From Russia, with thought

As the world “slow” pops up more and more (today, slower than expected US factory growth, and lower than expect PMI in China), it might be a good time to post a presentation I gave earlier this year in Moscow:

The New System of the Global Economy

My research specialty is long-term economic change, rather than short-term financial policies. So I am going offer a picture of why the current world order is ending, and what I think the new economic and political order will look like. I also will present some ideas on what will be the best responses to that change.

The change will be difficult to accept. I see the world economy, in a manner of speaking, as pregnant with a new order that is waiting to be born. But it will take time, and like with many pregnancies, there will be periods of discomfort, there will be birth pains, and we will not know exactly what the new child will look like before it is here.

Why do I say that the current world order is ending? We are in a periodic crisis of the kind that only comes to the world once or twice in a century, where existing patterns of technology and economic and social order have played themselves out and are going to be replaced by new ones. For the last thirty years, the world economy was driven by several processes that contributed to rapidly expanding globalization. In China, and to a slightly lesser degree in India and other developing countries, we saw billions of new workers added to the global work force. Particularly in China, they came with very low wages, but good discipline and good infrastructure, and contributed greatly to world output. The surpluses earned by Chinese workers were circulated as capital through the banks of the United States, Europe, and East Asia. The banks turned that capital into credit, which was extended to consumers and businesses, and that financed a global consumption boom that in turn created a boom in commodities, to the great benefit of countries like Russia, Canada, Brazil, and Australia. All of this worked very well for decades, and the demand for ever more credit fueled a huge boom in banking profits as well. However, credit expansion cannot continue indefinitely. Once credit expansion exceeds the rate of growth in the underlying economies and credit levels for sovereign states, companies, and households start to approach 70, 80, 90, 100, 120 percent of current income, this situation is no longer sustainable. Creditors no longer believe that the debt can adequately be serviced and repaid. We reached this point for many banks, financial institutions, and sovereign debtors in 2007-2009. Since then, following a wave of defaults, bankruptcies, and bailouts, we entered a stage of deleveraging, writing off debts, and adjusting to a world in which easy credit for all consumers and businesses is a thing of the past. Central banks have replaced this with rapid expansion of the money supply, which has driven down interest rates for the most credit-worthy borrowers.

Nonetheless, the contraction of easy credit and global deleveraging has produced a brake on the growth of global demand that that is contributing to the current Great Recession, and which will likely sustain it for several more years.

This contraction may be a cyclical effect. Yet other things are happening that will create lasting changes for the future. First, as the full impact of China’s one-child policy arrives, the growth of the Chinese labor force has ended. China’s census announced that in 2012, for the first time, the working age population declined. Growth in the labor force is also slowing down in India, Mexico, Brazil, and Indonesia. All of this means that the easy access to low cost labor to drive rapid increases in manufacturing will not be here. In fact, if you look at the world as a whole, 90% of all children under age 15 are growing up in developing countries outside of China, in areas where infrastructure, education, worker discipline, and security are far weaker. That is in Africa, the Middle East, parts of Central Asia, parts of South Asia.

And indeed Africa is, in a sense, the new China. Half of all global population growth in the next few decades will take place in Africa. However, Africa cannot simply step in to take up China’s role as a source of low-cost labor for the global economy; too much of Africa lacks the infrastructure or the labor force skills for its large and fast-growing population to match Chinese productivity. Thus a major adjustment of the global economy in the next 20 to 30 years will be China shifting to an economy that relies far less on exports driven by low cost labor, and far more on domestic consumption and higher productivity of labor. At the same time, the world will be striving to find a replacement for China’s role in the world economy by creating new sites for labor-intensive manufacturing, and seeking to develop the low cost labor force that is growing fast in Africa. But these changes will not occur very quickly. They will take decades.

Europe is also going through a period of major adjustment. I believe Europe is heading towards greater integration, but a great deal remains to be seen as to whether that integration will lead to stronger governance from Brussels, or to policies that are dominated by national leaders, particularly those of Germany. Europe will be wrestling with the form its integration will take — more centralized? more federal? It will be wrestling with the reform of its banking system and adapting it to cope with differences in productivity between different countries. Most importantly, Europe will be looking for new sources of economic growth. I think Europe will emerge as a stronger, more united continent, but those changes will take time.

Finally, the US and Russia are also going through changes. The United States is going through a boom in cheap energy, driven by an expansion of natural gas and crude oil production. Manufacturing that is driven by the search for low cost energy will increasingly move back to the United States. All of this will be difficult for the Russian economy, which has depended on high-volume, but relatively high cost, production of natural gas and oil. As the global market for oil and gas is increasingly saturated by expanding production outside of Russia, Russia will have to greatly diversify its economy and change its core economic relationships.

What we will see, then, in the next thirty years is capital being redeployed on a large scale to Africa to increase agricultural, mining, and manufacturing output and to improve human capital in that continent. At the same time, we will see a competition for capital in Europe, Asia, North America, and Latin America trying to put the available capital to the most productive and efficient uses.

All of this will put great strains on the welfare state model of European and rich country economies. The welfare state model functioned to drive resources to the elderly for pensions and to those needing health care, and to workers needing support in the marketplace. All of that was perfectly feasible when countries had fairly strong population growth, large youth cohorts, and rapid increases in productivity. But all of those conditions are now going away. All of the rich countries are facing rapid aging, and all of them are struggling to maintain productivity growth at the levels of the post WWII period. Indeed, the level of aging soon coming to countries from Europe to Japan – with populations over age 50 comprising half of all adults – have never been seen nor were anticipated. The U.S. has a somewhat younger population, but this will be offset by the combination of a large increase in the aged, as the baby-boomers move into retirement, and America’s far higher medical costs than prevail in other advanced countries. The basic contours of the welfare state, with governments providing generous pensions, heath care, and support for the unemployed, is going to have to be substantially restructured and rethought.

Technology is on the edge of some truly amazing and dramatic changes. Three-dimensional printing will have an unknown effect on mass manufacturing. Nanotechnology will have an unknown effect on the basic materials we use. The advent of driverless cars, most of them with electric motors, will change the way we organize our ground transportation. We are going to see a new thorium-based nuclear cycle that will lead to an expansion of safe and efficient nuclear power and greatly aid the electrification of our economies. The problem is that all of these technologies are in their infancy. Unlike computer and information technology, which has been the driving force of innovation the last 20 to 30 years, these new technologies will effect basic processes of energy production, transportation, and materials and will therefore have, I believe, a much bigger impact on our life than tablets or the internet. But it will be three or four decades before these processes are mature, and before they can replace our existing energy and transportation infrastructure. Technology thus will not come to our rescue; rather we face several decades in which the major economies of the world will have to adjust to powerful demographic shifts and economic constraints before the next wave of technological advances can transform our lives.

One last point that I wish to raise about global change: we have seen a spread of democracy that has been as inevitable and global as the growth of population and the growth of the economy. The number of countries claiming to be democratic in their government has grown from a handful in the 19th century to the great majority of the countries in the world today. But the very meaning of democracy is under contention now in a way that it has not been. In Europe, the question is whether democracy will continue to function mainly at the level of the individual states—Germany, Bulgaria, the United Kingdom—so that these governments set the policy for Europe, or will there be a new democracy in Europe focused on Brussels so that European voters as a whole shape the continent’s policies? This issue will take years to resolve, but will have to be resolved in order for Europe to function effectively.

In the United States, we have a problem with our two-party system becoming so ideologically driven that it ceases to function. This week, a major budget cut occurred in the United States not because of a deliberate policy choice, but because of a default that reflected a failure to make policy choices. Meanwhile, countries that do not currently have a competitive party system dominating their politics—China, Russia, countries in the Middle East, Africa, and Central Asia—will have to grapple with demands for greater accountability from their people. It will be a difficult time because corruption and poor governance that was tolerable during a period of rapid economic growth will be intolerable when people are struggling with major economic adjustments.

In sum, we will see huge changes in technology, in the configuration of the global economy, and in the meaning and operation of democracy that will need to be settled in the next 20 to 30 years. These are likely to be years of conflicts, major adjustments, and considerable power shifts in the world economy. I believe those countries that are most open to creative destruction, to moving away from the past, and to welcoming investment for the future will emerge as most successful countries 30 years from now. Nonetheless, the new world order that arises will look very different than that of today.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
This entry was posted in The Global Economy and tagged , . Bookmark the permalink.

5 Responses to From Russia, with thought

  1. Bien redigé, cet artcile me permet de comprendre ce sujet complexe.

  2. Thanks for sharing such type of useful information. And you have a nice blog with good post which is very helpful for us

  3. Fern Yengo says:

    I adore your wordpress theme, wherever did you download it through?

  4. Enoch Meuser says:

    I tend to stay away from the following blogs that are steeped in gloom and doom and depict people who have given up hope and are simply waiting for the “final” shoe to drop.

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