts this year and something a little less than that in ’19. I think 0.3 is probably about right but maybe even a little low for the budget deal.
So I actually think we are going to get a huge stimulus and I do think it’s ridiculous when our debt level is this high and when the economy is doing well and the structure. But to say something which I know you’ve spoken about in the past, economics isn’t exactly a morality play. So just like Tim Geithner used to talk about, well, we have to bail out people in the crisis just because—not because they deserve it but because we have to, that otherwise things get worse, similarly, we can say this is a really stupid irresponsible reckless fiscal policy. It’s wasting money we should be saving for something else or investing in something else.
But that doesn’t mean the punishment is immediate. There are dozens of examples of populist governments in other countries who’ve done this, who have run irresponsible fiscal policies for a couple years, and maybe it helps them with the next election and maybe it helps them with their constituencies and the world doesn’t immediately fall apart. I wish the markets or public opinion or business—I’m just a little (nervous ?) here—you know, would strike back and say this is stupid, we have to stop it right now. But it’s not that automatic. I could see them running this irresponsible fiscal policy, having a very good boom for the next couple years, and it’s bad but it’ll happen.
MALLABY: OK, let’s go to Europe. So Doug is a close student of all matters eurozone. There, of course, there’s been a good recovery in terms of macro growth. But on March the 4th, I think we’re facing a twofer, a political twofer in Europe: We’re getting the Italian election results with some prospect of the rise of the fringes, and we’re also getting the result of the postal ballot, I believe, which has to ratify the new German coalition. That’s a ballot of the Social Democratic Party. So the politics in Europe are quite uncertain, even as the economy looks quite promising. How do you see that playing out?
REDIKER: All right. So go back a year ago and a year ago, more or less, Europe was the big risk in the world, I mean, over and above—well, let’s say alongside the uncertainties in the Trump administration. Because you had a whole slew of risks emanating from elections in 2017 in Europe that were supposed to put, potentially, an anti-euro populist party in power somewhere. And none of that happened. All right?
Now we’re in 2018. You have the two things on March 4th, as you suggest. I’m not smart enough to predict what the SPD membership is going to do amongst the 465,000 voting members of the SPD. But on balance, while the risk is higher than it should be that they reject it, the likely scenario is that they pass it. And if they don’t, then the likely outcome is Chancellor Merkel governs for some period of time as a minority government chancellor. Is that terrible? No. So the risks that we all feared last year of really the breakdown of eurocurrency as a stable, you know, currency on the political and economic stage is not all that real.
Italy, similar dynamic, which is that we’ve gone from expectations of a Matteo Renzi sort of center-left, third-way, Tony Blair, Bill Clinton sort of, you know, that mindset that a lot of political and economic elites sort of wanted to see happen—that’s not going to happen. But some of the parties that were the most stridently anti-euro, anti-Europe, antiestablishment—the 5-Star, the Northern League, some of the others—have toned down their rhetoric such that even if the outcome is a really bad one—I’ll get to that in a minute—but if it’s the worst-case scenario in Italy, most of those parties are no longer espousing that anti-euro, anti-Europe, down-with-the-establishment rhetoric.
So the likeliest outcome in Italy is a hung parliament with a lot of jockeying amongst a lot of parties that don’t really agree on a lot. And they’ll do what Italy usually does, which is muddle through. They might have a technocratic government, they might have a coalition of not-so-like-minded parties that are all willing to swallow some ideological principle for the purpose of being in power, but they’re not likely to challenge the stability of Europe, the European Union, and the euro.
So what does that mean for Europe moving forward? Well, you’ve got good growth, you’ve got a lot of reforms that did take place post the euro crisis, the establishment of the EFSF, which led to the establishment of the ESM, a sea change in behavior at the European Central Bank. So that now in 2018, there’s a lot more stabilizing institutions than there were five years ago so that if Europe were to fall into a crisis, which I’m not predicting by any stretch, there are actually tools to take care of it. Overall, that’s a good thing.
MALLABY: The tools being the bailout, the ESM—the European Stability Mechanism.
REDIKER: Well, yeah. In other words, at the height of 2010 and some years thereafter, the risk was that Europe had no safety net. The treaty-based prohibitions on bailouts and transfers and others meant it was very difficult to see where country X falling off a cliff would have an outstretched hand to say we’re not going to let you fall. And that’s why you had these emergency meetings that were so fraught over various weekends with Greece, with Ireland, with Portugal. That has now been replaced by an institutional norm of an activist central bank within the constraints of what the ECB can do and the ESM, which is now, on the cards, is a migration to make them more financially and surveillance-oriented in terms of what they can do without resort to the IMF here.
The one big risk that I see in Europe—well, there are two big risks, but they’re related—are an inability to deal with the banking systems as a whole, and the nonperforming loans, Italy being the most acute case. But really, it is endemic to Europe or at least parts of Europe where for decades, centuries, the linkages between the politics, the business, and the financial system is something that we are not really accustomed to in this country. And to break those links is very politically, economically, and commercially very difficult.
And I raise Italy because it’s not all the election on March 4th, but because Italy is too big to fail. It’s also too big to save. And it is an existential question that Europe has to deal with. So if you go back to Matteo Renzi’s term as prime minister, he was a reform-oriented prime minister, and those reforms, when it came down to it, were, you know, partially implemented and then ultimately rejected through a referendum. What that means is the platforms of every single party running in Italy right now are, by certainly my mindset, but I assume many of those in the room and certainly on this panel, irresponsible.
So it is not to maintain reform momentum. It is not to maintain primary surpluses to pay down an exceptional debt load that Italy has. Even Matteo Renzi is extolling the virtues of a 2.9 percent budget deficit because 3 percent is the red line under the Stability and Growth Pact. Well, Renzi used to be advocating for surpluses. Well, what means is Italy is putting itself to be incapable of reforming from within and the European Union and the eurozone and others who are advocating for moving Europe ahead know this.
And the risk, I think, that we have to keep our eyes on is not that Italy fails to reform from within and is allowed to continue, but that Europe creates institutional changes that effectively force Italy to change from without. And the acute point of change is going to be the banking system, which is a real vulnerability for Italy. It’s much better than it was last year, much better than it was the year before, but it’s still not over the hump.
MALLABY: So let’s pick up on that theme, either Susan or Adam. I mean, there are, I think, two questions about the resilience of the European recovery with respect to, you know, what are the ways in which a crisis would be handled next time. One is whether the switch to activism under Draghi at the ECB would be sustained under the next leader, which, after all, could be a German, Jens Weidmann. And if you think back to the Bundesbank’s resistance to activism in the past, why wouldn’t that resistance reassert itself, particularly in the context of German politics where the anti-euro, AfD Party has grown? It seems like not a given that the Draghi central bank would always be there. That’s one question I’ve got.
And the other is on this question of the “doom loop” between the banks and the sovereigns. Italian banks, I think as Doug was sort of alluding to, still hold enormous amounts of Italian sovereign debt. And so you get this connectivity, unhealthy connectivity, which in turn makes it impossible credibly to restructure sovereign debt and bail-in bondholders because the bondholders are the domestic banks and they can’t take that balance sheet hit.
So on both those things, Susan, if you’d like to start.
LUND: Look, I can’t—I can’t project what the ECB will be like under a different leadership. I think that the ESM is an important tool. And I’m not looking forward to the next eurozone crisis. I think we’re barely getting out of the last one.
When I look at what’s happening on the ground in terms of some of the rebalancing within Europe, it’s impressive. So wages and—real wages and unit labor costs have risen in Germany, they have fallen in Spain and Greece, and so this is a real readjustment. You’ve got more countries like Spain running surpluses externally and those are positive signs.
So when I think about monetary policy and the banks—and even in the banking sector, let me give you a positive spin, which is, when you look at Spain, many of the small, regional banks have consolidated and then since gone out of business. Yes, in aggregate, the banking sector holds a lot of government debt and that’s true in every European country. But a lot of the weakest banks have already been folded, bailed out, or gone under. And the ones that are remaining admittedly have not restructured to the same extent as U.S. banks still 10 years on. When you look at the very largest institutions, they are slowly reforming as opposed to undertaking very radical restructuring. So the banking system is a work in progress, but I think some of the things that worried me a lot five years ago about this link between banking fragility and sovereign fragility, you know, have been lessened.
So I’m back to your IMF forecast. Like, Europe—the eurozone grew faster than the U.S. last year, right? And the projection is, like, they are coming out of a deep recession, but they’re finally gaining momentum. So this conversation about the risks in Europe while always we need to be mindful—I come back to what Doug said in the beginning, which is remember what we were saying a year ago when we were sitting here. We had a lot of truly frightening elections, and that all came out very well. We ended up with Macron in France and, you know, things fell out, for an economist, you know, in a very positive direction.
POSEN: Well, I’m trying not to just repeat and say where I agree and disagree.
MALLABY: I have a different question if you’d rather, but—
POSEN: No, no, just real fast, I think Sebastian’s right to flag the leadership change at the ECB. It is going to be—it looks like it’s going to be Jens Weidmann, who has been singularly unconstructive during the entire European crisis. And for the ECB, it is an interesting question. I remember—many of you know, knew of Hans Tietmeyer, who was the Bundesbank president several times ago, and he was among the various German central bankers who used to talk about the Becket effect. You start out in government, but like Thomas a Becket, when you go to the church, you become a person of the church, independent of Henry. And that was seen as how in the Bundesbank Tietmeyer was seen as a social democrat, and he went to the Bundesbank and he was pure German central banker. So I guess the hopeful question is, will Weidmann moving to the ECB be switching from high church to low church monetary policy—(laughter)—and get a little looser. I hope so, although I doubt it. I do think the doom loops have been fundamentally diminished for the reasons that my colleagues said, so I am much more worried about a situation where the ECB provokes a panic in the government bond markets, which would of course affect Italy the way they did with Spain and Portugal and Greece. And that shouldn’t happen in the near term, but the potential is there.
MALLABY: I’m going to invite members in one second to join the conversation, but I want to ask Adam one more question because he has a new essay out in Foreign Affairs, which I think there are copies of as you walked in, in which he makes an incredibly articulate statement about the threat to the rules-based international order. And I guess you see this as a long-term threat to the—
MALLABY: Talk a little bit about that and then we’ll get—
POSEN: Oh, you’re very kind, Sebastian.
So my article, which I’m grateful to publish in the new issue of Foreign Affairs, is called “The Post-American World Economy.” I originally titled it “Withdrawal Pains,” but the editors knew better. Basically, the idea being the U.S. is withdrawing from its role of economic leadership. Many people talk about that, and I tried to spell out what are the actual costs and channels through which this happens and how long does it take and how bad does it get. And there’s obviously some contingencies.
But sort of the big message, in the spirit of the Sebastian’s concern about rules and governance, is to recognize that the U.S.—there is this tendency sometimes to assume that worrying about international rules or the liberal system is the province of us pearl-clutching Council on Foreign Relations members, that it’s not real or tangible, it’s abstract, and everyone’s freeriding the sucker that is the U.S. And my argument is, no, that’s fundamentally a mischaracterization, even though much of the Trump administration holds it dear, that the U.S. has been essentially chair of the club, and it’s a club that we can’t force people to join and we can’t casually kick people out of. It doesn’t—the club only extends to certain activities. But, you know, as chair we actually have a bunch of privileges.
The U.S. in some ways has actually been freeriding on everybody else: For example, its timeliness of support to the IMF and the World Bank, in terms of its own protectionism of sugar and other things. And so it’s been a good deal because the rest of the world really wants us to remain in the chair, but that may go away if—depending how the midterm elections go. And so when we talk about the erosion of rules, essentially what’s at stake isn’t just the trade wars—which, as you may know, our institutes spends a lot of time worrying about, which Doug already mentioned. What it’s about is breaking down the barrier between national security and international economics, that when Cordell Hull and Franklin Delano Roosevelt and their counterparts set up the liberal international system, it was really as much about preventing conflict and bullying by large states—be it the Japanese empire of the day, or the Italian empire, or the German empire—of other countries and making it so that commerce took place. As long as your country was a member of the club, there was no discrimination, and relative military force was not the determinant of commerce. Again, there were exceptions. The U.S. got more involved in Latin America, not always in a good way. But broadly speaking, people could go about their business without threat of expropriation, without military getting involved, without foreign policy deals being the main driver.
And if we move to the kind of bilateral bullying system, which is the only excuse the Trump administration has for saying we should pursue bilateral deals in the trade realm and other realms—because otherwise it’s so much more efficient to do multilateral deals and have standard rules. So the only reason you could possibly prefer to do these kinds of bilateral deals is if you think you’re the big bully on the block and you can lean on somebody. And when you start doing that, then you’re giving a lot of strength to autocrats and other countries that you don’t like, and the system starts to unravel.
And I don’t think it unravels tomorrow. I’m sorry, I don’t want to go on too long. I don’t think it unravels tomorrow. In fact, I think trade in many ways, in part because of things like Carla and others have built, is going to outlast the U.S. in some ways. And we’re seeing that with the TPP going ahead without the U.S., with the EU reaching out to Mexico and Canada. In finance, it may be harder. In other areas, international investment, it may be much harder. U.S. brands may suffer as national champions rise up around the world. Particularly who gets hurt are emerging markets. And this gets into governance issues that Doug has worked on at the IMF. You know, there are a lot of things that could happen over the next few years, and they’re all bad, and it just comes back to the Trump administration changing from being a slightly tardy absentee chair of the club to being a chair who’s attacking the rest of the club. And that’s bad.
REDIKER: Sebastian, can I just add one thing before we—
MALLABY: Yes, quickly.
REDIKER: Yeah, yeah. Just I think that what Adam’s describing is the need to question fundamental assumptions that most people, whether you’re in the markets or in policy or just, you know, advocationally interested, have never questioned.
And the example I would give is recently—now if you want to get really bored or boring, you know, read IMFC communiques, or G-20 communiques. It is very wonky. It makes Fed statements look exciting. But under this administration, under the Trump administration, there has been a hard-fought battle at each of those drafting sessions over whether to use what had been traditionally U.S.-inspired boilerplate language supporting flexible exchange rates, right? Now this is an administration that criticizes China and others for manipulating exchange rates, but they have tried to insert language supporting stable exchange rates. Well, without getting into a broad-based discussion about the difference between the two, it’s fairly obvious that flexible exchange rates mean the market determines, stable means you’re intervening, and suddenly the U.S. has decided that we are at least trying to change the debate to include stable exchange rates as the baseline. When you’re questioning those assumptions, it raises all of the international world order questions that Adam highlights in his article. But that’s where, you know, specifically it’s one of those things that people don’t even focus on until suddenly they realize the world has shifted beneath them.
MALLABY: So I do want to get to members. And remember, this is on the record. And if you have a question, put your hand up and the microphone will arrive, as if by magic.
Yes, there’s a question with a man with the red tie.
POSEN: While the microphone moves, I’ll say thank you again to Sebastian for the plug.
Q: Great. Eric Sein from Eaton Vance.
First question goes back to the beginning of the discussion on productivity between Susan and Adam. And I think, you know, your thoughts, Susan, that maybe companies are just kind of coming out of the financial crisis, and Adam saying that they’re, you know, choosing not to invest. But what if we just have different types of companies? Technologies companies don’t invest in physical capital, you know, the way manufacturing companies did. So do we just have a different landscape for investment that isn’t corporate-driven based on, you know, what they think is best or, you know, coming out of the financial crisis is just different?
LUND: Look, I would say part of the story is this mix in sectors, as you’re pointing out. So the economy over time is evolving towards more service sectors, which notoriously either we don’t know how to measure productivity in them, and when we do it appears that there is very little, if any productivity growth—so things like health care and education. So that’s definitely part of this story. We just have different sectors.
But, yet, I can look at even those sectors, health care—and tell you a story that I think Robert Gordon’s wrong. I was a research assistant back in the day, as an undergraduate, for Robert Gordon. But I just think—you know, I can look at, say, health care, and look at the advent of electronic medical records, the impact of AI on diagnostic—to help doctors, not replace them but enhance their ability to do diagnostics from images, looking at big-data analysis, looking at treatment outcomes, and figuring out what works and having that information then widely spread. I mean, there are huge potential gains to productivity from the technologies that we have today.
And then when you look at other sectors—like transportation, manufacturing, commerce, and logistics—I mean, again, you can look at some of the new technologies and say we’re at the early wave of adoption. And this is—you know, we’ll see in five years if we’re here. You know, if Adam is right or I’m right. But certainly even—despite the fact that the economy has shifted its composition, we still think there is room for productivity growth.
POSEN: I mean, I think Susan put it exactly right, in the sense that as both investors and policymakers it’s about deciding is there a turning point in the future that we haven’t seen yet. And you go back to Sebastian’s The Man Who Knew, one of the ways in which Greenspan knew—and I would argue his biggest contribution—was realizing in the mid-’90s that there was a productivity jump upwards in the U.S. and seeing that before most of his colleagues in the Federal Reserve and many of the people in markets. And so, you know, read the McKinsey report. It’s literally just out. Make up your own mind. Place your bets. The only thing—no, no, seriously. I mean, and I can’t prove otherwise.
The only thing I would say is we have to—the reality I think people have to recognize, though, is a lot of these things were already underway. And the data—we don’t have great data on intangibles, we don’t have anything. But in the national data, if there’s more productivity, we should have had higher growth and we should have had lower inflation. And it just hasn’t happened that way. So it may be coming, but it’s—you can’t really argue from a measurement point of view it’s already happening and we’re just not noticing it.
MALLABY: Another question. Yes, this guy in the middle. Yeah.
Q: Hi. Steve Myrow with Beacon Policy Advisors.
Just wanted to return for a second to the issue of the fiscal stimulus in the United States, and Sebastian’s worrywart tendencies. Adam painted a picture where I think we could say that you could be short- and medium-term optimistic, but maybe long-term pessimistic. In theory, the rating agencies are supposed to give us a heads up. What’s the—what’s the prospects of—given the deficit trajectory now—of one of the major CRAs putting the U.S. on negative watch? And if so, when will that come?
POSEN: I have many good colleagues in Moody’s and some of the other agencies. So I’m not going to presume to speak for them. I’d just say that, as my colleague Jason Furman has said, this is—this is irresponsible policy because there’s so much better things we can do with the money, whether it’s public investment or whether it’s having the fiscal capacity or the spare ammo for a future day. It’s not that it tips the U.S. suddenly into an unsustainable debt situation. So you’re right. I mean, it doesn’t even have to be ratings agencies. The treasury market is supposed to give us a warning. Ratings agencies too. I mean, it is potentially there.
But if you do, in the classic IMF sense, like we talked about with Greece, or Italy, or something, you do a debt sustainability analysis, the U.S. debt is not unsustainable, even if we add 10-12 percent of debt to GDP. It’s worse than it was. It’s high-risk. It’s not good. And I’m sorry, I’m not trying to duck your question, but I’m not going to predict the rating agencies. But just fundamentally, any sensible debt sustainability analysis isn’t going to tell you that by doing this, we’ve tipped over the edge. We’ve done something that, I think, any reasonable analysis would tell you is ill-advised. And if we end up needing debt for something else in the near future—God forbid, a crisis, a pandemic, a sudden recognition that schools need money—I don’t know, whatever it is, we have a problem.
But I wouldn’t bet on the U.S. getting a major downgrade or anything like that. Again, I shouldn’t speak about specific downgrades. But I mean, it’s just—it’s hard to see, even on the very big projections of this, that you get to that point. It’s, again, the morality play. It would be nice if the system was self-correcting. Like, it would have been nice in Brazil if four years before Dilma blew everything up people said, oh my God, this is unsustainable. But people didn’t say that. It’s like a great party, Carnival, let’s go. You know, we may end up with Carnival for a couple years in the U.S., even though at the end of the Carnival you have a big hangover.
LUND: And in this case, at the end of Carnival we’re going to have Social Security and Medicare to finally deal with.
POSEN: Right. I mean, that’s—
MALLABY: I think Mike Mosettig had a question. Did you?
Q: Yeah. Mike Mosettig, PBS Online NewsHour.
Following up, to a degree, on what you just last said about the government and it not being unsustainable, but there’s other kind of debt going on inside the private economy, the rapid rise of student debt. God knows what the Chinese level of debt is versus state-owned companies, et cetera. What about a more global assessment of where debt is and what kind of risks it poses.
POSEN: Susan and her colleagues have done a lot of work on this, so let me say for a strawman my, what, me worry, line, and then she can correct me. Despite everyone liking to tell the 2008 story as a problem of excessive debt, my version of the story is it’s a problem of excess of leverage and, what’s the opposite of excess, a shortage of regulation, OK? So I don’t have this convenient mapping in my head that there are levels of debt that are just—
MALLABY: You lost me there—leverage is debt, isn’t it?
POSEN: Not quite. Debt—depends what you do with the money. It depends what you do with the money. And it depends how it’s collateralized—and, sorry, you’re right. Literally, leverage is debt. But what I mean is are you borrowing if—like, some of the funds you’ve written about in the past when you’re borrowing 40 to 1 on capital. That’s pure leverage, versus—
MALLABY: Versus the asset, yeah.
POSEN: Yeah, it’s nature of the asset. Sorry. I apologize.
So just to say, Chinese debt, for example. There’s been a lot of attention paid to it. My colleague, Nicholas Lardy at Peterson does a lot of work on this. Our view, his view, consistently has been, again, it’s one of these things that’s bad, but not critical. So his view, if I reinterpret it, and which I buy, is it’s more like Japan or Korea in the past, that you’re misallocating a lot of capital to state-owned enterprises instead of—(inaudible). You’re getting low returns on that. If push comes to shove, the government can force you to roll over loans to them. This wastes a lot of capital and lowers returns on savings in the economy to the people. But it’s not immediately dangerous in the sense it’s going to collapse. It’s not Greece. It’s not Thailand.
And, again, the morality play—I know that wasn’t what you were saying—but just to say there is this tendency to assume that stuff gets punished—bad stuff gets punished, debt has its reckoning. If that were true, the economy would be a lot more stable and things would work out a lot more than they do. You can run up a lot of debt for a long time and nothing terrible happens. You just waste a lot of money.
LUND: I would agree and disagree. So I do agree that in China you can run up debt for a very long time and it will not necessarily result in a crisis. And that’s in large part because the government has, in the past, bailed out the banking system when it needed to. And it has the financial firepower to do so again. So when you look at Chinese government debt, as opposed to U.S. government debt, it’s extraordinarily low. It’s less than half the level relative to GDP than the U.S. So the central government has plenty of fiscal capacity to bail out the banking system, if needed.
That said, certainly somebody will pay the piper in China, because they’ve had extraordinarily rapid credit growth for 10 years now. And they have more than quadrupled the overall amount of debt in the economy. It’s very largely in the corporate sector. Much of it is linked to real estate, either directly because it’s loans to commercial property developers, or indirectly though steel companies, cement companies, et cetera. And so, certainly there’s overcapacity in many industries right now in China. I mean, if the housing and real estate prices stop, you know, appreciating, there could be a reckoning that somebody will pay.
But it could well be the central government. And there aren’t really strong financial linkages with the rest of the world. So unlike what happened in the U.S. 10 years ago, where we had taken a corner of the U.S. mortgage market—subprime mortgages—and then collateralized them into tradable securities and sold them to virtually everyone in the world—lots of European banks, you know, Norwegian pension funds, Chinese. And so, when that thing blew up, it had repercussions everywhere. The Chinese situation is very much self-contained.
MALLABY: But you just wonder, if there was a slowdown in Chinese growth, then there would be linkages to the rest of the world because other emerging markets, which depend on China as a growth engine.
LUND: Yeah. So it would come through the trade links and the real economy links, but not through a financial crisis-type scenario.
For the rest of the world, yes, debt has continued to grow. Are there worrisome pockets? There are. So the era of low interest rates has seen a lot of corporate debt issuance, particularly among high-yield borrowers. So non-investment-grade companies, that has skyrocketed. And over the next five years many of those bonds will come due and need to be refinanced. That will test investor appetite. And if interest rates continue to slowly creep upward, it could push many of those issuers into bankruptcy. Emerging-market debt could become an issue, again, with higher interest rates, as many of the bonds that were originally issued at low rates are now going to be refinanced at higher rates.
So there are pockets of worry. But I don’t think we see anything—I think that the systemic forces that were in place in 2007 that resulted in this global crisis have been unwound. So the securitization, and re-securitization, and re-securitization of an asset, that has largely disappeared.
POSEN: That’s what I was—she’s doing it much better. That’s what I was trying to say by leverage and lack of regulation, was CD-squared—CDO-squared, things like that.
LUND: Exactly. And that is not entirely gone, but it is largely. And so, in that way, I think the global financial system truly is safer. And banks are far more capitalized, and ready and prepared for any kind of shock to their individual balance sheet than they were.
REDIKER: Well, I just want to pick up briefly on Susan’s point about emerging markets. I think over the years the ability to issue debt from emerging markets on the assumption that they would pay it back has been replaced by issuing debt on the assumption that it will be refinanced. And in a low interest rate environment, which we’ve had for the last decade or so, that’s been fine. You borrowed to a willing audience at X, and then you refinanced five years later at X. It was fine. But actually, now everything has to be refinanced in a generally hiking interest rate environment.
And without pointing to specific countries, as an ex-emerging markets banker, I have looked at some of the issuance over the past year or two and I have had to shake my head, because these are countries that in a, quote, “normal environment” should not be issuing sovereign debt. And who’s buying them? Well, the people buying them are emerging-market investors whose entire skillset and experience set is based on the last 10 years, which is an unorthodox monetary policy post-financial crisis environment.
So as things go back to, quote, “normal,” I am more concerned about some emerging-market sovereign issuers who have gone out, raised money on the assumption that they’re just going to roll it over. And I’m not sure that that is going to end well for everybody.
MALLABY: So you’re more worried about sovereign high-risk than corporate?
REDIKER: Yeah. Selective, selective. But, you know, as I say, there are some countries—and I won’t name them—but they should not be issuing.
MALLABY: Yes. Let’s go here.
Q: Bill Courtney, RAND.
A number of countries seem to have severe problems with structural economic barriers: Japan, China, Russia, Ukraine, a number of European countries. State-owned enterprises are a big part of the problem. A number of those countries have pretty good monetary and fiscal policy—for example, Russia—but just can’t seem to tackle the structural barriers. Is there some light at the end of the tunnel? Or should this issue get higher priority from the G-20 or IFIs or something?
POSEN: I’m going to actually push back. The light at the end of the tunnel is structural barriers are overrated. You know, one can say that, but the fact is these kinds of things which you’re mentioning generally are not first order compared to these large swings in productivity growth that go with technological cycles, large swings in financial busts and booms. They matter somewhat for labor markets, which of course is important. So you think the paradigm is the—paradigmatic example is Germany’s labor reforms in 2003, which had very large effects.
But generally, the sort of walking around in what I used to refer to as the OECD checklist mode—that you sort of walk around, and you go into France or you go into Italy or you go into wherever once a year and you say, oh my God, look at all the ways you’re not a perfect market economy, here’s a list of things you should do, that’s turned out to be both overrated and moot. Overrated, in that many of the countries that have done these things have not done that well. And moot, in the sense that they’re—just going back to what Doug was saying about Italy—that you—as a result of that, you can sustain these reforms for quite some time, and then there’s no obvious benefit and people stop sustaining them.
I mean, the biggest example is Latin America. So there are—clearly, we could talk about a divide in Latin America between countries like Mexico and Chile, that basically did Washington consensus, did a bunch of wonderful things on paper—I don’t mean on paper in the sense that they didn’t do them, they really did; I mean on paper in the sense that they were supposed to be wonderful and they weren’t. And you look at the average productivity and per capita growth performance of Mexico and Chile versus, you know, not Venezuela and Ecuador, but other Latin American countries or other emerging markets, it’s not that great.
And so—and flip it around and look at Putin and Russia. I mean, there’s a lot of coverage recently—I think—I don’t know if it was Fox or The Economist—about the fact it’s not just sensible macro policies, although that was a big part of it in Russia, but, you know, they’re actually done pretty well.
Now, we can say we don’t like state-owned enterprises because over the long term they waste money, going back to what I was saying earlier about China, similar to what Susan was saying. And we can say that they lead to various kinds of unfair trade competition. That’s all fine. But let’s not forget that a vast number of countries in the world have state-owned enterprises. The U.S. is the outlier to the degree that we don’t. And they somehow all survive. And, if anything, our absence of a state-owned health care system is the single biggest structural barrier in the U.S., I mean, because we’re throwing away 9 percent of GDP a year for bad results.
So, you know, again, markets work. Markets are good. Deregulation is often good. But I think one is blinding oneself to the realities of the world if you sort of walk around and say, oh, well, why aren’t China and Japan and Russia getting on the Washington consensus or the structural reform bandwagon. Well, they’re doing pretty darn well, and not everybody has to do that.
MALLABY: Do you want to comment on that? Micro, that’s your thing.
LUND: I would have to push back a little bit.
POSEN: Give it a shot.
LUND: I mean, South Korea is not doing well. Japan’s not doing well. And what—
POSEN: Japan’s doing great. In per capita income terms, it’s doing—
LUND: OK. OK, fair enough, in—
POSEN: —it’s doing better than everybody else in the G-7 for the last 18 years.
LUND: OK, in per capita terms.
POSEN: What else do you want?
LUND: All right. (Laughter.) Fair enough. They’re at 0.5 percent growth, you know—
POSEN: Not per capita.
LUND: Not per capita.
POSEN: And they just added a million women to the workforce and sustained the growth.
LUND: Which is helping, yeah.
POSEN: So, sorry.
MALLABY: But maybe the women coming into the workforce has something to do with labor market reform?
POSEN: Sure. But—and it does.
MALLABY: Proving the importance of micro and structural changes.
POSEN: No, absolutely. (Laughter.) I mean—I mean, as I think you’re aware, Seb, I was—I was testifying—I’ve said this, I think, to this audience or something like this audience before. I mean, I testified to the prime minister’s structural reform commission in Japan in the 2000s, back in 1999, and I said: You have a choice, you can stop being racist or you can stop being sexist, you can’t be both. (Laughter.) And I wasn’t invited back for a while. (Laughter.) You know, so I’ve been advocating for what’s become womenomics for a very long time, again, partly as a justice issue as much as an economics issue.
I’m not saying reforms don’t matter. I’m just saying let’s step back a little bit from this—and obviously, labor market reforms matter greatly in Germany. Just let’s step back from this assumption that—just casually saying, oh, Japan’s in trouble. No, it’s not. Russia’s in trouble. No, it’s not. It may not be just. It may not be long-term sustainable. It may be unfair in various ways. But just be a little careful with the statement that if somebody’s not doing well, A, they really aren’t doing well—
MALLABY: But are you saying—are you saying, Adam, that macro dwarfs micro? Or are you saying that micro doesn’t matter?
POSEN: More the former than the latter, but some forms of micro matter. (Laughter.)
MALLABY: Well, I hope that Macron’s labor market reforms turn out to pay dividends of some sort.
I think we can squeeze in one very quick last question if there is—if there is one. Yes, right here. Here.
Q: Thank you very much. Mark Finley with BP.
We touched a little bit on China just on talking about debt loads. But from a global macro overview, it wasn’t really part of the conversation. So I’d be interested in the panelists’ views on, you know, the short-term issues, you know, for China’s economy. Thank you.
MALLABY: Who wants to give a short answer about the short-term issues?
LUND: Sure. They’re growing very fast. They’re going to grow slower, but it will still be very fast. That’s my view. (Laughter.)
MALLABY: OK. That was so short that Doug gets to say something.
REDIKER: So, look, I think that if you look at what President Xi has said, that the emphasis on growth as the sole target and the sole political agenda that is—that judge—that everybody is judged by is no longer the case. And I think that most people would agree that that’s a good transition. Whether it’s credible, how long it takes, remains to be seen. But I think that they have started to talk about things other than growth—social wellbeing, you know, inequality, some other things that a more advanced model would suggest are important, says to me that if he follows through that’s a good thing. It may be at the expense of the—you know, the high growth that Susan mentioned. But it’s not going to be absurdly low growth. And the question is, how did they manage that. I think some of the personnel choices that are being made and that will be solidified next month are pretty solid. And they are technically competent people who, if they’re given the authority to implement and actually go forth, have the opportunity to manage growth down a bit, but make it a more sustainable economy.
MALLABY: OK. We’ll leave it there. Thank you, Susan Lund, Adam Posen, Doug Rediker. And thank you for coming. (Applause.)