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 Business News | January 2006 
Look Out for Imbalances in 2006
 Philippe Martin - Libération
2006 is forecast to be a good vintage for global economic growth. The emerging countries of Asia, but also those of Eastern Europe and even Latin America, should enjoy continuing strong growth. The United States' economy should slow down slightly, but the forecast of 3% for 2006 remains well above that for other industrialized countries.
As in 2005, 2004, and 2003, the conjunctural conjecturists predict that Europe will finally rally. According to them, therefore, 2006 should pretty much resemble 2005 - which is not surprising, since forecasts are generally based on the hypothesis of a continuation of the tendencies of the most recent past.
The risks that hang over this optimistic scenario are, however, numerous, and are of both the political and the economic variety. According to Ken Rogoff of Harvard University, the most obvious political risk is that of a major terrorist attack with two types of economic consequence: direct ones linked to the destruction and, perhaps more serious, risks linked to an overreaction in governmental security measures - for example, in the ports - that would disorganize international trade by dramatically increasing the cost of transportation.
With the production line having become global (every stage of production is in a different country), it is now very dependent on the well-oiled operation of global trade. Negative consequences would therefore manifest themselves on both the demand and the supply side. Central banks would respond to the drop in demand with expansive monetary policies, but the negative shock on the supply side would be much more difficult to counteract.
A further increase in the cost of oil could also come and disturb the optimistic scenario. Its associated economic consequences depend fundamentally on the source of the increase. If, as in 2005, oil prices increase due to growth in global demand, then, as in 2005, the impact should be rather benign. In fact, oil price increases have not been as dramatic for Europe as feared, since exporting countries - which have seen their revenues increase robustly - have a tendency to import more from Europe than from the United States or Japan. Part of that income has also been used to buy American shares, which has raised the price of the dollar - which has also helped our exports. On the other hand, if oil prices increase in 2006 because of a supply-side problem (from a deterioration in the political situation in the Middle East), the consequences will be far more negative.
The economic risks are linked to different global imbalances and the way in which their adjustment will play out. Sooner or later, the enormous American current account deficit will have to be absorbed, which will occur through a combined drop in the dollar and in consumption, which will weigh down our exports and hence our growth. Certainly, the dollar at the moment defies all the laws of gravity, but China's recent decision to diversify its reserves and therefore buy fewer dollars could be the signal for a reversal. Another imbalance that requires adjustment is the property market, which, in a large number of countries, including France, has taken the form of a bubble.
The two problems are not unconnected, moreover. In both cases, the longer adjustment is put off, the more painful it will be. If the dollar falls deeply from the adjustment of the American current account and people intervene to sell American shares to avoid the drop in their value, there could be a strong increase in interest rates.
Now, the low level of interest rates partly explains how the property bubble has been able to develop and persist. Its sudden bursting - or even a soft landing - will clearly have a negative impact on consumption, which depends partly on property-holders' sense of wealth. An increase in interest rates would also have implications for the relative calm in emerging countries that have not experienced any major financial crisis for several years.
Another type of latent imbalance is related to the distribution of the gains from globalization.
Whether in Europe, the United States, or China, these gains are poorly distributed. Suddenly, inequalities between Capital and Labor, skilled and unskilled workers, even between regions within the same country, are increasing. Governments' inability to respond to these imbalances in an innovative way could push them back to the old protectionist recipes, with depressing consequences for both trade and global growth.
If, in spite of a series of destabilizing shocks, 2005 was a relatively calm year for the global economy, it's not because adjustment to global imbalances is finally not necessary, but rather because those adjustments have been put off until later. Sooner or later, those adjustments in imbalances that governments seem incapable of - or uninterested in - preparing will, nonetheless, have to take place, and the calm of 2005 will bear the turbulence to come.
Philippe Martin is a Professor at Paris-I Panthéon-Sorbonne. |
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