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My wish for the second term Samuel Brittan The Financial Times 05/11/04 Most official and academic forecasts indicate that the re-elected US president faces a fairly benign world economic outlook. The UK's National Institute of Economic and Social Research, for instance, suggests a slight slowdown in world growth in 2005, which will not take it far from trend rates. The US upturn will slow, as recent stimuli wear off. Japan and the UK also face modest dips in their growth rates, as does China. Eurozone growth will pick up slightly. Many private sector analysts disagree. There could be a housing blow-out in the English-speaking economies; China may experience a hard landing; and the American Enterprise Institute worries about excess industrial capacity in the west. The great majority of crystal gazers see, moreover, little inflationary risk despite soaring oil prices. Even in its own terms, the pessimistic tone is overdone. Milton Friedman, whose now very occasional reflections are well worth attention, has remarked that the present world upturn looks disappointing because the previous recession was so minimal. A severe slump would have produced a more spectacular rebound. The conventional mode of analysis seems to me like picking up a plant by its roots every few weeks to see how fast it is growing and then recommending extra doses of fertiliser. Most of the spectacular expansion in output and incomes of the past two centuries took place when there were few forecasts and demand management was an unknown art. None of this justifies a Panglossian complacency. We do need to examine problems and stresses. Here again there is a conventional wisdom, which brings us to the US agenda. This revolves round the twin deficits - budget and balance of payments - running at about 5 per cent of American gross domestic product and projected by some analysts to escalate. This is all familiar stuff to those who lived through the 1980s. The pessimists can fairly point out that the scale of these deficits is higher this time around. A substantial reduction in the payments deficit would require a sizeable further fall in the dollar and a reduction in US domestic expenditure growth, both of which would be contractionary for the world economy. It is as well, therefore, that progress towards reducing either deficit is likely to be slow. There is something to be said for the heretical view expounded on these pages on Monday by Richard Cooper, a former member of a Democrat administration and not a Bush apologist. He argues that the current payments deficit is the other side of inward investment into the US, which is still a highly secure location for overseas savings surpluses. A case can also be made for the Chinese policy of accumulating dollar assets and thus preventing an undue appreciation of the renminbi against the dollar. The main reasons for alarm relate in my view to a different area: the nexus of energy, oil and the Middle East. According to the economic establishment, the recent oil price explosion will cause only minor damage. The opposite case was most clearly spelt out in an article by Joachim Fels of Morgan Stanley (FT, October 12). He points to disturbing parallels between the current situation and the stagflation of the early 1970s. Oil prices have roughly quintupled on both occasions. Monetary and fiscal policy has been highly expansionary both times, with periods of negative real interest rates. In both periods the established industrial nations have faced new competitors in world markets. Then it was Japan and South Korea. This time it is China, India and central and eastern Europe that are causing severe dislocations. Finally, global productivity slowed in the 1970s for reasons that are still disputed. The same might happen in the present decade once gains from the electronic revolution are absorbed. Mr Fels does not expect anything as bad as the 1970s. The international competitive climate makes it more difficult for inflation to take off and unions are not in a position to inaugurate a cost-push inflation. I would, however, argue that the energy outlook is worse than 30 years ago. Now oil production is limited much more by capacity than by cartel action. Moreover, the west is still relying too much on an increase in Saudi Arabian oil production. This is subject to a double risk: increasing physical difficulty in boosting production and increasing risks of political instability. If I had one wish for US policy in the next four years it would be a steep rise in taxes on petrol. It would promote cleaner air, reduce global warming, help cut the budget deficit and diminish political dependence on the Middle East. Any one of these benefits would be sufficient to justify a big increase in petrol prices. Taken together the case is overwhelming. A prescription of required treatment is helpful even when early implementation is unlikely.
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