Blog Post

A cognitive bubble in Brisbane

When the world leaders met in Brisbane on November 14-15, some sense of urgency may have been expected. Instead, they promised more “structural reforms” along with other assorted unspecified actions. These, they inanely claimed, would deliver precisely 2.1 percent more GDP by 2018. If they believe that—or expect others to do so—they must live in a cognitive bubble.

By: Date: January 6, 2015 Topic: Global economy and trade

In December 2007, Professors Carmen Reinhart and Kenneth Rogoff compared the gathering U.S. subprime crisis to previous financial crises. They predicted a severe economic crisis was imminent in the U.S. and that it would take about three years before the economic recovery started. They proved to be remarkably accurate. The recovery in the United States started in 2010 and, although tepid, it has persisted.

But there was no similar analysis for how the world economy would fare. Although the world economy has become more interconnected, there has never been a framework to assess global prospects other than by just adding up country GDPs. In 2007, the global economy appeared extraordinarily healthy. At about 9 percent a year, world trade had experienced unusually dynamic growth between 2004 and 2007. The presumption was that the U.S. scare would have a temporary effect.

But more than six years later, the world economy is in worse shape than since the U.S. tremors initially rolled across the globe. Japan is back in economic recession and the eurozone economy is entering a new danger zone of debt-deflation dynamics. The Chinese economy is slowing rapidly. After a brief upturn early this year, the Indian economy has slowed again. Using historical analysis similar to that of Professors Reinhart and Rogoff, Harvard professors Lant Pritchett and Larry Summers predict that China and India will continue to decelerate. Brazil has ground to a halt.

So, when the world leaders met in Brisbane on November 14-15, some sense of urgency may have been expected. Instead, they promised more “structural reforms” along with other assorted unspecified actions. These, they inanely claimed, would deliver precisely 2.1 percent more GDP by 2018. If they believe that—or expect others to do so—they must live in a cognitive bubble.

The most serious policy failure has been in the eurozone where the ill-conceived monetary union is saddled with a governance structure plagued by near paralysis

The world economy refuses to restart for three reasons: bad policy, the fading of the U.S. as a global economic locomotive, and deeply-rooted development challenges faced by emerging markets. The geopolitical tensions and the turmoil in oil markets only add to the risk of terrible outcomes.

The most serious policy failure has been in the eurozone where the ill-conceived monetary union is saddled with a governance structure plagued by near paralysis until it is threatened by imminent meltdown. From annual growth of 2.25 between 2004 and 2007, eurozone GDP growth is down to less than 1 percent a year since 2011 and prospects are getting ever bleaker. Italy is trapped in a cycle of falling prices and rising public debt burden; Spain and Portugal are on that threshold.

And, yet, at its latest meeting, European Central Bank’s Governing Council boldly promised more action, but only “if needed.” Fiscal policy remains contractionary in the most distressed economies, and there seems little appetite to close and merge weak banks.

In Japan, Prime Minister Shinzo Abe did finally take decisive action in December 2012. But so fragile is the Japanese economy that one misstep—prematurely raising the value-added tax—has knocked it back into recession. At the current pace, the Japanese economy is set to do worse than in its “lost decade.”

Today, the world has no global locomotive. Between 2004 and 2007, U.S. imports grew at 6 percent a year; they have slowed down to a 3 percent rate since 2011. Put simply, without vigorous US demand for world imports, other nations are unable to sustain their own momentum. China briefly played the traditional US role in 2010, but is slowing down rapidly. Add to that the eurozone’s stupor and the reasons for the collapse in global trade are clear. World trade, which grew at a heady 9 percent a year in the boom 2004-7 years, is now bumping along at just above a 3 percent a year pace.

Today, the world has no global locomotive

And with slower trade pulling down growth prospects everywhere, the world has moved to a new equilibrium of lower output and trade growth.

Emerging market growth was puffed up by the transmission of the US bubble through world trade. Now, the costs of those wasted years of fiscal populism in the major emerging economies are all too evident. While some will continue to catch up with the advanced economies, even that is not assured for Brazil and others.

The new equilibrium also adds to global deflationary tendencies. With Chinese producers’ prices falling for nearly three years, the recent allegations of steel dumping by China are symptomatic. As countries seek markets more aggressively, prices and wages will continue to be bid down.  

This time last year my concern was that despite the cheerleading—especially in the euro area—“a sustainable global recovery may remain elusive, in which case 2014 could end in low gear as well.” US economic performance has been steady; everywhere else the prospects are much bleaker.

The concern now is about the real possibility of a shift in market confidence, reversal of capital flows from emerging economies, and a debt-deflation spiral in the euro area

The extended and widespread weakness is breeding vulnerabilities and new crisis risks. The concern now is not just about an elusive recovery but also about the real possibility of a shift in market confidence, reversal of capital flows from emerging economies, and a debt-deflation spiral in the euro area.

The world leaders in Brisbane were evidently out of ideas. They lacked a fundamental grasp of global growth dynamics. But scarier still, they had no map to mount a defense against the next crisis.  

This article appeared on The Australian and the Business Standard.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
18
14:30

Is China’s private sector advancing or retreating?

A look into the Chinese private sector.

Speakers: Reinhard Bütikofer, Nicolas Véron and Alicia García-Herrero Topic: Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Upcoming Event

May
19
15:00

Three data realms: Managing the divergence between the EU, the US and China in the digital sphere

Major economies are addressing the challenges brought by digital trade in different ways, resulting in diverging regulatory regimes. How should we view these divergences and best deal with them?

Speakers: Susan Ariel Aaronson, Henry Gao, Esa Kaunistola and Niclas Poitiers Topic: Digital economy and innovation, Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Podcast

Podcast

The cost of China's dynamic zero-COVID policy

What does zero-COVID mean for both China and the global economy?

By: The Sound of Economics Topic: Global economy and trade Date: May 11, 2022
Read article More on this topic
 

Opinion

For Europe, an oil embargo is not the way to go

Even at this late hour, the European Union should consider taking a different path.

By: Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 9, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article
 

External Publication

The Global Quest for Green Growth: An Economic Policy Perspective

A review on green growth and degrowth arguments.

By: Klaas Lenaerts, Simone Tagliapietra and Guntram B. Wolff Topic: Global economy and trade, Green economy Date: May 5, 2022
Read article More on this topic More by this author
 

Podcast

Podcast

Global trade Down Under

A conversation on the global trading landscape.

By: The Sound of Economics Topic: Global economy and trade Date: May 4, 2022
Read article More on this topic
 

Opinion

A tariff on imports of fossil fuel from Russia

A tariff on imports of Russian fossil fuels would allow Europe to hit Russia's energy sector without great suffering.

By: Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read article More on this topic
 

External Publication

How to weaken Russian oil and gas strength

Letter published in Science.

By: Ricardo Hausmann, Agata Łoskot-Strachota, Axel Ockenfels, Ulrich Schetter, Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read article More on this topic
 

Opinion

A phase out of Russian oil may be less effective than a tariff at reducing Putin’s rents

A punitive tariff on all energy imports from Russia would be a better choice than a gradually phased-in embargo on selected fuels.

By: Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read about event More on this topic
 

Upcoming Event

Jun
22
13:00

BRI 2.0: How has the pandemic influenced China’s landmark Belt and Road Initiative?

China's Belt and Road Initiative is undergoing a transformation after two years of pandemic. How is it changing and what are the consequences for Europe.

Speakers: Alessia Amighini, Eyck Freymann and Alicia García-Herrero Topic: Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

Blog Post

How a European Union tariff on Russian oil can be designed

The European Union should apply a tariff on imports of Russian oil; it can be accompanied by a quota for a gradual, conditional phase-out of all Russian oil imports.

By: David Kleimann, Ben McWilliams and Georg Zachmann Topic: Global economy and trade, Green economy Date: April 29, 2022
Load more posts