Saturday, 31 January 2009

Martin Wolf in Davos

Robert Peston interviewed Martin Wolf in Davos (along with Roger Carr and Richard Lambert, but they needn't concern us at the moment; Lambert did display a useful clarity, requesting nothing but opening of the credit markets). Martin, as always, had some exciting things to say and said them in his unique way. My paraphrasing:

The UK is the most vulnerable economy in the G7 because the financial sector is so important, because the housing boom was so large and because household debt is sensationally high, and we are also highly dependent on the rest of the world which is suffering a recession too. And our underlying fiscal position related to these vulnerabilities is much worse than anyone thought 2 years ago.
It's interesting that the fact of a recession is the problem - that is, a reduction in GDP, rather than the actual level of output or consumption. If the UK has benefited (as it undoubtedly has) from huge growth in the financial sector and housing-related investment over the last ten years, and we now have a brief slowdown from a peak of economic activity, you might think it isn't something to regret.

However, there seems little doubt that negative growth is perceived as a big problem by both consumers and businesses, when compared with a hypothetical scenario of slightly slower but more stable growth. My post from Wednesday discussed this, but in that item I neglected to consider the psychological effects of today being worse than yesterday, and what it implies about tomorrow. So unless we collectively get used to volatility, then Martin is right that over-reliance on an unsustainable financial economy will have intrinsic problems.

And yet... I am not convinced that our finance sector is unsustainable. I have started to build a model to try to work out an optimal level of finance and business services activity in a modern economy. My intuition is that the optimal level is far higher than most people suspect, and that with hindsight we may not blame the City as much as it's now being blamed.
Politicians undoubtedly get that there is a massive cyclical downturn, but people don't get that it's a structural change. 2006 is not coming back with its consumer-led debt boom driven by the English-speaking countries. We might get back to past growth - I hope we will - but the world will have to be rebalanced. Governments are doing a good job of short-term stimulus and saving the banking system. A sensational level of stimulus! But for stability, healthy private sector demand is needed. Lots of changes are needed that China, the US and UK don't yet get, but they are essential in getting back to a healthy economy.
I guess the message here is that China is storing up too many claims on the US and UK economies, which are likely to lead to problems in the future. The US and UK (among other countries) are consuming China's output now, and instead of paying for it now by exchanging our own services, we are exchanging promissory notes to pay later. Fair enough, and the Chinese are willing to let us do it, but there must be a risk in this.

Just as some private borrowers will keep borrowing as long as the lender is willing to stump up, but when it is time to repay, start quibbling. Have you come across those services which supposedly allow you to write off your consumer debt by challenging the terms and conditions under which it was lent? I feel there's something basically dishonest about that course of action, but perhaps there is an analogy.

I suspect Martin is hinting that the overhang of debt between creditor and debtor economies will tempt politicians to these kind of escape routes; and even if they resist, the scale of the debt will automatically cause distortions in trade and investment.

So perhaps we need to figure out what we have to offer the Chinese consumer. China does buy a lot of investment goods from the West - industrial machinery, software and other technology - but fewer consumer goods or services. Perhaps we have expertise in media, well-designed and marketed consumer goods, high quality food and consumer infrastructure that they would be interested in. But I don't know what policy routes Martin would suggest that governments take to stimulate trade in these goods.
[The changes are beyond most people's understanding] We need to protect emerging economies now - change the way we finance them and expand the IMF; and have a serious, intelligent dialogue with the Chinese to make their growth more compatible with the global economy - the US and UK need to change too, and make the world financial system work better - because it has worked terribly.
Again Martin's beautiful turn of phrase and charming voice - Robert Peston may think he's a sensationalist but Martin Wolf can frighten him under the table.

I am very much warming to the idea of supporting emerging economies with the stimulus. I am convinced that the underemployed resources in the Western economies could create something useful for poor countries, if the stimulus is designed correctly. I hope to write something more on that next week.

Other than that, I look forward to hearing just what the Chinese, American and British governments are supposed to do to encourage Chinese consumers to buy more from Western suppliers. Undoubtedly there is a way. Perhaps we need another Martin - Sorrell - to come to the rescue.

Update: Ahem - I just discovered Martin Sorrell is at Davos, also blogging for the FT!

1 comment:

Don said...

"So perhaps we need to figure out what we have to offer the Chinese consumer."

The younger generation in China were beginning to become spenders as opposed to savers, but this crisis has shifted their perceptions. And that's the big problem: You're asking savers who have seen the spenders bring on a crisis to become spenders. I don't see it.

I think that there has to be some allowed default by the spender countries, either through debt cancellation or allowing us to use inflation to get out of this. Other solutions lead, and I hate to say this, to social disruptions and dislocations. Fortunately, the alternatives we face aren't as bad as in the 30s.

Don the libertarian Democrat