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Global economic trends Samuel Brittan: Chairman's remarks OKB conference, Vienna 12/12/02 The economic setback which the world experienced last year (2001) was somewhat different to the normal post-war pattern. It was not triggered off by central banks clamping down in response to an inflationary boom. It was almost entirely generated by the private sector and reflected two phenomena. The first was the puncturing of the US stockmarket bubble of the late 1990s. Both the bubble and the burst originated in the US which is still the economic leader, at least in the OECD part of the world. The asset bubble phenomenon may not be over. The most explosive rise in house prices and the accompanying acceleration of consumer debt has been in Britain. But many analysts have argued that the rise in American house prices, though less spectacular, has already taken real estate values to 20 per cent or more above what would be normally expected at current GDP levels. There is therefore room for more downward adjustment here. This is worrying, as the relatively good performance of the Anglo-Saxon economies is led by consumer demand, which in turn is supported by high and rising real estate values. Secondly, and only slightly less remarked, has been the phenomenon of over-investment, especially but not only in the ITC sectors. This is a real phenomenon and not just a matter of share prices; and it will take time before this over-investment can be absorbed and normal capital expenditure resumes. If I can digress for a second, as we are in Vienna. Some analysts have said that the present cycle represents a return to the pattern analysed by prewar Austrian economists. Yes and No. It is true in the rather vague sense that Austrian economists - together with many other venerable dead figures from the past - have pointed to the phenomenon of overinvestment triggering the downward phase of the business cycle. Their works are worth rediscovering if only as an antidote to the exhortations and incentives to invest poured out by governments and international organisations in the recent years. But at a more detailed level, the recent boom and bust does not conform to the analysis, which for instance Friedrich Hayek, used to give before World War Two. In the Hayekan version excessive investment (due to cheap and easy credit) was made possible by a relative contraction in consumer spending. This did not happen in the late 1990s. On the contrary, overseas borrowing, to the accompaniment of large current balance of payments deficits, enabled consumption to go ahead merrily. Austrian economists did not foresee this because like nearly all other economists until very recently, they operated implicitly with a closed economy rather than global models. It would be well worthwhile for somebody trying to reformulate this analysis for a global economy in which large sums of capital flow across the exchange. Looking ahead: there are two obvious danger points. One is a setback in consumer spending which has been the main motor of the limited recovery we have seen. The other is the dangers arising from the prospect of war in Iraq and other terrorist outrages in the aftermath of the Twin Towers. Economists have no right to shrug their shoulders and say that these are exogenous shocks which are outside their subject. It is surely obvious that that US preoccupation with the Middle East, and the capacity of Middle Eastern rulers to damage the US reflect perceived oil dependence. I believe this to be exaggerated. Middle Eastern oil accounts for some 13 per cent of US consumption; and about the same in Europe if exports are netted off against imports. Nevertheless much the most important contribution that economists could make to world peace and prosperity would be to wean the US off its oil standard. This should be done without either anti-American gloating or anti-growth propaganda. The use of the price mechanism - for instance via gasoline taxes - could contribute all the incentive required to save oil and invest in renewable energy. For the moment however this incentive is more likely to be provided by a familiar type of oil price explosion if the Iraqi venture goes badly or is prolonged; or if it leads to a reduction in oil supplies from other Middle Eastern countries. That is one reason why so much of the fashionable talk about deflation is just nonsense, which financial people like to whisper to themselves to make our flesh creep. The actual prospect could be worse: a return to the stagflation we knew in the 1970s - that is a combination of recession and inflation, which is particularly difficult to treat as remedies for one part of the problem make the other worse. The main bright spot on the horizon is that Asian economies have been doing surprisingly well. Any signs that they can thrive independently of the US and even of Japan are highly welcome. But I do not need to remind this audience that the eurozone has been the weakest performer on the world stage. For we all know what is wrong and I do not have to follow tactful government or central bank jargon. Labour costs are too high; and they are too inflexible to reflect local supply and demand. Everything else is secondary. This is sometimes called the European social model. I prefer to call it the European anti-social model. No doubt the European Central Bank can help by acting swiftly and wisely and can aggravate matters by being too slow and sluggish. But these are all on the margins of the real problem.
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