The global economy is in trouble -- if political and business leaders don't stop substituting short-term tactical responses for real, substantive reform.
- By Mohamed A. El-Erian<p> Contributing editor Mohamed A. El-Erian is CEO and co-chief investment officer of global investment management firm Pimco and author of When Markets Collide. </p>
Today’s surprise macroeconomic indicators, be it Britain slipping back into recession or America’s large decline in durable goods orders, speak to the unusual challenges facing advanced economies. Yet, way too many of today’s policy approaches to the problems at hand are tactically oriented. Rather than confronting the challenges comprehensively and setting a long-term destination, they are short-term responses designed simply to right a leaning ship. Aimed at achieving equilibrium just long enough for everyone to catch their breath, they deliver a tranquility that has repeatedly proved temporary, reversible, and therefore fundamentally elusive.
There are good reasons for this policymaking approach, and to be fair, it has worked in the past. Yet circumstances are fundamentally different today. So what appears tactically smart to some may well end up strategically shortsighted for all.
The recurrent inclination to opt for the tactical rather than the strategic solution to the current mess is evident in Europe and the United States — and it is visible in both the public and the private sectors. Facing their biggest debt crisis in modern history, European government officials have muddled along for more than two years. Through a series of small steps — be it the financial bailout of three peripheral economies or the massive liquidity injections by the European Central Bank — they have done enough to avoid a catastrophe, but not nearly enough to leave the crisis firmly and decisively behind.
This type of behavior is also evident in the United States, though it’s somewhat less dramatic. Led primarily, if not exclusively, by the Federal Reserve, officials have taken steps to stabilize the economic situation and encourage a gradual healing. The Fed, however, has not been sufficiently supported by other government entities possessing better policy tools to lift impediments to growth, including the reform of housing and housing finance, labor retraining and retooling, education reform, and public finances. As a result, the economy is yet to attain the escape velocity needed to dramatically lower long-term unemployment and restore the United States on the path of sustained growth and medium-term fiscal sustainability.
The same can be said of the international monetary system. Reacting to mounting pressures, advanced economies have agreed to small steps that reflect the ongoing global realignments. Yet measured against the unambiguous shift in the balance of power between the advanced countries and emerging economies, the changes are way too limited, be it on voting and representation at multilateral institutions or how their heads are selected. As a result, these institutions lack legitimacy and credibility at the very time they are needed to facilitate international policy coordination and improve the functioning of a stumbling global economy.
The private sector has not been immune to this type of tactical behavior. In the last couple of years, companies have shown unusual resistance to making long-term commitments. Rather than invest and hire for future business, they have repeatedly opted instead to wait. In the process, they have accumulated huge cash balances on their balance sheets at a time when interest rates are so low as to imply a loss in real purchasing power.
This dominance of tactical mindsets is not irrational. It reflects the trio of an "unusually uncertain" outlook, powerful short-term incentives, and highly polarized politics.
Coming out of the global financial crisis, advanced economies have experienced a series of unthinkable scenarios that speak to deep structural transformations and a murky future. They range from the failure of economies to recover "normally" from the Great Recession to the persistence of unacceptably high unemployment; from the loss of AAA ratings in France and the United States to a government-debt restructuring in Europe (notably Greece); and from the remarkable resilience of emerging economies to concerns about the integrity of the eurozone.
These unthinkable scenarios are a reflection of two major, multiyear forces, and they add up to a historic realignment of the global economy. First, a deleveraging requirement in advanced economies after years of excessive indebtedness, lax borrowing standards, and an unreasonable sense of credit entitlement; and second, a development breakout phase in systemically important emerging economies such Brazil, China, India, and Indonesia.
To be handled in an orderly fashion, these major structural changes must be met with proper reforms at the national, regional, and global levels. But instead — whether because of tight election cycles, quarterly earning calls, or inadequate coordination — too many policymakers and companies have been incentivized to choose short-term approaches that, essentially, kick the can down the road.
Unusually polarized political setups in the United States and Europe have made things worse. Moreover, politicians have been inclined to opt for quick, catchy headline measures, rather than more comprehensive and durable reform packages. Indeed, it should come as no great surprise that politicians of different persuasions find it very difficult to iterate to a common analysis of the ailments in advanced economies and a common solution. Therefore, it should come as no surprise that companies prefer to stand on the sidelines and wait for greater clarity about the outlook.
In the old days, this way of proceeding was less risky as most advanced countries tended to operate in a predominantly cyclical — that is to say, a more structurally stable — world. Accordingly, tactical responses could prove satisfactory or, for the most part, at least neutral; and, accordingly, the private sector was much less hesitant about engaging energetically in national economies, acting as the locomotive for growth and helping link economies globally.
Today, advanced economies no longer live in an overwhelmingly cyclical world. They are navigating major structural and secular changes. They require comprehensive policy responses to overcome the twin problems of too little growth and too much debt; and they must adapt to the rapid developments of emerging economies and their consequences for the functioning of the global system. Until this materializes properly, the private sector’s engagement will prove insufficient to provide the powerful creation of jobs that is so desperately needed.
Conditions on the ground call for a rapid pivot from tactical to strategic. Realistically and unfortunately, this may well require the sense of another impending crisis before leaders in advanced countries truly grasp the urgency and importance of this transition. But in one sense, we may already be creating the conditions for just that eventuality — because, in the meantime, what appears tactically smart today may well end up tomorrow looking strategically shortsighted.