Global economic hazard You have four primary risks. You have the unsustainable pattern of capital flows, which at some point won’t be sustained and may lead to a disorderly adjustment process.
You have substantial geopolitical risks around the price of oil and what’s going on in the Middle East, and while the world economy has weathered those well so far, you can’t be confident that the process will continue, and there’s substantial implied volatility in the oil market today.
You have the prospect that the US, which has been the major source of demand for a growing global economy for the last several years, will slow down as a consequence of the increase in interest rates that have taken place, and as a consequence of a slowing of consumer spending as the housing-spurred spending of the last couple of years unwinds.
And finally you have the risk of another shock that we’re not now planning for, another terrorist shock or a flu shock or financial problems arising from some expected source after a period when risk premia are very low.
Advice to Hank Paulson
Only about a third or fewer of people who smoke die of something related to their smoking, but nonetheless smoking is highly imprudent. In the same way, no one can be confident that the US trade and current account deficits and associated foreign borrowing will lead to substantial financial disruption, but it is surely running a risk that we don’t need to run – the right set of solutions have been recognized for quite some time.
They involve increased US saving, the promotion of domestic demand in east Asia; they involve the more active growth policies on both the supply and demand side in Europe; they involve – they hopefully will involve over time – a lower price of oil promoted by better energy policies in the US and elsewhere.
There is less mystery in what should be done than in the politics of getting it done. While the current account deficit very importantly reflects developments in other parts of the world, in a kind of investment shortage relative to the supply of savings in other parts of the world, the actions the US takes will have a very important impact on whether these imbalances are corrected.
We’re running real risks. Just how great the risks are I don’t know, but they’re certainly larger than we need to be running.
The US leadership challenge
After the Second World War, there was an enormously productive period of US leadership, which was channelled through the creation and strengthening of international institutions ranging from the UN to the World Bank. In retrospect, the post Cold War period has not seen an equally productive period of institutional innovation. That is a profound challenge.
The US does need to play a leadership role if global public goods are going to be provided, if the system is going to remain open. But it cannot play that role alone, and it will have to find more effective and legitimate ways to pursue its interest in a stronger global system than it has these last few years.
The appropriate approaches vary from sphere to sphere. On the one hand, the new US development efforts and increased commitments are welcome. On the other hand, there have been serious problems with the follow-through on those commitments, and it’s unfortunate when assistance is provided in so fragmented a way by so many countries working separately.
The US could take a substantial role in fostering cooperation there. There’s a growing consensus on the long-term risks associated with global warming. Kyoto is surely imperfect in many ways, but that’s not an excuse for abdication. And here too the steps that the US takes could be enormously important. On the other hand, there is a danger that multilateralism can become a device for promoting inertia. And the US is right to be focused on trying to bring about productive change, so it’s a very difficult balance that needs to be struck.
It’s always a mistake to assume that there are ultimate victories or ultimate defeats – for the Doha Round, much less for the world trading system. There tends to be a failure to recognize that the integration taking place through information technology, through the changing nature of output, through reduced transportation costs is actually probably a larger integrating force than the changes that are brought about by public policy through trade agreements.
Nonetheless, the breakdown [in trade talks] is a serious matter and reflects what is a central challenge – maintaining a political consensus for an open trading system in the US, Europe and around the world. I don’t feel in a position to apportion blame. There’s plenty to go around, but it’s less a matter of the intransigence of individual officials than buttressing political support for the system, which will go importantly to the broad thrust of economic policies, certainly in the United States.
I think there are real domestic political constraints in the US, but in other countries as well, certainly in Europe, against pushing integration forward. —Interview by Taimur Ahmad