Germany

The recently published IMF report on the state of the world economy is a very sobering [and very long!] read. It predicts that, for the first time in decades, the world’s economy will shrink. Normally a recession in one area is offset by continuing growth elsewhere, so the global economy keeps on expanding as a whole. Not this time. The recession, that started here and is now infecting everyone else will cause the world’s economy to shrink by as much as 1.3% this year. The report notes that this is, by far, the worst global downturn since the Great Depression. The outlook for 2010 has been revised sharply downward too, with a meagre growth of 1.9% predicted.

This somber outlook provides a cautionary tale for those who argue that the US can lift itself out of its own malaise by constraining domestic consumption – a worthy goal if we want to reduce our reliance on debt, which I think we do – while, at the same time relying on exports from a reinvigorated American manufacturing sector.

The problem can be expressed simply as this: who do export to?

The two industrial countries with the most severe contraction to deal with are Japan and Germany. They both have very similar economic models. They rely heavily on exports of manufactured goods to support a their economies and both have a much more modest level of domestic consumption than the US.

The news for both Japan and Germany is getting much worse.

Several economic think tanks in Germany are now predicting that GDP there will shrink by as much as 6% this year largely due to the collapse of trade. Also today, Japan is set to announce its first trade deficit in thirty years, also a result of trade market for its exports drying up.

The experience of Japan and Germany suggests that, apparently, the global nature of this downturn has taken away an export led recovery as one policy option we can consider.

The lesson is best learned by looking at the japanese experience. There has been much play made of the economic problems Japan had during the 1990’s: they were the most recent to experience the ‘zombie’ bank phenomenon we fear so much here. Their economy languished at close to zero growth for a decade because they made policy mistakes early on in the crisis, failed to inject a large enough stimulus, and were tentative in dealing with failed banks.

Sound familiar?

The Japanese economy revived largely because world demand sucked in Japanese products in sufficient volume to offset very low growth in domestic spending. So successful was this strategy that it has become the normal Japanese method for maintaining a rising standard of living. It is a model for economic management that works well as long as there is always somewhere in the rest of the world with a growing market for Japanese goods. It doesn’t work too well when the entire world goes down together as we now are.

Which brings us back home: if an export led boom is not a viable option for us, we have to rely on getting our own domestic house in order. Indeed, since America has become the world’s consumer sucking on goods from places like Japan and Germany, there must be plenty of foreign policy makers hoping we get our house in order too.

And we do that by pumping up demand and keeping savings low in the short run. Oh, and we have to fix the banking system … did I mention that?

So our recovery relies on the same tricks that got us into this mess: low savings and high consumption. Which is already presenting policy makers with a difficult, or should I say more layered, problem. The near term remedy is exactly the wrong medium term policy. Longer term we want to convert our economy by achieving a more balanced mix of savings and consumption. We want to re-establish the kind of structure it had back in the immediate post World War II decades.

Interestingly an economy built around a higher savings rate is one that can pay down government debt at a more rapid rate than one built around borrowing: those savings can be channelled into Treasuries. This is one, but not the only, reason why all the hue and cry about running up massive future debt loads is misplaced. As long as we are careful and construct a more fiscally balanced economy in the medium term, let’s say by 2015, then our ability to recover and return to relatively low and sustainable levels of national debt is assured. Those same post-war years provide a good example: US national debt at the end of World War II was very high, but within a decade it was returned to pre-war levels.

So: exports are not our answer. And we have a very delicate balancing act between the near and medium terms.

This really is quite a mess we got ourselves into.