Arguing the World Economy

I was fortunate last week in being able to gather round the dinner table in my London flat a group of economists, media folk, geopoliticians, and foreign-policy types to review where the world is, and where it is going. Whereas the heads of state convened in Evian yesterday were bound by the stilted scripts prepared by their sherpas, my dinner companions, protected by the Chatham House rules (that forbid naming names) always in force in my home, could be completely candid.

The first thing we learned is that if you want an uncontested prediction of the course of the U.S. economy, don’t invite more than one economist. We had several. In my view the day was carried by the optimists, who say that we have learned from past errors how to respond to bursting bubbles. They predict that the American economy will be growing at an annual rate of a bit under 3 percent by year end, and at a still higher rate in 2004.

As these cheerier economists see it, all the pieces are in place for such a recovery. Interest rates are already low, which should keep the housing market growing at the record pace of recent months. The decline in the dollar will stimulate the export-led sector of the manufacturing and service sectors, and ward off any deflationary tendencies. And now we have the president’s tax cut.

In June every family with an income between $26,000 and $100,000—the middle class in White House terms—will receive a child credit check of $400 per child. On July 1, paychecks will rise to reflect the lower deductions for income-tax payments. Businesses will benefit from more rapid depreciation rates. And share prices should end up something like 7 percent higher than would otherwise be the case in response to the lowering of the tax rates on dividends and capital gains.

The net result will be to pump some $210 billion in purchasing power into the economy over the next sixteen months—a non-trivial 1.4 percent of GDP. The neo-Keynesians in the White House—yes, such there be—believe that it is necessary to stimulate demand in order to sop up the excess capacity that is deterring new investment in several key industries.

Moreover, everyone is underestimating the size of the tax cut. Congress halved the president’s request, and approved $350 billion in tax relief over the next ten years. But Congress managed to keep the figure so low by assuming that taxes will be allowed to return to their prior, higher levels on January 1, 2005. That, say the politicians who have experience with such things, is highly unlikely: congressmen are not about to campaign in November of 2003 on promises to raise taxes shortly after taking office. So the reductions won’t expire, and total tax relief is likely to approach the figure the president originally requested.

Great stuff, and pass the claret, but not the whole story, argue others. Japan also has low-to-zero interest rates, a loose fiscal policy—and an enduring recession. The unpleasant fact is that we just don’t know how to cope with the debris strewn about when bubbles burst. Even the optimists concede that it is possible that all of the measures taken won’t restore the U.S. economy to robust health—but they deem such a scenario highly unlikely.

The political types remain calm. Even if the economy should fail to recover, they say, Bush is likely to win the second term that was denied his father. For one thing, the steps he has taken to stimulate growth show that he “cares”—the “compassion” in compassionate conservatism. More important, even if the unemployment rate rises, the president will still have the leadership card to play. Cynics may scoff at his jet landing on the carrier Abraham Lincoln, but voters see it as further proof that since September 11 he has taken charge of their security, and is making progress in the War on Terrorism.

Talk then turned to the world’s other leading economies. Japan is so deeply mired in recession and so resistant to reform that no extended comment was deemed necessary. Until the government gets the banks to write off the loans that everyone knows will never be repaid, they won’t be in a position to make the new loans that might spur new investment and economic growth.

Germany is considered a basket case, its economy shrinking and its population declining to the point where it will be “economically irrelevant,” in the words of one observer, within the next several decades. All made worse by a soaring euro that is reducing the international competitiveness of Germany’s already high-cost industries.

France is somewhat better off, partly because the one-size-fits all monetary policy of the European Central Bank suits it better than it does Germany, partly because the exchange rates prevailing when the euro was adopted were more favorable to France than to Germany, and partly because the French simply ignore many of the growth-strangling rules that the more orderly Germans obey to the letter. In short, France’s black economy provides a source of flexibility and growth not enjoyed by their German allies.

Finally, the United Kingdom. The consensus view is that the Chancellor has got it wrong. His optimistic forecast ignores the noticeable slowdown in consumer demand, and the productivity-draining effects of the massive increase in taxes and the swelling of the public sector. Indeed, all of the jobs growth in the British economy now comes in the public sector, and consists of piling administrators on top of already useless administrators.

Worse still is the effect that the new European Constitution will have on Britain. The bureaucracy’s ability to ensnare Britain in red tape will increase as the European court puts flesh on the bones of the constitution and its call for “worker dignity,” stronger unions, and an enlarged welfare state. The U.K. economy will pay the price—and soon, was the view offered as the pudding was served.

And so to bed.

This column appeared in London’s Sunday Times on June 1, 2003.