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Summer’s Unhappy Returns

As much of the world resumes its normal post-summer routine, nothing in the global economy or the geopolitical order seems either normal or routine. What will it take for the world’s policymakers to overcome their crisis of imagination?

SEP 2, 2016 


The end of August is, across much of the northern hemisphere, the time for what the French call la rentrée – the return to work and resumption of normal routine that comes with summer’s end. It is typically a period that alloys melancholy with renewal and gusto for what lies ahead.

Not this year. For policymakers, August failed to bring about a return to anything like normalcy in the global economy or world politics, much less to generate a sense of renewal. On the contrary, most Project Syndicate commentators see a policy landscape littered with old ideas that don’t work, and even older ideas known to cause significant harm.

Unorthodoxy Unlimited

By the time central bankers from around the world convened last week at their annual gathering in Jackson Hole, Wyoming, it was clear that the hopes of just a few months ago of a return to monetary-policy normalcy was premature. Confronted with new shocks such as Brexit, and with much of the world economy, including China, in the doldrums, policymakers have been unable to avoid what might be called the Corleone effect. Indeed, to “consider the actions taken by the world’s major central banks in the past month,” says Harvard’s Carmen Reinhart, “is to invite an essential question: when – and where – will all this monetary easing end?”

Adair Turner, a former head of Britain’s Financial Services Authority and current Chairman of the Institute for New Economic Thinking, explains why central bankers cannot break out of the cycle of low interest rates and quantitative easing that began with the financial crisis of 2008. “Eight years after the 2008 crisis,” says Turner, “governments and central banks – despite a plethora of policies and approaches – have failed to stimulate enough demand to produce sustained and strong growth.” That is glaringly obvious in Japan and the eurozone, while “[e]ven the US recovery seems tepid.”

Nobel laureate Michael Spence spells out the dilemma: “years of ultra-low interest rates and massive quantitative easing have not increased aggregate demand sufficiently, much less reduced deflationary forces adequately.” And yet “raising interest rates unilaterally carries serious risks, because in a demand-constrained environment, higher interest rates attract capital inflows, thereby driving up the exchange rate and undermining growth in the tradable part of the economy.”

That’s why Reinhart worries that recent “interest-rate cuts and nonconventional forms of easing” have become “contagious.” After all, “[t]he prospect of deflation is a threat to prosperity and financial stability, particularly for countries with low growth and high levels of public and private debt.” And such countries are hardly alone: “It would seem that among many of the world’s largest central banks,” Reinhart concludes, “no one wants to be the one with the strong currency.”

But someone must have it – a fact that Yale University’s Koichi Hamada says has put Japan, which has pursued perhaps the most daring monetary policies since 2008, in the crosshairs of the world’s hedge-fund managers. Hamada, who is also a leading economic adviser to Japanese Prime Minister Shinzo Abe, strongly doubts that the authorities’ pledge to “act swiftly against exchange-rate movements deemed to be speculative” can achieve anything substantial. Even after Japan’s finance ministry said that it would defend the yen, “markets moved only slightly, within a range of a couple of yen to the dollar.” Hamada is not surprised: the ministry’s intervention threats have “lost credibility,” which means that “speculators remain convinced that they are making a one-way bet – win big or break even – and continue to push the yen higher.”

Whereas Hamada seems to see no viable alternative to opening the monetary floodgates even wider, Yanis Varoufakis, a former finance minister of Greece, believes that such resignation betrays a failure to accept a more radical diagnosis of the problem. “Central bankers who never predicted the Great Deflation are now busily trying to find a way out with economic and econometric models that could never explain it, let alone point to solutions,” he argues. “Unwilling to question the political dogma that central banks must be apolitical, they continue the search for a technocratic fix to a problem crying out for a philosophically astute political solution.”

Turner, perhaps, comes closest to offering such a solution. He believes that with a little courage, central bankers – and the governments they serve – could unleash a powerful weapon: permanent monetization of fiscal deficits, or so-called helicopter money. The problem, Turner argues, is that false arguments and political timidity are preventing its deployment. The real question, for Turner, is whether we can “design rules and institutional responsibilities that ensure that monetary finance is used prudently?”

The Stagnation Game

In fact, policymakers must confront a more fundamental question: why, despite wave after wave of monetary stimulus, can’t aggregate demand be increased? Spence is clear that there is no magic bullet, whether fired from a helicopter or not, to boost demand and restore growth. Moreover, “there is a strong case to be made that many of the growth-destroying headwinds that we currently face would be difficult, if not impossible, to counter in the near term without endangering future growth and stability.”

Nonetheless, Spence believes that there is a “set of policy responses that could, over time, increase the level and quality of growth.” One “key element” is to “focus on tackling rising inequality.” Though driven by relatively intractable forces – “in particular, globalization and progress in digital technology” – this trend “can be mitigated through redistribution via the tax and social-security systems.” The rationale is straightforward: “As economies undergo prolonged structural transformations, individuals and families need the resources to invest in new skills.”

The biggest structural transformation of all, of course, is playing out in China, the world’s second-largest economy. As Yale’s Stephen S. Roach points out, given China’s outsize contribution to global growth, a “hard landing” there “would have a devastating global impact.” But Roach is optimistic: in contrast to the advanced economies, the “Chinese authorities have ample scope for accommodative moves that could shore up economic activity.” Moreover, “unlike the major economies of the developed world, which constantly struggle with a trade-off between short-term cyclical pressures and longer-term structural reforms, China is perfectly capable of addressing both sets of challenges simultaneously.”

But the rapid emergence of consumer sovereignty that has accompanied China’s shift toward domestic-demand-driven growth, argue Andrew Sheng and Xiao Geng of the University of Hong Kong, “represents a major challenge for a government that has long relied on top-down decision-making.” Today, Sheng and Xiao argue, Chinese consumers “have become a key driver behind the transformation of the housing market, supply chains, finance, and even monetary policy.” With consumers’ power “testing the capacity of the bureaucracy and political system,” the success of China’s structural transformation will depend on the authorities’ ability “to respond more effectively to their citizens’ needs and desires.”

But, whereas China’s response to economic uncertainty appears to be a greater willingness to embrace economic reform, the response in the United States – at least among the Republicans who control Congress – has been to double down on policies that have failed time and again.Simon Johnson, a former IMF chief economist, thinks that many senior Republicans want “to return to the pre-crisis world,” even “to less financial regulation than existed under President George W. Bush.” In other words, the Republican leadership has embraced “a recipe for repeating the boom-and-bust cycle that created the worst crisis since the 1930s and caused at least a decade of damage to the US economy.”

The Return of Mars or Venus?

In international affairs, too, familiar approaches – soft power and détente with rivals versus hard power and deterrence of foes – continue to define an increasingly unfamiliar strategic terrain. For Mark Leonard, director of the European Council on Foreign Relations, the global order is in an “interregnum.” After the end of the Cold War, “the world was held together by an American-policed security order and a European-inspired legal order,” he argues. “Now, however, both are fraying, and no candidates to replace them have yet emerged.”

This is not a benign condition. Leonard rightly notes that interregnums are often the “most frightening periods in history.” He paints a grim picture: “Disorder, war, and even disease can flood into the vacuum when, as Antonio Gramsci put it in his Prison Notebooks, ‘the old is dying and the new cannot be born.’”

To see this, one need look no further than the Middle East, where both Columbia University’sJeffrey D. Sachs and the University of Denver’s Christopher R. Hill are sharply critical of US President Barack Obama’s approach to Syria’s civil war. For Sachs, the problem is the administration’s resort to old US habits of secrecy and covert action, which has prevented “democratic scrutiny” of its Syria policy. Hill, by contrast, faults the policy itself: “The initial decision to break off all ties” with President Bashar al-Assad “and call for him to step down represents failure of analysis, the effects of which the Obama administration has never been able to escape.”

And yet perhaps there is new life to be found in old approaches. German Foreign MinisterFrank-Walter Steinmeier believes that the best way to rebuild a new structure of peace for Europe and the world is to restore the mindset that underlay Willy Brandt’s Neue Ostpolitikand Henry Kissinger’s détente with the Soviet Union. Of course, today’s confrontations are “not defined by antagonism between communism and capitalism, but by a dispute over social and political order – a dispute about freedom, democracy, the rule of law and human rights – as well as by a struggle for geopolitical spheres of influence.” Nonetheless, to bridge the current chasm between Russia and the West, we need to bring about a “re-launch of arms control in Europe as a tried and tested means of risk-reduction, transparency, and confidence building between Russia and the West.”

But for Steinmeier’s predecessor, Joschka Fischer, arms control is not enough. Only a determined push “to finish the project of [European] unification” will secure stability and peace in Europe. But the “historic window of opportunity that was opened during the period of Western liberal internationalism is quickly closing.” Time is running out for Europe, and if it “misses its chance, it is no exaggeration to say that disaster awaits it.”

Leonard, a keen supporter of European unification, might nonetheless say that Fischer is standing before the wrong window. “The danger is that much of what the EU rightly pushed for during the good times could hasten its unraveling now,” he argues. “For example, given so much uncertainty about the future state of Europe and the world, debating enlargement,” much less common initiatives, “seems pointless – or worse, because even opening such discussions is certain to play into the hands of Euroskeptics.”

Whereas Europe’s strategy of soft power and integration may be failing, Eric K. Fanning, US Secretary of the Army, argues that the hard power represented by the US Army’s deepening presence around the Asia-Pacific region is playing a “critical role in maintaining peace and security.” Indeed, “the Army is assuming an increasingly important role in strengthening regional partnerships.” In Fanning’s view, the imperative is clear: “At a time when six of the world’s ten largest armies are located in the Pacific theater of operations, and 22 of the region’s 27 countries have army officers as their defense chiefs, the need to invest in the US Army’s mission in the region is clear.”

But, as Jacek Rostowski, Poland’s former minister of finance and deputy prime minister, points out, the US can no longer bear the global security burden alone and must push its NATO allies to bear more of the costs of defending the West. Unfortunately, Chancellor Angela Merkel’s government, “which loudly demanded that Greece keep its promises to the EU, is now standing in the way of NATO members’ ability to meet their commitments to collective defense.” In fact, “German resistance in the name of supposed fiscal rectitude” may end up heightening the need for hard power, because its “misguided imposition of austerity on the eurozone has undermined European political cohesion, thereby opening the door for Russian revanchism and aggression.”

The Silenced Guns of August

In an increasingly risky global order, the just-concluded peace agreement ending the insurgency by the Revolutionary Armed Forces of Colombia (FARC) suggests that only a combination of hard and soft power can yield truly positive results. The agreement, says Columbia University’s José Antonio Ocampo, a former Colombian economy minister, is “a historic achievement, one that promises to end more than a half-century of kidnapping, forced displacement, indiscriminate attacks on villages, and violence that has resulted in tens of thousands of deaths.”

Shlomo Ben-Ami, a former Israeli foreign minister who advised President Juan Manuel Santos throughout the negotiations, identifies the main factors underlying a deal that he believes “has furnished a conflict-ridden world with a new model for peace.” First, “the Colombian armed forces’ increased effectiveness,” he says, “enabled them to decimate the FARC’s ranks.” Second, Santos “repaired Colombia’s previously fraught relations with neighboring Venezuela, Ecuador, and Bolivia, an axis that had long contributed to sustaining the FARC by providing logistical and political support.” And, third, “Cuba’s new policy of rapprochement with the United States” helped Santos “in his own efforts to make peace.”

Equally important, while hard power and astute diplomacy were certainly crucial, a final agreement was possible, Ben-Ami argues, only because Santos was willing “to address the root cause of the conflict.” In particular, the Victims and Land Restitution Law, which Santos signed in June 2011, “was a watershed.” The law worked, according to Ben-Ami, “because it simultaneously pacified violent regions, delivered justice for millions of dispossessed peasants, radically improved standards of living, and blunted the appeal of a guerrilla group that used the banner of land reform to justify its untold atrocities.”

Still, as Ocampo points out, the agreement, which must be approved in a plebiscite later this month, has detractors. “In particular, former President Álvaro Uribe, whose government attempted to defeat the FARC militarily,” and his party “want to force the FARC to surrender fully,” which is a formula for further violence. “The good news,” says Ocampo, “is that most surveys indicate that a majority of Colombians will vote in favor of the agreement.

The Return of the Nativists

Uribe’s all-or-nothing approach is reminiscent of populists across the West nowadays. As Ana Palacio, a former Spanish foreign minister, emphasizes, “it is much simpler – and electorally more rewarding – to criticize a system than it is to defend it, especially when that system is far from perfect.” And, given the absence of solutions for growing political and economic insecurity, it is no surprise that people are “gravitating toward voices and ideas that provide comfort and an outlet for frustration.” Nonetheless, “the fantasy of deus ex machina,” she says, may “make things much worse,” given its avatars’ efforts to “undermine the rules-based system that has delivered untold prosperity and security over the last seven decades.”

Claremont College’s Minxin Pei points out that such leaders have a terrible track record in power. While they “tend to self-destruct, owing to colossal mistakes that doom their grandiose ambitions,” they also typically “leave a severely compromised democracy and a derelict economy in their wake.”

And yet even the world’s oldest republics are not impervious to what Pei calls the “siren song of ‘strongmania’.” In France, says Dominique Moisi of Sciences Po, former President Nicolas Sarkozy appears to have “read the popular mood well” in announcing his candidacy for the 2017 presidential election. “He knows that the French are feeling defensive and angry,” Moisi argues, “and he wants to use those feelings to win support,” even – or especially –from the far-right National Front, whose leader, Marine Le Pen, is also a strong contender. But it may not work for Sarkozy: “With his buzzy energy and nervous tics,” Moisi says, “he may not seem like the kind of reliable and steadfast leader that a nervous country so desperately needs.”

The same may be true of US presidential candidate Donald Trump, whose campaign appears to be imploding. Elizabeth Drew, one of the keenest observers of US politics, points out that few “presidential campaigns have featured such evident chaos and churn in personnel.” And the recent appointment of Steven Bannon, who previously headed the “hyper-nationalist – indeed white supremacist – online publication” Breitbart News, is the latest indication of a campaign running more on paranoia and rage than on political cunning. Though Trump’s rhetoric has come to reflect much of Breitbart’s extremist worldview, Bannon has no previous campaign experience. Such “poor judgment in people,” Drew concludes, “is yet another reason why” a Trump victory in November, though increasingly unlikely, remains “a dangerous possibility for American democracy.”

Look Long

Given widespread policy failures and the populist resurgence seen in many countries, observers may be right to be worried. But J. Bradford DeLong of the University of California at Berkeley isn’t convinced. Pessimism, he says, “understandably comes easy these days – perhaps too easy.” In fact, an “enthusiastic and positive contrarianism is in order: if we look at global economic growth not just five years out, but over the next 30-60 years, the picture looks much brighter.”

DeLong makes a compelling case. “[T]he large-scale trends that have fueled global growth since World War II have not stopped,” he argues. At the same time, “[m]ore people are gaining access to new, productivity-enhancing technologies, more people are engaging in mutually beneficial trade, and fewer people are being born, thus allaying any continued fears of a so-called population bomb.” And “innovation, especially in the global north, has not ceased, even if it has possibly slowed since the 1880s.” Finally, “while war and terror continue to horrify us, we are not witnessing anything on the scale of the genocides that were a hallmark of the twentieth century.”

Of course, such measured optimism about global trends may not bring solace to people worried about their jobs and their future. But knowing that the broad forces shaping the world are moving in the right direction should give policymakers the confidence they need to act more boldly and innovatively than they have been doing up to now. If there is light at the end of the tunnel, our leaders’ highest priority should be to get us there as quickly and smoothly as possible.

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