Global Policy Forum

By Robert J. Samuelson

Let's imagine that the world economy worked the way everyone wishes. The United States, Europe and Japan -- representing almost half of global economic output -- all have vibrant economies, meaning that a recession in any of them has only modest worldwide effects. Meanwhile, advanced countries invest heavily in poor nations, whose poverty declines. Growing middle classes clamor for more democracy.

This is globalization's glorious vision. Unfortunately, the world economy works differently. Europe and Japan don't have vibrant economies. In the 1990s Europe's unemployment rate averaged 9.7 percent; for a decade, Japan's annual economic growth had barely exceeded 1 percent. Nor has globalization yet rescued most poor countries. In Africa, average incomes have hardly increased since the early 1980s. For Latin America, gains averaged less than 1 percent a year. Only Asia, including China, has enjoyed big advances.

Globalization has run afoul of two obstacles. One is culture, which often defeats economics. Corruption pervades many poor countries. Even in Asia, "crony capitalism" contributed to the financial crisis of 1997-98. Vast amounts of investment capital, channeled to favored clients, were wasted. (Even in the United States, as recent scandals attest, capital is often wasted.) There are other enemies. In Africa, Botswana was a rare example of economic progress. Its gains are now receding before a 36 percent rate of HIV infection among adults, reports the Wall Street Journal.

But globalization's second problem may now be more pressing. It is potential instability. Terrorism and oil disruptions pose obvious threats. But there is another large and less-noted vulnerability. In the 1990s, the robust U.S. economy supported the world economy. American consumers gorged on imports: shoes, computer chips, toys. From 1997 to 2001, U.S. trade deficits totaled almost $ 1.7 trillion. Now, the American economic slowdown leaves a vacuum that could go unfilled.

Dangers are obvious. Without a strong force for expansion, collective weakness feeds on itself. Too many sellers chase too few buyers. Prices and profits weaken. Business investment remains feeble because companies -- not just in telecommunications -- have surplus production capacity. Stock markets languish because profits languish. Unemployment rises because poor profits discourage hiring.

At worst, the result is classic deflation with political ill effects: more economic nationalism and protectionism. Globalization means that for more products and industries, the law of supply and demand has gone international.

How likely is deflation?

Well, the global economic outlook has deteriorated. The recovery "could peter out," warn economists Jim O'Neill and Bill Dudley of Goldman Sachs in a recent report. The only bright spot is Asia outside Japan. In 2002 China could grow as much as 8 percent, India as much as 6 percent, South Korea 6 percent and Thailand 4 percent, says economist Gregory Fager of the Institute of International Finance. Asian countries have repaired much damage from the 1997-98 financial crisis, he says.

But elsewhere, economic growth is feeble or nonexistent, and "without Japan, Asia isn't big enough to revive the world economy," Fager says.

The truth is that the world economy has become overly dependent on the United States and its mushrooming trade deficits, which are "unsustainable," say O'Neill and Dudley. To promote more balanced global growth, they suggest that:

* The United States abandon its "strong dollar" policy and allow -- or prod -- the dollar's exchange rate to decline by 15 percent to 20 percent, helping U.S. exports and discouraging imports.

* The European Central Bank cut interest rates by 1 percentage point (the key rate is now 3.25 percent), and Japan and Europe increase government budget deficits.

* China allow its currency -- the yuan -- to float upward against the dollar, encouraging more imports and discouraging exports.

On paper, this approach could succeed. Europe and Japan would grow more rapidly. China would buy more on the global market. But in practice, the problems are huge. Governments may disregard the advice. The United States remains wedded to a strong-dollar policy; China may be loath to surrender any advantage for its exports. Even if adopted, the plan might not work as advertised.

Foreigners have invested billions in American stocks and bonds. Fear of a dollar depreciation, which would make the investments worth less in their own currencies, could trigger a sell-off that would depress stock prices. And Europe and Japan may not be able to increase their growth.

Europe suffers from generous unemployment benefits, rigid regulations and high taxes. The first perpetuates joblessness; the second and third deter job creation. In Japan, low interest rates and big budget deficits have failed to revive an economy cursed by weak banks, cautious consumers and low corporate profits. None of these problems is easily treatable by economic policy, because all are deeply rooted in national politics and psychology. The desire of the Japanese for social "consensus" has kept them from making needed economic changes. Europeans prefer generous welfare benefits and strict regulation.

Globalization allows countries to enjoy one another's strengths -- through the flow of products, ideas, technologies and investments. But globalization also exposes countries to one another's weaknesses. Everyone increasingly depends on the overall world economy, which in turn depends on the health of its major parts. When a few small countries (say, Argentina and Thailand) are in trouble, it doesn't matter much. When all the big players (the United States, Europe and Japan) are in trouble, it matters a lot.

The danger of deflation lies less in the mild U.S. slowdown than in the possibility that weakness abroad will amplify it into something larger and more stubborn. The presumption has been that -- through changes in trade, capital flow, exchange rates and interest rates -- the world economy would spontaneously maintain growth and stability. One area's strength would offset another's weakness. But the presumption could be wishful thinking.

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