“The global economy is a runaway train that is slowing, but not quickly enough. That is what the extraordinary run-up in prices for oil, metals, and food is screaming at us.
The spectacular and historic global economic boom of the past six years is about to hit a wall. Unfortunately, no one, certainly not in Asia or the US, seems willing to bite the bullet and help engineer the necessary co-ordinated retreat to sustained sub-trend growth, which is necessary so that new commodity supplies and alternatives can catch up.
Instead, governments are clawing to stretch out unsustainable booms, further pushing up commodity prices, and raising the risk of a once-in-a-lifetime economic and financial mess. All this need not end horribly, but policy makers in most regions have to start pressing hard on the brakes, not the accelerator.
Don’t look to the US for leadership in a presidential election year. On the contrary, the US government has been handing out tax-rebate cheques so that Americans will shop until they drop .
Don’t look to emerging markets, either. Desperate to sustain their political and economic momentum, most have taken a wide variety of steps to prevent their economies from feeling the full brunt of the commodity price hikes. ....
I am puzzled that so many economic pundits seem to think that the solution is for all governments, rich and poor, to pass out even more cheques and subsidies so as to keep the boom going. Keynesian stimulus policies might help ease the pain a bit for individual countries acting in isolation. But if every country tries to stimulate consumption at the same time, it won’t work. A general rise in global demand will simply spill over into higher commodity prices...
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No, this time, commodity resources are the primary constraint, rather than a secondary problem, as in the past. That is why commodity prices will just keep soaring until world growth slows down long enough for new supply and new conservation options to catch up with demand.
This runaway-train global economy has all the hallmarks of a giant crisis in the making — financial, political, and economic. Will policy makers find a way to achieve the necessary international co-ordination? Getting the diagnosis right is the place to start. The world as a whole needs tighter monetary and fiscal policy. It is time to put the brakes on this runaway train before it is too late.”
Kenneth Rogoff, “Time To Put the Brakes on This Runaway Train”, Posted on RealClearMarkets Blog (7 July 2008).
http://www.realclearmarkets.com/articles/2008/07/time_to_put_the_brakes_on_this.html
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University. He was formerly Chief Economist at the International Monetary Fund.
Rogoff’s argument can be summarized as follows: Over the past five years, the world economy has grown so fast that it has outrun the world’s capacity to increase its production of key primary commodities and, as a result, prices for food, oil, and metals and minerals have all risen markedly on international markets. To reduce the demand-pull pressures on existing productive capacity generated by rapidly rising incomes across the globe, Rogoff says world growth will have to be slowed, and it will take at least several years of sub-trend growth to rebalance commodity demand and supply. If, to the contrary, as they are now, governments everywhere insist on trying to promote growth rather than adjustment, the consequences, in his view, will be accelerating inflation and a deep worldwide crash. While he recognizes there is no painless way out of the present situation and reversing policy will bring its own problems, Rogoff is of the view that the worldwide boom of the past few years must be brought to an end.
There is no question the world economy has enjoyed a robust expansion in recent years, with real world output increasing 3.8 per cent on average each year from 2003 to 2007. World growth was centered in the developing countries, where the annual pace of the expansion exceeded 5½ per cent in all main geographic regions; in Asia, it often exceeded an 8 per cent increase in one year. The volume of world trade – a major spur to the rapid increase in world production – rose during this period about 9 per cent a year. With the brisk rise in output has come a corresponding increase in incomes and spending in support of higher levels of living being created, especially in developing countries, where the demand for food and petroleum has soared in recent years. As Rogoff notes, new supply needs long lead times and it appears supply has not been able to keep up with the demand generated by a rapidly growing world economy. This tension shows up as global commodity price inflation.
Before one agrees that too rapid world growth is the root cause of the inflation the world has suffered the last few years it would be interesting to compare recent rates of world growth with longer-term trends in order to see exactly how unusual the recent spurt of growth was. As above, world growth averaged 3½ to 4 per cent a year for the past four or five years. This is somewhat above the long-term rate of growth of the world economy, which has average 3.4 per cent since 1950. This long-term average, of course, masks periods of rapid growth and periods of slow growth. World growth, for example, averaged 5 per cent annually from 1950 until the mid-1970s – a much faster pace than recent growth for a much longer period. Over the course of the past quarter century world growth has averaged over 3 per cent a year. It is true that growth during the global upturn that began early in this decade has been strong, but past booms have been even stronger, and for over a half century the world was able to raise output more of less in line to match the rise in incomes.
Having said that, all booms come to an end, and recent growth has been above trend. And global booms sometimes come to an end because, among other reasons, the pressures caused by the upswing in world demand overwhelms existing supply capacity, and the current additions to capacity are too small and come too late to meet the growing demand. In recent years, there is no doubt that the U.S. and other countries have dithered when it comes to increasing the supply of oil and other primary commodities, dreaming that high prices will dull the demand for commodities and encourage a rapid shift to alternatives. Consequently, high prices have cut our incomes and employment and economic growth and they will continue to do so until we increase actual supply so that it meets actual demand. One could also add that the world as a whole and this country in particular has followed expansionary fiscal and monetary policies promoting aggregate demand at the same time they have discouraged increases in aggregate supply. One should not be surprised the result may well be stagflation.
Slowing down world growth, as Rogoff advocates, no doubt would help rebalance demand and supply, but at the price of reducing the incomes in the poorest countries where demand for food and oil is increasing the fastest and need the most. Better to focus on increasing supply, which in the end we must do if we are to maintain our standard of living and raise that of the world’s poor.
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