World Economic Update

Wednesday, February 6, 2019
China Daily CDIC/Reuters
Susan Lund

Partner, McKinsey Global Institute

Isabelle Mateos y Lago

Managing Director and Chief Multi-Asset Strategist, BlackRock

Adam Posen

President, Peterson Institute for International Economics


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations

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: OK, I think we can get started. Welcome to today’s Council on Foreign Relations World Economic Update with Susan Lund, Isabelle Mateos y Lago, and Adam Posen.

I’m Sebastian Mallaby, CFR’s senior fellow for international economics, and I’ll be presiding.

So we’re starting this World Economic Update at a time when I think U.S. stocks had their best January since 1989. And so far, February isn’t so bad either. But if you’re determined to be worried, as I generally am, with stuff to be worried about, I want to explore the outlook in two ways. We’re going to do the normal thing we do in these sessions, which is to talk about the main three regions—U.S., China, Europe—but I want to reserve some time at the end to talk about the state of globalization because I think that feeds into where the concerns are, at least in the longer term.

So starting with the U.S. and maybe with Adam, we’ve got a position where the market rally seems to have been driven by a change in the Fed’s signaling in early January. And the question in the sort of short-term way is whether that’s sustainable. The Fed at its meeting last week announced there’s a pause. But the question is, can the economy remain sort of, you know, at a point where it doesn’t overheat when you’ve got full employment? Does it—can you have full employment that carries on without eventually forcing the Fed to resume tightening?

POSEN: Right. And I think if you’re thinking in terms of the short-term outlook, Sebastian, the risks are actually in the other direction. The question is less about the U.S. economy overheating and more making a judgment how long can it sustain growth and continue to add jobs without falling off.

And I think it’s important to identify two aspects to this, to sound very economist. There’s the long-term trend and there’s cyclical. And the long-term trend in the U.S. is poor. It’s getting worse over time. Some of you have heard me and others say this for a while. You know, if this is the amount of growth we have, this is the amount of inflation we have when you’ve got pretty loose monetary policy and very extreme procyclical fiscal policy, the baseline of growth is pretty weak. And similarly, if—thank goodness—we’re continuing to add so many workers to the workforce, pulling them out of unemployment or out of nonemployment, then productivity is lousy because you’re having to add lots of workers just to keep the same amount of stuff going forward.

So the long-term trends for the U.S. are not good, and you could argue—and I’ll be interested in what Isabelle has to say—something similar is the case in Europe and something already was the case in Japan. But around that trend, you can still get good news. And I think that the Fed, frankly, is making the right call, whether or not they’re doing it for the right reasons is for people to decide.

But they’ve made the call that a number of us had been arguing for for a while, which is experiment, see how low unemployment can go. The odds of inflation accelerating are very low. And Vice Chair Clarida actually has been very frank about saying—and now Chair Powell also—saying that, you know, you can have wage growth that doesn’t necessarily lead to inflation in the short term.

So I’m not going to make a call on the market—sorry to disappoint—but just to say that sustained 2 ½ to 3 percent growth for the U.S. well through this year, sustained 2 ¼-plus percent growth for the U.S. in 2020, to me that is the right forecast.

MALLABY: But, Adam, just a quick follow up on that. I guess what some of us are confused by is this sort of idea that long-term growth potential I think in the Fed’s view is 1.9 percent or thereabout.

POSEN: Right.

MALLABY: But at the same time, as you’re describing it, we could have a sustained period, not just a year or two, of growth significantly above that. You know, you’re saving—I mean, right now it’s about 3.

POSEN: Right.

MALLABY: If we could keep going at that rate by absorbing more people into the labor market, it turns out not to be inflationary, doesn’t that actually mean that—I mean, what’s—how do we—

POSEN: No. No. I mean, you’re right to frame it that way, Sebastian, that there is this idea very much baked into our bones and, to some degree, in the data that there is this run rate of the economy and if you don’t have a lot of spare capacity and people, then you can’t keep expanding it without inflation.

But what—again, I’m not alone—a number of us have been saying for the last several years is, the flatness of the Phillips Curve, I mean, basically the inability of labor to bargain for higher wages, even conditional, on high employment is very low. The elasticity of labor supply, the ability to pull more people in the workforce, to have people reallocate—Susan and her colleagues at MGI have done some work on this—their ability to get people out of gig work or part-time work into other work, this is also very high. And so it’s not to say that you’re not going to run into that eventually, it’s just to say that if you look fairly at the capacity we have and the lack of bargaining power of wages, you’ve got a ways to go yet.

MALLABY: So that’s a good segue to Susan and her colleagues at the McKinsey Global Institute.

I believe you’ve done work on the labor market and productivity. Can you talk a bit about how that feeds into this perception of what the growth rate could be?

LUND: Yeah. So right now we’re in an unusual situation where unemployment is much lower than we thought we could drive it without seeing any wage gains, as Adam said. And I think this is one of the things that is confounding the Fed on what to do next. Because on one hand, we continue to add jobs, but the wage gains are now starting to kick in, but not very strongly. So ultimately, the long-term growth of the U.S. is going to depend on productivity growth. So with an aging population and fewer people in the workforce due to aging, we’re going to have to see some productivity gains.

And I hate to say it, Adam, I’m a relentless optimist. And so I spend a decent amount of time—

POSEN: It’s great to be an optimist. (Laughter.)

LUND: —talking to companies and businesses about automation and artificial intelligence. And there are business applications that are being deployed that are moving the needle hugely within one company in terms of efficiency, productivity. And right now you don’t see it in the productivity statistics yet, but, you know, an optimist would say let’s see how that plays out, and if we get enough firms adopting, we will move the needle on productivity, which gets us out of Adam’s more dire, long-term forecast for, you know, very minimal growth.

MALLABY: Is there—yeah, go ahead. Yeah.

POSEN: Sorry. Just Susan and I, as you can tell, have debated this before. So I just want to put on the record my or the other point of view, which is that, yeah, we all would like this to be like the Greenspan moment of the mid ’90s. It’s the computer revolution, the IT revolution are coming; it’s not yet in the data, but I can feel it within the statistics.

And Chair Powell has very clearly said—very similar to what Susan has said—I’m a, literally, I’m a productivity optimist and we want to see that surge. So that’s fine. But I have to say, and I think some of you heard me say this in this room before, I don’t think the evidence is there for that. Because if that was happening, we would be seeing a lot of investment pouring into these new fields, we would be seeing a lot of getting ahead around—it wouldn’t be a simultaneous productivity slowdown around the world that we’ve seen.

And so I reluctantly—I’m not happy about it—but I’m very much a pessimist, I guess, because I think the Fed’s trend growth rate is an overestimate. It’s, like you said, it’s 1.9. I think Susan’s is well above 2. I think it’s less than 1.7, might be 1.5. And being antimigration, where I know Susan and I agree, being antimigration isn’t going to help that.

MALLABY: Quickly. So is there one example of a company-level innovation that has moved the needle, as you say, a lot on productivity, which strikes you as the kind of thing that might permeate through the economy and show up in the data later? Is there an illustration?

LUND: Oh, absolutely. There are 16 companies around the world profiled in a recent report that we contributed to from the World Economic Forum called Lighthouse Factories. So these are cutting-edge, advanced manufacturers, one of which is in the United States. And when you deploy big data—internet of things, automation, artificial intelligence—at scale, you get gains like 80 percent improvement in defective parts, you get 30 percent improvement in cost efficiency. I mean, you get huge gains.

Now, I do agree with Adam that when you look at the investment data, I will quibble with you. I think that investment—first of all, venture capital investment is going into this. And even when you disaggregate national investment into firms, plant, and equipment, that is actually doing well and that would pick this up. But at any rate, it’s not at scale. So this is still individual companies that are reaping gains, but you’ve got to see this deployed in a big way before you’re going to raise national productivity.

And I will agree with Adam, you’re fighting against the overall shift of the workforce to low-productivity sectors, like health care, government, education, as technology, IT, soon to be finance, manufacturing all become more automated, the labor shifting to the places where there isn’t a lot of productivity growth. So that is another headwind for raising national standards of living.

MALLABY: Isabelle, you wanted to—I have a question for you, but you can comment first if you’d—

MATTEOS Y LAGO: No, I was—I was in fact largely going to make the point that Susan just made at the end, that productivity in firms that are at the frontier hasn’t come down. If anything, it’s even somewhat higher. The problem is the structural shift in the economy towards a larger and larger wage for the parts of the economy that have very low productivity. And I’m not sure how much you can really have the same productivity gains in those sectors as health care, caring for the elderly, entertainment, et cetera. By definition, it’s going to be much harder. And I think that’s the—that’s the structural challenge for the—for the long term.

But just to bring it back to the short term and the market outlook and the implications for the Fed, I think one important message, at least people in the markets seem to have heard from the last Fed press conference, is this concept of patience and the reality we don’t really know, but we’re not going to try to be too far ahead of the curve. And that’s really important because, you know, I hear very often my colleagues who manage portfolios saying, you know, with Yellen we knew what to expect, she was, like, going to be very dovish; with Chairman Powell, we’re still learning, maybe he’s still learning. And so this message of patience and removing any kind of bias in the stance of the—of the FOMC was very important to reassure markets that this fear of overtightening, which was very present in December and really drove this terrible market performance, that fear has now abated.

MALLABY: So on this question about the Fed and the markets—that’s what I was going to ask you about since you’re at BlackRock—you know, there was this whole debate and almost recrimination about the so-called Greenspan put in the past. How do you avoid having a power put if, you know, December is terrible in equity markets and the Fed shifts direction in response to that, then markets come back, the Fed shifts again or may shift in the future again—I mean, if you’re responding to the market and you’re responding particularly to market weakness, how do you avoid having an asymmetric bet?

MATTEOS Y LAGO: It’s very hard. And when you look at the amount of tightening that markets are pricing in, you know, we’re looking at essentially a rate cut or close to a rate cut by the end of 2020, which seems a bit extreme when you look at, you know, where job creations are or where, you know, how strong the economy still is well above potentials.

If you look at this as an—as an economist, you’re thinking, you know, this doesn’t make sense, the Fed is going to have to go back to hiking. But markets have heard the message from last week as, oh, actually, we care about markets and there is a put.

My own view is this is probably wrong, this isn’t what they meant to convey. And I think it’s a good thing that there’s going to be now monthly press conferences which are going to give, you know, as many opportunities to clarify what really the Fed is trying to do. And to me, the important thing that they should emphasize more is there’s no—there’s no put in terms of, you know, the stock market, but we do care about financial conditions.

MALLABY: Quite how to distinguish those, right?


MALLABY: I mean, equity markets is a big part of financial conditions.

MATTEOS Y LAGO: It is a big part, but that’s, you know—I mean, by our own measure of financial conditions—everybody has their own—you know, you had over the first quarter a round of forty (bits ?) of tightening of financial conditions, of which only five from the Fed itself, so there was a lot more tightening than the Fed intended to deliver, so it made sense for it to pull back.

If markets get all ebullient again, they will need to get back on the tightening path. And I think they need to convey that much more clearly.

MALLABY: Right, but just on that, but aren’t we pretty much there? I mean, just in a crude way, if you look at the equity market, it comes down in December, has recovered in January, now continuing, we’re surely quite close.

MATTEOS Y LAGO: So our indicator of financial conditions suggests that we’ve walked back only about a quarter of the tightening. In January, we’ve walked back only a quarter of the tightening in Q4, so we have some way to go.


Let’s move the discussion on to China and I’m going to start with Susan here.

2018, the growth of 6.6, that’s the slowest since 1990, and that’s despite the fact that the Chinese authorities have been trying to stimulate. They froze the deleveraging policy they had before. And there may have been some massaging of data, I read about. The question, I guess, is, is China fine? I mean, 6.6 is still a lot of growth. Is China basically fine growing at 6.6 percent? Or are there instabilities that emerge when the rate is lower?

LUND: Right. Well, I’m not a political scientist, but that is the fear, that if growth slows too much they will not be able to absorb enough workers coming from the western provinces and the countryside that there will be a backlash.

So China right now, I think I’ve heard the best description is it’s like a continent and it has rich countries, middle-income countries, and poor countries all within its own borders. And so that’s the fear of the government, right, that you’ve got to keep growth going to keep people happy.

Six-point-six is still pretty fast. It’s going to continue to slow, though, because China is aging quite rapidly. The size of its workforce is actually declining because of the one-child policy. And they’re also caught in this interesting situation where they’re no longer low wage, that the low-wage manufacturing that they started out with is now going to Vietnam and Bangladesh and maybe Ethiopia, but they are also automating. So China’s buying a lot of industrial robots, so they are going to be faced with a situation where they’ve got a lot of workers displaced. And it’ll be interesting to see how that plays out.

On top of all of this, they have a big debt overhang and potential real estate bubble. And we know from our experience and the experience in the U.K. and Spain and Ireland exactly how that combination can end.

MALLABY: Right. So there’s the question of the absorption of workers and then separately the question of the debt-carrying capacity to the extent that Chinese corporates have borrowed in the expectation of a background 10 percent growth or something, you know, 6.6 and that measure is terrible.

So you can—you can answer, you know, in full voice, not in whisper.

POSEN: Well, I’m whispering so I get your permission. (Laughter.)

I think this discussion fundamentally misses the point. And this is based on very much the work of my colleague Nick Lardy, whose new book, The State Strikes Back, which title tells you what my message is going to be.

This isn’t about the demographics, although Susan’s right to mention it. You can—you can debate over how much they’ve got, more workforce to pull in, less workforce to pull in. It’s not about the bubble because they’ve got lots of savings in the public sector and because nobody was expecting 10 percent growth anymore and there were not long-enough-term loans that anybody was really basing it on that.

And frankly, Sebastian, the government is doing contradictory things. They are not—they didn’t completely freeze their credit crunch. A lot of the slowdown is because they’re crunching credit. So what ties this all together? It is that President Xi made a choice that he was going to reinstate the role of the state in a whole number of ways much more aggressively than some of us realized at the time. And Nick and others have looked at this, and the last four or five years you just see a complete shift in where they’re allocating capital in the protection from competitive pressure, in the—in the public sector, in the state-owned enterprises, and this is directly slowing things down in addition to whatever other temporary effects or long-term effects.

And so to me, I think Susan’s invoking the image of the multiple countries is very informative, but I would cut it a different way. It’s like South Korea or Japan on steroids. It’s you have a zombie sector that isn’t just keiretsu or zaibatsu or chaebol. You have a zombie sector that’s the state-owned enterprises and you have an extremely lively, vital, pretty competitive private sector. And President Xi has given orders that we’re just going to put a lot more resources into that public sector. And that’s, frankly, doing terrible things to their return on capital and their productivity growth.

And I have to say this again—this is me speaking, not Nick—you know, I think it is ironic at a minimum that the U.S. political class, not just the Trump administration, is getting insanely paranoid about China taking over the world economically and technologically at the very moment when they’re blowing it.

MALLABY: Yeah. (Laughter.)

Isabelle, I want to ask you about the way that the trade talks are going to feed into China in terms of the market perspective and the market participants you’re in touch with. What’s your message about the two scenarios? You know, one is by March the 1st we have some de-escalation, the other one is we don’t. How do—how dramatic is the—is the impact on the Chinese markets or economy?

MATTEOS Y LAGO: I mean, look, sentiment has come to recover in China from very deep lows of last year. So the trade question is obviously very important and it’s particularly important for the dynamism of the private sector. And Adam was right to stress that, you know, structurally in recent years there’s been a tendency to favor the state sector. But recently, under the pressure from this cyclical slowdown, the authorities are beginning to realize that, oops, it’s actually the private sector that’s facing a credit crunch and they’re now actively telling the state-owned banks please do lend to the private sector. But the private sector is only going to invest if there is some resolution of these trade uncertainties. So that’s definitely important.

Our expectation is actually much less binary than what you described. And we don’t think that March 1 will bring full clarity around these tensions. We think that there’s now, you know, a strong desire on both sides to not go into a phase of additional tariffs. Whether we will get an extension of the truce or some minimal agreement that means, let’s say, that, you know, the threat is off the table, I’m not sure.

But what is for sure is that the reasons for these tensions run much deeper than tariffs on this or that or the size of the bilateral deficit. They’re very structural and have to do with the way the Chinese economy operates. And the Chinese economy has decided to double down on how it operates in essentially nonmarket ways. So these issues are not going to go away. And even if there’s an agreement on a narrow set of trade issues, we expect these tensions will persist and the rivalry in the tech sector in particular is going to become more entrenched and possibly even more acute.

MALLABY: So let me stick with Isabelle and ask a question about Europe, another region in a way where there’s a slowdown. You know, I think the IMF forecast for growth in the eurozone for this year is 1.5 percent. Italy, always a problem case, it’s actually still positive, 0.6. So again, the question, I guess, is, is this the sort of slowdown you can live with? Or does the slowdown reopen various cans of worms, whether that’s Italian debt or something else? How worried should one be about the European outlook?

MATTEOS Y LAGO: Yeah, that’s actually a really good—a really good question, a really good way of looking at it. I think I would answer that by saying, if we get a stabilization/pickup in China by the end—by the end of the second quarter, then we’re not too worried that Europe would get into a recession or a deep slowdown. But that’s a big if, that’s our base case, but there’s clearly significant downside risks there.

You know, Germany’s slowing down, In the grand scheme of things they can handle it. If anything, it will make the ECB less trigger happy to, you know, remove stimulus too early, it will kick in automatic stabilizers on the fiscal side, which is not a bad thing.

The big worry, as you noted, is really Italy, which, I mean, as you say, yes, 0.6 is still—is still positive, but it’s a—it’s a much slower growth outlook than people were talking about just a few months ago. And Italy has a—has a very large debt burden. So, you know, even before this slowdown, we were concerned that the agreement reached with the European Commission last December on the Italian budget had resolved nothing whatsoever, just had swept a bunch of difficult issues under the rug. These issues are going to come back in September when the Italians have to discuss their 2020 budget. And if at that point the economy is even closer to a recession, to zero growth, and people realize the debt has grown bigger and all these unfulfilled promises still need to be fulfilled, I’m afraid we’re going to be back exactly to where we were last September and potentially with even less cohesion in the European policymaking structure because we will have had elections in the European parliament, which will likely strengthen the voice of the populist parties. So all the policy reaction function of Europe, if you will, is likely to be even less efficient than what we’ve seen in the past, which was already not exactly a model. So that’s the worry.

MALLABY: So Italy is the main worry to watch.

But, Adam, do you want to add anything else? Is there—you know, France, sidetracked by gilets jaunes? Is there Brexit spillovers, something else in Europe that worries you?

POSEN: Thank you, Sebastian. I very much agree with Isabelle and her colleagues’ analysis. I think—I think that’s broadly right.

I would just say, you know, we’ve had this discussion and you’ve rightly framed a lot of the things we’ve said about U.S. and China, sort of this indirect, you know, what’s structural, what’s long term, what’s short term. Unfortunately for Europe, in Europe the future is now. Their structural problems of the euro area are very real and pressing, and so they are not resilient in a way that China or the U.S. is. And it pains me greatly to say that, but it just is not.

And this is because some of us, myself included, were mistakenly optimistic about this window between elections when you had Macron and Merkel and you thought there was going to be some progress on a common European agenda to fix some of the structural problems of the euro area’s ability to withstand a recession. And they just didn’t—they did some, but not enough.

And so just picking up on something Isabelle was saying, you know, the issue—she talks about the policy reaction function, as it were, and I agree with that—the issue is going to be, how much of a fiscal response can Europe have and will Germany do its part, which has both direct impacts on the rest of Europe and on the market perception of how viable it is for Europe to do that? And they didn’t build a common fiscal capacity in any sense, but they’re not going to—they’re not going to have much choice.

The ECB just doesn’t—you know, again, I don’t like talking about central banks being out of ammo. But in the European context, it’s much more realistic to think about that because negative rates are not as viable as they are in some other countries. I mean, I know you’re aware of the stuff that Brunnermeier and others have done—Markus K. Brunnermeier is a very brilliant professor at Princeton—that if you have a sufficiently bank-dependent system and you make rates negative, you can end up not being stimulative or even being slightly contractionary, not because it hurts savers, but because it makes the banks unwilling or unable to lend. And so there’s a real worry for Europe.

Again, I agree very much with Isabelle that, you know, that a broader global context, it’s not like there’s baked in a recession. But if they don’t have a fiscal act together, they’re going to have a real problem coping with the next recession.

MALLABY: So before coming to members for questions, I just want to do—get a little bit on globalization on the table then.

I guess the question I have is, you know, just reading even in the last day or two about the German economy minister wanting a state fund to preempt Chinese bids for German corporations, it’s just sort of a sign of the times that cross-border FDI is falling in response to a bunch of things, but these include quite difficult to wish away security worries about China. And then on the other hand, you’ve got European responses to American tech companies, which are not on the same order of concern, but they go broader than economics, that’s the similarity. They’re about, different perceptions of privacy, they’re about a sense of sort of strategic dominance of the economy by U.S. tech firms, which Europeans bridle against.

So I guess, you know, Susan, you’ve done work at MGI in the past on whether globalization was slowing. And I think you’ve cautioned not to overstate that in the wake of the 2008 crisis. But how do you feel about it now given these geopolitical factors?

LUND: Well, it’s—there’s no question that we’re entering a different chapter. Most of us, most of the people in this room, right, grew up in the last twenty-five years in which we thought globalization was a one-way process towards more liberalization, more openness, more economic integration. And what’s very clear is that history has shown us, but a very long time ago, that that process can go in reverse.

The research we released most recently looks at industry supply chains. So these are what actually drive global trade flows. More than 90 percent of trade flows through what we call a value chain. So how these industries are reshaping themselves actually matters a lot in the long term for what we should expect for trade flows and integration.

And a couple of things that we found irrespective of the current U.S.-China tariffs and, you know, trade disagreements is that industries are, first of all, becoming more regional. We see that actually trade as a percent of what the world produces is going down, gross output, this is largely because of China and other developing countries consuming now more of what they make rather than exporting it.

So a couple of these shifts have been underway that point towards I wouldn’t say less globalization, but certainly less trade in goods and more regional and nationally focused value chains. Now we’ve got trade disputes uncertainty, we’ve got all of the digital policies you mentioned around privacy rights, cybersecurity. The Europeans are taking the lead on defining this, the U.S. has not had a response on what should be privacy policies for digital, and so there are all sorts of tariff and nontariff barriers being thrown up. And that may accelerate what we see fundamentally happening in a variety of industries anyway.

MALLABY: So “slobalization” as the economists call it.

Let’s go to members. Please remember that this is on the record.

And who has a—who has a question? Let’s take one right here on the aisle first of all. The microphone is coming to you. And please state your name and affiliation.

Q: Thank you. Mark Finley with BP.

Thanks to all of you for your comments. Following up on the last theme, in the last couple of days I’ve read public opinion polls here in the United States reporting stronger positive views toward socialism than toward capitalism. How big a deal is this? And, yeah, what are the pluses and minuses of it? Thank you.

MALLABY: Who wants to take that? (Laughter.)

POSEN: There’s two—there’s two dirty little secrets, Mark. The first is, what shows up in the polls has very little to do with what actually happens in Washington, as you know. No, seriously. So, I mean, given the inertia and the lack of responsiveness in this democracy, the idea that, you know, if all the statements by Trump Cabinet officials about federal workers having to go into breadlines for being out of work didn’t cause pitchforks to go out in the street, I’m not that worried that we’re going to overshoot in a socialist direction because of some poll.

But the second dirty little secret, as, again, you know, but bears repeating, is that the U.S. has been a ridiculous outlier in terms of the self-delusion it has about the government role in the economy. Because, of course, we have all these horrendous subsidies for environmentally destructive things, we have an unbelievable military complex that subsidizes all kinds of things, we have at the state and local level all kinds of weird land distortions. So if socialism were to take the form of increasing revenue to the government and allowing us to get rid of some subsidies, I’m all for it. (Laughter.)

MATTEOS Y LAGO: I’d like to add a slightly less optimistic perspective on this. Not disagreeing on the specifics of Adam’s response, but as investors, one trend that we’re noticing, not in opinion polls so much as in actual elections, as well as polls, is increasing support for political ideas that essentially trump economic interests. And we’ve seen this with Brexit. We’re seeing this with immigration policy or immigration views in a number of countries. And this is not people who don’t understand the economic costs, they’re just saying I don’t care, there’s something that is more important.

And that, as investors, worries us because if these things come to pass—and in democracies, you know, there’s broad support, they will happen at some point—this will inevitably lower the rate of growth and the rate of return to everything, to capital and labor.

MALLABY: And would you put in the same bracket it’s not just that people are putting “socialism,” quote, unquote/unquote, maybe that just means redistribution higher than growth. So what about they’re putting national security?

POSEN: Or they’re putting racism?

MATTEOS Y LAGO: You know, racism or, I mean, in the case of Brexit, I don’t know if it’s racism, but a sense that they want national sovereignty more than—more than anything else.

MALLABY: OK. Another question. Let’s go to Paula.

Q: Thank you.

MALLABY: The microphone should be just arriving.

Q: Thank you. Paula Stern.

I’m curious about the rational thinking of Xi and China leadership because your description of the increasing impact, power, subsidies, influence of state-owned enterprises adding to or subtracting from Chinese growth prospects. The Chinese have been very rational economically over the years. Is this all politics, or is there—what’s behind the economic thinking? And what is the kind of counterbalance in the thinking of Chinese leadership with regard to this increased influence and favoring of state-owned enterprises?

POSEN: I think Paula was asking me. So like Susan, I have to put in the disclaimer I’m not a political scientist. There are political science experts you can go to for this.

But I think your question or the issue you raise, Paula, dovetails very nicely with what Isabelle was just saying.

Yes, the Chinese leadership has been extremely pragmatic and extremely successful in taking seriously economics. But additionally, there has never been any question that the primacy of the Communist Party of China is the paramount goal. And if anything else, Xi has said that.

And so is it some sort of rational thinking, oh, gee, we’re trading off X percent of growth because we’re at a sufficient point so people will get—from the underdeveloped-country part of China are going to be less mad? Maybe.

I think more realistically you have to look at the fact that a few years ago Xi, starting with Liu He and some other people, had a bunch of people talking a very rational, reasonable reform economics game. And he shut them down. He may—he may have kept some of them in office, but he shut down those reforms.

And so just as implied by Isabelle and I’ll make explicit, you know, Brexit is about putting these nationalist, little England—because it’s mostly England, not Scotland nor Ireland—ahead of economics. Our friends in the yellow vests in France, you could argue, it’s economics, but not—so it’s more about their ability to drive their cars. No, seriously.

And, you know, in the U.S. right now, I mean, we just published another paper at Peterson today by Kirkegaard and Huertas summarizing and extending the literature on how significant Hispanic migration has been to U.S. growth. I mean, it’s just enormous. And notwithstanding Tom Brokaw’s slanders, Hispanics actually have assimilated, invested, been more entrepreneurial than other immigrant groups by comparison at this point. So, you know, the main thing an economist can do in the face of this is just remind people economics is not determinative. There are things people care about more than economics.

Now, you can say President Xi—and this is the discussion, right—at some point it becomes costly enough. And this is what Isabelle was saying. There are some people who are saying, oh, look, they’re backing off some of the credit tightening because they know the private sector has to bail them out.

My view, for what’s it worth, is, yeah, I think they will make a few small adjustments because they don’t want a sharp falloff in growth. But the direction of travel is clear, just as President Trump is trying to take us in the direction of travel that is economically costly, but he’s got other things he cares more about.

MALLABY: Either of you want to comment on that?

LUND: Well, that was very well said. But I would say there is a side of China—and I didn’t read Nick Lardy’s book, which I will now go do—I think there’s another side of China, though, that is the high-tech side. I mean, China has made enormous progress in moving out of labor-intensive manufacturing first into durable consumer goods, automotive, and now into advanced industries, automation and artificial intelligence. There are mobile payments and some of their financial system is much—is much more sophisticated than what we have here. Right? You pay with your phone and that’s taken off to an unbelievable degree.

So I think China is—it’s big and it’s complex, so while I don’t disagree with anything Adam said, I wonder how much they think they can have their cake and eat it, too. Because the Made in China 2025 plan is all about moving to be at the frontier of advanced industries. And so we’ll see how that plays out, but I don’t know, I’m not convinced that China itself accepts that they’re going to be growing slower forever. I think they think they’re moving in the direction of an advanced economy.

MALLABY: Another question? Yeah, you’ve been waiting here.

This gentleman there.

Q: Irving Williamson, International Trade Commission.

I was wondering if we could go back to this question of regional value chains and that phenomena. And what does that say about growth and development in, say, Africa or South Asia? Are we going to get increasingly a gap between the haves and the have nots?


LUND: Well, that is sadly one of the conclusions of our report or that’s a worry, let’s say. A lot of the trends we look at, the increase in innovation and R&D, the decreasing importance of wage rates and labor in production all favor doing more production in or near the major consumer markets, which would be the United States, Western Europe, and China. So I think Southeast Asia, a lot of what’s driven the regionalization of trade is trade within Asia. Also, trade within the EU 28, so the integration of Eastern Europe with Western Europe.

And it does raise a question. So what will be the development path for the low-income countries that haven’t gotten on the bandwagon yet of globalization? And I don’t know the answer. I mean, certainly in the case of Africa, intraregional trade has been exceptionally low, the lowest in the world. And there are opportunities there to create more economies of scale by joining markets, as you see, like, at the East Africa community. But it’s a question mark as to—as to what happens.

MALLABY: Another question? Let’s go in the back there. Yeah.

Q: Thank you. Charles Cobb, formerly with the Committee for Economic Development.

Former OMB Director David Stockman has been predicting that we’re going to have the mother of all asset bubbles and that we’re going to have a recession much greater than what we saw in ’07, ’08, ’09. And to back this up, he points to the Fed’s loose monetary policy, ten years of zero interest rate policy, effectively, three rounds of quantitative easing. And he argues that this has created excess liquidity, high leverage, debt everywhere you look. So my question is, is he right?



MATTEOS Y LAGO: No. There’s been—there’s been people warning us about hyperinflation and asset bubbles since the very first days of QE. So far, they’ve been proven remarkably wrong. I would tend to agree with Adam, the answer is no, although there is a question mark of, you know, how much longer can we—can we run with monetary policy being essentially fairly loose without generating asset bubbles?

As of today, if we had a recession tomorrow—and this is a question we’ve looked at very closely—when you look at any kind of metric of financial imbalances in the U.S., but also in most other advanced economies, they’re actually significantly lower than on the verge of the last crisis.

Now, you will find people telling you the overall level of debt has gone up, and that is correctly, but generally, that debt is borne by economic agents who can bear it more safely, in particular governments and, to some extent, you know, corporates rather than households in the—in the—in the U.S.

Now, there’s a lot of talk around leveraged debt, corporate debt in the—in the U.S. and that’s been—that’s been going up. But frankly, again, when you look at the ability of firms to cover their debt service, interest coverage ratio is at a very healthy level, the maturities have gone longer, so there isn’t much of a wall of, you know, repayment coming due anytime soon. So unless you have a precipitous decline in earnings, we’re not—we’re not terribly concerned at this point.

Now, if we carry on for another two years with, you know, real interest rates that barely positive, could we have a bubble? Possibly, but I think that’s a big if. Today? No.

POSEN: I want to strongly support what Isabelle said, make three very brief additional points that go with that.

First, it’s worth, when you look at these corporate debt numbers and people who intellectually lazily just look at the levels, is to think about the fact that we’ve basically had a shift in the fundamental financing model of corporations in the last twenty years, that American corporations are becoming more geared, there’s much less equity issuance, much smaller proportion of the economy is in the public equity markets.

And so part of that rise in debt is a structural shift. It’s not an indebtedness shift. And if you look at Europe and Japan, they’ve always had much more geared to much more debt-heavy corporations than we do and they have not had more frequent bubbles. So you’ve got to keep that in mind.

Second point is that when we think about monetary policy and debt—I’ll make only two points, then I’ll shut up—the second point is monetary policy and debt. This, I think, to me, underlines the stark secular stagnation layer. Some—(inaudible)—or some of the pessimism I have in contrast to Susan, because nobody’s preventing people from taking the low value, the low-interest-rate stuff, money, liquidity and putting it in something other than these supposedly overvalued asset classes. And instead, they’re still pouring into Treasurys and safe assets, which tells you there just aren’t that many investment opportunities out there. Again, Susan may disagree, I may be missing it.

But it’s not a pattern of bubble when it’s not a huge real estate speculation, it’s not a huge amount of financial innovation products. It’s actually the opposite. It’s a bunch of money sitting in the well-known asset classes getting low returns because it’s scared to go anywhere else.

MALLABY: Another question?

Yes, right to Mitzi—coming microphone.

Q: Yes. I’m Mitzi Wertheim with the Naval Postgraduate School.

I’m at a real disadvantage in this audience that I never studied economics.

POSEN: Lucky you.

Q: I have two views. One is—or two questions. It’s my understanding that in the U.K. they intertwine politics and economics when they teach them. And the fact that you say, oh, I’m not an economist or I’m not a politician, I can’t answer it. So I’m going to ask you whether or not that would make sense here.

And the other is, how do you explain economics in terms that the general public can sort of understand it? Now, it’s very complicated, I understand that. I think it needs to be explained visually because it’s not just a few linear roads, other things—

MALLABY: OK. The communication of economics. Can I—can I just say this. This is a fine set of people who are explaining it very clearly. (Laughter.) So we at CFR are doing our best to—and this is being, I think, streamed or—it is streamed sometimes?

POSEN: Yeah, absolutely. Yeah.

MALLABY: So, hey, we’re doing our bit. But who wants to—

POSEN: All right. I need to do a shameless plug, but then you should go to Susan. The first thing, though, to say is, yeah, the political/economy combination in the U.K. is very real. And without wanting to offend Sebastian and some of his friends, there is an argument that all the people who studied PPE at Oxford should be banned from public office because they keep causing major problems. (Laughter.)

MALLABY: There’s a further argument that the historians are even worse. (Laughter.)

POSEN: Yes. So, you know, so economists are bad, but they’re not uniquely bad.

I mean, all three of us, I think, to greater or lesser degrees, would be considered by peer economists as horribly political and horribly untheoretical. So I’m sorry to disappoint with our abstractions. But on the spectrum, we’re actually pretty good. “On the spectrum” is sort of a pun, I guess. (Laughter.)

But the real—the shameless plug is we’re actually wrestling, we at Peterson Institute, are actually wrestling with this very point, which is how, beyond doing the fact checking of the twenty-two thousand untruths put out by various government officials, what can you say that explains things? And we—Alan Blinder gave an endowed lecture at our institute last year, which, Sebastian, I think, has had Alan speak at the Council on this, he did a whole interesting lecture about how hopelessly difficult it is to teach comparative advantage, which is one of the most fundamental insights of economics, underlies trade, and people just don’t get.

So we’ve made a try. The shameless promotion is, thanks to our video editor, Melina Kolb, and all our team, we have this new microsite called “What is Globalization?” And it’s aimed at smart undergrads, normal people. It’s very visual, try it. And if you think it makes sense to you, get other people to try.

MALLABY: Let me quickly just—


MALLABY: Let me just quickly put an extra spin on this and then see if Isabelle or Susan want to comment. Because it seems to me that, you know, Alan Blinder had a wonderful line in the ’80s when he wrote one of his early books. He said, if economists don’t wade into the water, the quacks will dominate the pond. And, you know, that’s true, but I think there’s lots of economists who wade into the water and who make a huge effort to—I mean, one of—yeah, coming as originally a non-American to the U.S. and spending eighteen years here, I was just, you know, impressed by the way the level of public engagement by academic economists and professional economists is terrific. There’s a very vibrant debate and people make a big effort to explain things in terms that are understandable.

The question is the demand side, right? There’s plenty of supply of, I think, lucid economic commentary. The question is, how much do people want to listen to it? How much do they want to have that influence their choices? And this gets to Isabelle’s question about, you know, people actively and consciously decide I’m not going to prioritize optimizing economics. And that’s different from the 1990s when I think, you know, homo economicus sort of governed and walked the corridors of power. Now it’s some other kind of person who’s in there.

But let me ask either Susan or Isabelle if they want to pick up on that.

LUND: Nothing to add.

MATTEOS Y LAGO: Well, I’d like to comment around the gilet jaunes phenomenon in France, which is, you know, these protesters, et cetera. So the president has come up with this clever idea to diffuse tension, which is to have a big national debate. So he basically came up with, OK, here are four big questions that as a country we need to—we need to grapple with. So there’s a website where people are free to post contributions and millions of people have been doing that. And he’s, you know, holding town halls in various parts of the country. And so there’s all these ideas coming out and, frankly, more than half of them are completely crazy. And so there’s this—there’s this effort.

So I was on a—on a TV program recently. And the host tells me, OK, can you explain to us, you know, why it’s not a good idea or whether it’s a good idea to just have the government, you know, spend and spend and spend and the ECB to just buy the bonds and why isn’t that a workable solution? It’s really hard, you know, to do that in a kind of a mainstream way in two minutes in a way that people can understand. But I think it’s going to be absolutely necessary, too., and also to be willing to be simple. The problem is economics is complicated.

But on the other side, you have people who are completely willing to oversimplify, who don’t care at all. And, you know, frankly, I love the PIIE globalization website, but one of the best videos I’ve watched recently on trade is one produced by Stephen Colbert. (Laughter.)

POSEN: We helped him with that.

MATTEOS Y LAGO: Oh, you helped? OK. Well, you did a great job. (Laughter.) And, you know—

MALLABY: The relentlessness of Adam’s self-immersion is awesome. (Laughter.)

POSEN: It’s true, we did!


MATTEOS Y LAGO: And it wasn’t nuanced. It wasn’t tactful or anything, but it—but it worked. And I think sometimes we need to be a little bit—take ourselves a little bit less seriously and be willing to be—to be very simple as long as it gets the message across.

Q: If it’s funny.


Mitzi, we’re going to go to another question then.

Who’s going to—right at the back, yeah.

Q: Hi. Sorry. My name is Nau Maugua (ph) from the World Bank. And this is not actually from a bank perspective at all. This question is more so something that’s gnawed at me since I was an undergrad who decided not to major in econ after I actually went to school to major in econ.

But as we talk about the World Economic Update and the future, there’s these concepts of the degrowth theory, and growth is such a fundamental principle of economics. And yet, there are these concepts now of notions that countries could actually be overdeveloped or that millennials are not as consumerist as previous generations. So when you are putting together your calculus and your formulas for the future, what sort of social behaviors—I mean, we—there was always the ration actor when I was taking Econ 101, but what sort of social behaviors and trends actually go into your calculus? Or do you still keep using the same formulas for your predictions?

MALLABY: Well, there is the New Zealand government, which has a well-being index now baked into the national budget. But maybe others want to pick up on—

LUND: I mean, I think the issue of the millennials and demographics is huge. And I don’t have the answers to you, but I see the same data that you do about delaying purchases of cars, of houses. Part of that is a student debt problem for some people, but it does seem to be different choices in terms of work versus leisure that are foreign to those of us. And those of us who work with millennials all feel the pain here.

But that will impact long-term economic decisions. And it really changes the outlook for specific industries, whether it’s the automotive industry, every major car company now no longer calls itself an auto company, they are a transportation delivery service, they are about the future of transportation. And everybody sees and that’s being driven very much by millennials. So I think it’s a very interesting question about how a different generation could reshape the broader economy and the economic models that we’ve seen in the past decades.

POSEN: I think—I think another thing, not to be too economisty, is to distinguish between a shift in an emphasis on consumption, both among the people themselves and among policies, versus a shift away from growth. And because so much of the U.S. myth and propaganda, if I can use that word, has always been about the American standard of living and, you know, three cars in every pot, to pick up on Susan’s point—(laughter)—you know, I mean, so these do tend to get conflated. But they actually are distinct.

And if you step back, as I argued in the Economist a while ago, growth, in a sense, is the natural outcome of a healthy economy because there is some growth in the number of people working, there is some addition of the skills that the people gain, there is some accumulation of savings that gets put to new use, and some fruit of past investment, and there is some gain in knowledge and even in process, which is productivity.

And if you think about it that way, you know, a society can decide, you know, we’re not going to spend—we’re going to change to a more green economy or we’re going to reward savings more than consumption or it can make a cultural shift, but that society should still grow. And so even if you have those values—and I personally would be fine with that—but even if you have those values, it still should bother you, it should tell you that something’s very wrong if you’re still not getting growth. And that’s why I worry so much now.

MALLABY: Do you want to apply that Europe, Isabelle?

MATTEOS Y LAGO: I don’t think Europe is any different in this—in this regard. I mean, to me, if there’s one dimension in which there is a need to maybe reconsider the old economic model, it’s not to reconsider them, but it’s to be much more mindful of the distributional effects of any policies. I mean, again, look at the blowback in France against the carbon tax. That was largely due to a distributional effect. You can think of a lot of the support for the antitrade policies as, again, reflecting the fact that some communities have been disproportionately affected by the—by the downsides. And I think there’s a tendency in the policymaking circles to just think about policies as, you know, what’s going to be the macro impact on the country? And if we want to make them politically acceptable, I think people are going to need to care a great deal more about the distributional effects of policies that might be good, but not for everybody.

MALLABY: OK. With that, we’re going to wrap it up.

Thank you very much to Susan, Isabelle, and Adam.

And thank you all for coming. (Applause.)


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