Sure, growth could be more robust. Sure, some workers are getting left behind. Sure, corporate debt is high and markets look frothy. But those problems aren’t the biggest threat facing the economies of the United States and Europe.
What is? The answer from a group of top economic thinkers convened by POLITICO isn’t something in the economy. It’s politics.
At a time that technology is transforming society, the postwar order is being challenged and Asia is on the rise, we convened some of the smartest economic minds from both sides of the Atlantic in a working group at POLITICO headquarters. Our goal was to identify the factors that would make or break Western economies in the decades to come.
So we were surprised that a conversation which ranged from robots to transfer pricing kept returning to one central theme: Political systems on both continents have become so dysfunctional that they threaten the West’s economic future.
That’s not to say the economic risks aren’t real. Our participants, many of them economists, cooked up a witches’ brew of worries, from a dangerous overhang of corporate debt to wage stagnation to the stubborn underemployment of 20-something men. But they considered those problems solvable — at least, if political systems were operating normally.
“The economy itself is doing quite well,’’ said one participant. “It’s the political risk underlying our system which is the greatest risk to the economy going forward.”
“Are there policy prescriptions for all this? Absolutely,’’ said another participant. “As an economist, you can sit there and say, ‘Look, there’s a solution.’ It’s just politically, they’re all very hard to do.”
The conversation was the second in a trans-Atlantic journalism project called The POLITICO Cabinet, organized jointly by POLITICO newsrooms in the U.S. and Europe. It was conducted under Chatham House rules: Names of the participants are public, but specific quotes are not attributed to individual participants. (For a list of participants, click here.)
Our participants described a vicious cycle underway between Western economics and politics: Economic dislocations and limited upward social mobility are eroding communities and fueling resurgent nationalism. That in turn fragments political parties and promotes a dysfunctional political discourse that retards constructive economic remedies.
“In a time where the economic forces are requiring a lot of political reaction, we are not able to react,” one participant said.
“I have been surprised and disappointed that neither party in the U.S. has done any kind of credible job of looking at these issues of preparing a workforce with the skills they need to succeed, helping individuals and communities that are adversely affected by change,” said another participant. “You would have thought, coming out of this election, Republicans would join Democrats in saying, ‘Here’s our base that we need to do something for.’ And there’s been almost no serious discussion of what to do.”
Working group members debated the rise of what they called “economic nationalism” — the idea that governments will reject globalism and multinational institutions in the name of promoting domestic industries and political constituencies. It’s the idea motivating Donald Trump’s “America First” rhetoric as well as China’s new push to dominate some parts of the global economy.
Political fragmentation, participants warned, means that economic nationalism could give authoritarian capitalist systems like China an advantage over the West, since they are more politically cohesive.
Participants disagreed, however, over whether China would be setting the rules of the road for the global economic system in the future. Some called that likely as China’s economy grows, saying its leaders might aspire to global dominance. Others thought China was likely to continue to chart a somewhat independent course, content to share leadership with the U.S. and Europe.
“I don’t think you’re going to see China step up and say, ‘OK, I’m now the biggest economy in the world, the old world is passe and I’m going to go to the [World Trade Organization] and write a new set of rules for the world’,” one participant said. “I think they’re just going to do their own thing … The tendency could also be that we have regional groupings driven by ideas of economic nationalism being relatively antagonistic with each other and the world.”
But a clear consensus around the table held that globalizing forces will likely prevail, in part because the growth-driving technology and financial sectors are fundamentally global in nature.
“The economics, if nothing else, will drive us back towards more global institutions and global organizations,” one participant said.
WHAT WE SHOULD WORRY ABOUT
Here are other key takeaways from the conversation:
Companies have taken on too much debt, and if we’re not careful, that could trigger another financial crisis.
In the wake of the 2008 financial crisis, when interest rates were kept very low, companies around the world found it easy to raise money by issuing bonds and other forms of corporate debt. Now, as interest rates creep up, there are warning signs that some companies are having trouble servicing their debt. If companies begin to default on their debt and debtholders (including large investors like banks) can’t easily sell off their holdings, that could trigger a 2008-style financial crisis.
Participants didn’t say that scenario was likely, just that the underlying conditions are there. But they urged preparation for it, since a series of defaults would require bailouts that would dampen economic growth for years. (That’s assuming political leaders have the ability to address the crisis in the first place.)
Stock markets are too optimistic, and are not pricing in real political risks, so they are extra-vulnerable to political instability.
Bull markets at a moment of political instability can appear too good to be true. And indeed, the working group economists agreed that the markets are effectively ignoring real risks.
One participant quoted a credit agency officer who acknowledged being fatalistic about global risk: “Either the risk happens, or it doesn’t and there’s no point in pricing it until it’s so close to happening that you can see the whites of the eyes.”
The result, the participant said, is that a political crisis, such as a conflict with North Korea, could trigger a stock market crash and a larger global financial crisis.
“You have asset valuations that are just really out of line with fundamentals and with actual risks,’’ the participant said.
Economic inequality is a real problem.
Middle-class malaise threatens the social fabric in both the U.S. and Europe, despite the fact that economies in both the U.S. and Europe are growing. Because of wage stagnation and dimming career prospects, more workers are bailing out of the workforce.
“I think that’s the issue,” said one participant. “It’s inequality. Lots of people aren’t feeling this recovery, because we haven’t had any wage growth in the U.S. or in Europe.”
This trend is likely to only worsen in coming decades, as automation reduces the need for many middle-tier jobs.
“Automation really carves out the middle chunk of jobs, and that exacerbates inequality,” said another participant.
Social mobility is also a real problem.
On both continents, there’s a palpable sense among workers that they won’t do as well as their parents, and their children won’t do as well as they have. This is fueling a toxic political environment that has fragmented political parties, making it harder for them to respond coherently to economic threats.
In the U.S., the lack of social mobility appears mostly connected to wage stagnation and the decline of manufacturing. In Europe, by contrast, participants said the roots of the trend are more cultural — driven by fears that immigrants will transform European societies for the worse.
Trade deficits are NOT a real problem.
Although the participants came from across the political spectrum, they agreed that trade deficits are not a cause for concern, since deficits tend to worsen when the economy is strong and consumers are buying a lot of goods, and that the ebbs and flows tend to balance out over time and between countries. One participant called the trade deficit “a ridiculous metric.”
“We had a wonderful, wonderful trade surplus during the Great Depression, and we had a yawning trade deficit in the 1990s, when we added 22 million jobs,” the participant said.
Globalization will win in the end … whether some people like it or not.
Technology and global supply chains mean that our economies will be integrated and interdependent going forward, even if politically we remain at odds.
“I think all the supernationalism is going to burn itself out in part, because it’s going to be economically unsustainable,’’ said one participant.
“I don’t think globalization is going to go away,’’ said another participant. But the world “is going to be fragmented and there’s going to still be dysfunction in government.”
WHAT CAN WE DO?
Is there a way to future-proof the economies of the West? Here are some measures the working group said Western policymakers should consider right now:
1. Tackle inequality
Growth has dominated the economic calculus for decades. But deepening inequality has become a threat to continued growth and prosperity.
Participants expressed skepticism about predictions that 40 percent of the U.S. workforce and 30 percent of the European workforce could lose their jobs to robots in the next two decades. But they conceded that automation will displace enough workers to exacerbate inequality. That means Western governments and economists need to be thinking about policy responses to those job losses now. And they need to think about how to share prosperity across geographic regions and generations.
One participant noted that it would be helpful if economists and policymakers stopped looking just at gross domestic product as the measure of an economy’s health.
“Who cares about growth?” the participant asked. “I understand why investors do, but is that the be-all and end-all? Should that be the gold standard for economists? No, inclusive growth is probably a more important measure. Measures of inequality, that’s what we should be looking at.”
Some participants expressed support for the idea of a “universal basic income,” a basic Social Security-style income payment to all citizens in a country that would provide a subsistence level of income, including to the unemployed.
“It’s politically toxic, so it’s going to take a crisis for any politician to go there,” said one participant. “But I just don’t see much of an alternative.”
Others expressed doubt that basic income payments would work, since as one participant put it, “It’s not going to be a satisfying way for people to live.”
2. Engage with China
Some participants expressed dismay over China’s resistance to many international norms of doing business. But they agreed that engaging Chinese leaders is crucial to navigating a world in which China becomes evermore economically and politically dominant, even if it hasn’t shown much benefit yet.
“We always knew that China was different, but the thought was, if we bring them in through the [WTO] or its other mechanism, they’ll become more like us,” one participant said. “The reality is they are not becoming more like us, really.”
3. Get serious about training and education in science, technology, engineering and math (STEM)
The working group agreed that the jobs of the future will need more workers with higher technical skills and that governments need to partner with the private sector to figure out how to train those workers – the sooner the better.
“We’ve been talking about the lack of a trained workforce for STEM for 10 years now,’’ said one participant. “How come we still have a lack of trained workforce?”
The participants noted that some European countries, particularly Germany, are outpacing the U.S. in promoting education in science and technology.
SEIZE THESE OPPORTUNITIES
Participants were able to point to some positive trends that might mitigate their otherwise a fairly gloomy outlook for the economies of the U.S. and Europe.
One participant noted that the surprising election of President Donald Trump and the unexpected vote of United Kingdom citizens to leave the European Union have spurred a backlash which might undermine the trend toward nationalism and improve prospects for globalism.
“Trump has been a major wakeup call in the United States and around the world, and may well have elicited a bit of a counter reaction,’’ the participant said.
“I’m actually quite optimistic that in some ways, a reaction to Trump will be a furtherance of globalization as other countries see what’s at risk is you go down this path of populism and you go down the path of isolation,” this person added.
Another participant predicted that the millennial generation on both continents will push governments and businesses to change for the better: “If you think about millennials, the generation to come, they are the most high-maintenance consumers that this world has ever seen. And there’s a lot of dysfunction that they will not tolerate.”
And finally, several participants expressed optimism that the dysfunction of political systems at the national level might spur more political engagement at the community level — leading to more cooperation and economic prosperity on a local scale.
“I think if you look at a truly local level, you will probably start to see [movement toward creative political solutions] because of frankly, the pushback against this past election,’’ one participant said. “I do think there are people out there, and it is the next generation, who are thinking differently about what the solutions need to be.”