New Republic: Four Steps To Avoid Global Depression
William Galston is a senior fellow at the Brookings Institution and a contributing editor for The New Republic.
As they have with the Great Depression, economic historians will argue for decades about the origins of our current crisis. But, surely, we can agree that the failure of international economic cooperation in the early 1930s — and worse, the sequential adoption of beggar-thy-neighbor domestic policies — made matters worse at a time when enlightened statesmanship could have made them better for everyone. Similarly, the current crisis is not just a U.S. problem or a European problem; it is a global problem that requires a coordinated global response. "We're all in this together" is not a moral bromide, in this instance, but a simple statement of fact.
Since the crash of 2008, the entire world has relied on a shared, if tacit, plan to avert all-out catastrophe and a second Great Depression. The United States would do what was necessary to prevent its financial system from collapsing and stem the economic decline with massive fiscal and monetary stimulus. Europe would cauterize its debt crisis, which threatened the integrity of its common currency, by bailing out its small, insolvent countries (Ireland, Portugal, Greece) while relying on German growth and Franco-German leadership to pull it through. Brazil and India would continue to grow briskly, and China would shore up global demand with a huge investment in public sector spending. And the world would muddle through, albeit with below-normal growth and above-normal unemployment for an uncomfortably long time. In the interim, social safety nets of varying strength would shield the hardest-hit workers and families from destitution, maintaining social stability.
Events of recent days, however, have made it clear that this plan has failed. Growth in output and employment in the United States had slowed well before the inconclusive outcome of the debt ceiling debate gave Standard & Poor the occasion to downgrade U.S. public debt. The European debt crisis has morphed beyond its previous bounds to include Spain and Italy, whose obligations far exceed what the European Central Bank can backstop, and even German growth is now showing signs of flagging. The most rapidly growing emerging economies are slowing and, in most cases, they are experiencing rising rates of inflation. In important respects, the Chinese stimulus was misconceived, with massive sums poured into unproductive infrastructure projects and loans that local authorities cannot repay.
Not only has the post-2008 arrangement fallen short; it has left the world economy less able to meet the current challenge. There is a limit to what central banks can do, and they may be uncomfortably close to it. (The Fed's portfolio has swollen dramatically since the crisis began more than three years ago.) The indebtedness of most major countries has soared relative to their GDP, increasing market and political pressures for long-term fiscal stabilization. Some countries — most notably the United States — have failed to respond adequately, while others — most notably the UK — have implemented austerity programs, only to be met with social disruption. The famous European social model, which stabilized the continent for two generations, is now in danger (or, perhaps, in the early stages) of being rolled back, with political consequences that are unlikely to be benign.
So what's to be done? Some elements of the response we need are pretty clear:
1. In the United States, large amounts of household debt (especially mortgages) incurred during the past two decades cannot be repaid, while in Europe large amounts of sovereign debt could be repaid only on terms that would prove ruinous (see Keynes' sadly prescient 1919 book, The Economic Consequences of the Peace). We need new mechanisms for lightening these debt burdens and allocating losses so that demand-led growth can resume and social stability can be preserved. If institutional creditors take a hit, as they should and will, governments should ensure that they remain adequately capitalized and on track to resume necessary lending when demand recovers.
2. The European Union cannot remain where it is. If its members cannot agree to move forward to more centralized institutions of economic management, then it must move backward by loosening the restraints on member-nations and permitting (or even requiring) individual nations under stress to suspend or terminate their participation in the euro. Argentina, which ceased pegging its currency to the dollar at the height of a debt crisis, may be a better model for Greece than is the IMF-style austerity program its government has been forced to adopt.
3. Here at home, we must go back to the fiscal drawing-board and implement what economists across the political spectrum recommend — another round of stimulus (well-crafted this time) as part of a package that stabilizes our debt-to-GDP ratio no later than the end of the decade.
4. The "Grand Bargain" that matters most is not between Democrats and Republicans, but rather between the United States and China. The world's two largest economies must finally renegotiate their unbalanced and unsustainable relationship. Just as OPEC learned that a policy of pushing oil prices ever higher eventually yielded negative returns, so China must be brought to realize that a policy of seeking to maximize its exports will eventually undermine itself by slowing growth, and eventually demand for exports, in other countries. As the United States confronts the entrenched interests that impede fiscal stabilization, the Chinese government must confront the entrenched interests that put ever-rising exports above the long-term well-being of average Chinese families.
None of this is the least bit easy. If statesmanship were easy, there would be a lot more of it. Its absence from the late 1920s to the early 1930s produced a disaster; its fortuitous emergence during the mid-1940s benefitted nations everywhere for two generations. Now it's time for the leaders of the world's largest and most rapidly growing nations to come together and declare that they are prepared to embark on urgent consultations designed to prepare the way for an economic summit that puts all the issues I've just ticked off (and many that I haven't) on the table.
We have reached the limits of workarounds and incremental measures. The world must now choose between much bolder action and the mounting risk of a catastrophe that could undermine the political and social stability constructed and preserved at such cost since the end of the Second World War.