Nouriel Roubini's Global EconoMonitor

Global Imbalances, the US Dollar and Globalization Challenges at Davos…

One of the themes widely debated at Davos this year is the state of the global economy, the risks deriving from global imbalances and the prospects for the US dollar. Last year the predictions of many at Davos that the US dollar would sharply fall proved to be wrong.So, there is a greater degree of caution this year.

At the initial panel on the global economy only long-term bear Steve Roach from Morgan Stanley repeated the bearish outlook on dollar, the US economy and the risks of a disorderly adjustment triggered by the bursting of the US housing bubble.  I happen to share the concerns of Roach even if, now, rather than a hard landing I predict for 2006 a significant US and global slowdown and a significant fall of the dollar but not a free fall. Other panelist, like Jacob Frenkel and Laura Tyson were muchmore sanguine about the prospects for the global economy, with Tyson not ruling out the continuation of the Goldilocks period of high growth and low inflation. People are concerned about the US housing bubble and the stagflationary effect another oil shokck driven by suply tighteness and a confrontation with Iran. But they were not willing to assign a significant proability to these poor outcomes as becoming likely.

On the sidelines of the official Davos proceedings Jim O’Neill, the chief global macro economist for Goldman Sachs, provided his outlook. His most interesting point is that, while expects a slowdown of the US economy towards a 2.5% growth rate towards the end of 2006, he does not believes that the US slowdown will lead to a global slowdown. He believes that there is enough momentum in the Eurozone – driven by the German recovery  – and in Asia where China, India, Japan and South Korea will grow fast because of internal demand that there could be a decoupling between a US slowdown and a sustained economic growth in the rest of the world. I am not convinced about the decoupling hypothesis; similar things were said in 2001 about Japan and EU decoupling from the US recession and the decoupling did not happen. Also, a US slowdown exacerbated by an oil shock would hurt both Europe and Japan. O’Neill was also very bearish on the Italian economy making a sharp remark – that made headlines in Italian newspapers today – that Italy is left with comparative advantage only in food and tourism. Given going concerns about the downward drift of the Italian economy, the risks that eventually Italy may exit EMU cannot be underestimated. On a possible EMU collapse I will talk on Friday in a Davos panel with Italian economy minister Tremont and ECB head Trichet.

In the afternoon brainstorming session at Davos both Larry Summers and Laura Tyson made some very thoughtful remarks. Summers argued that the two forces driving markets are “hope and fear”. His concern is that, on cyclical issues there is too much hope – i.e. complacency about the global imbalances – and not enough fear that asset bubbles and imbalances may lead to a disorderly adjustment. On long term issues such as the emergence of China and India he argued that there was too much fear (that China and India will take over the world with severe effects on unskilled labor in advanced economies) and not enough hope that the emergence of China and India and their intregration in the global economy will have long run beneficial effects. Summers went as far a suggesting that the emergence of China and India  (and more broadly of the BRICs and emerging market economies) may be the third most important development in the last millenium, next to the Reneissance and to the Industrial Revolution.  This is quite a bold statment that may have some truth.

But Tyson warned of the potentially negative implications of the emergence of China and India for unskilled labor in the advanced economies. With two billion plus workers in China and India joining the global economy this increase in the global supply of labor  should lead, based on simple trade theory, to a long run reduction in the relative equilibrium real wage for unskilled workers in advanced economies. This reduction in real wages and increase in income inequality such as the once observed in the US in the last few years is a source of fraying of the “social contract” that, in exchange for accepting globalization and freer trade guaranteed to manufacturing workers good wages and good benefits; for auto workers and other blue collar workers such manufacturing jobs were the ticket to entry in the middle class but both employment, real wages and benefits are being significanttly erored by globalization.

Summers echoed the concerns of Tyson when he said that we have a serious problem when globalization is associated with “local disintegration” in places such as Flint (home of former now closed down US auto plants), with the  emergence of failed states and with with struggling middle classes. To be successful globalization needs to lead to local integration not local disintegration.

Thus, in some sense the issues that globalization and the emergence of China, India and other BRICs pose to employment, growth and the social contract in advanced economies have taken a greater importance together with global imbalances in this year’s World Economic Forum at Davos.


2 Responses to “Global Imbalances, the US Dollar and Globalization Challenges at Davos…”

KatyFebruary 3rd, 2006 at 5:08 pm

Global adjustments are longer term than the ordinary human economist is willing to focus on. Please be patient, oh you pundits, and try to find ways to encourage voters to do the same, instead of enflaming fear.

Most Read | Featured | Popular