Column : Multiple equilibria

Written by Meghnad Desai | Updated: Dec 17 2012, 05:49am hrs
The combined outcomes of EU crisis, US fiscal cliff, slowdown in China & India are difficult to predict

The global economy is poised in a delicate state. It is in some sort of transition but it is difficult to say what sort of equilibrium it will end up in. There are multiple equilibria possible and where we end up could be determined as much by some random shock as systematic trends.

Consider this. The western economies have slipped down from their dynamic path of 1992-2007. The eurozone is struggling not to break up or to mire itself into stagnation for the foreseeable future. It has plans such as a fiscal union and a banking union, which, if implemented, can allow it to grow again. Most likely outcome at present seems to be stagnation unless the stronger northern members of the eurozone can fork out the resources to bankroll the deficit countries. The harsh adjustments going on in Ireland, Spain, Portugal and Greece are proceeding at various paces but they all are slimming down not growing.

The Maastricht Treaty was signed by many European Union members without realising that they were signing up to a denationalised currency, which was one of Hayeks most radical proposals. The euro cannot be created by the governments as the European Central Bank (ECB) cannot buy sovereign debt in the primary market. The consequences of this were not felt while excess savings from Asia were keeping interest rates low. A denationalised currency is like the Gold Standard. For a while, Asia supplied the extra liquidity like the California Gold Rush did in the 19th century. Now, the exogenous supply of liquidity is exhausted and the eurozone has to innovate to adapt to this new situation.

The US is poised on a cusp. If the fiscal cliff can be overcome, we may enter 2013 to face up to the serious challenge of long-run debt reduction. The US has perhaps the best surprise in its shale gas discoveries. If that fructifies, the US may change its international trade balance greatly. That raises its long-run growth prospect as well as the worlds growth prospect by making oil cheap, as shale gas is a cheaper substitute. The eurozone also has shale gas but it may refuse to sanction exploration because of environmental considerations. The US has no such compunctions.

If the fiscal cliff is hit and there is legislative gridlock, then the prospect is a fearful one. So far, the world has been willing to hold dollars as a safe haven in troubled times despite near-zero interest rates. But if the gridlock stays, the dollar could face serious decline. That, in turn, will raise the yield curve steeply and not just in the US. That way we stay in stagnation in all western economies.

Closer at home, the BRICS are slowing down. Xi Jinping emulating Dengs launch of liberal reform by going south is significant. This tells us that China wants to restore the growth rate back to high single digits if not low double digits. Its ability to do that will depend on the western economies reviving at least slightly. China is still not able to get rid of its export dependence. The growth of domestic consumption will take time and so we may drift for a while.

The successful passage of FDI in multi-brand retail in India is a relief. Yet it does not seem that the UPA/NDA implicit coalition on liberal reform works any more. The BJP failed to dent the UPAs majority and will not now give way on banking and insurance. The BJP does not see why it should award the UPA the good results of rapid reform, which can only improve its electoral chances. So we shall hobble along on the legislative front till 2014 with crucial issues of land and labour reform unresolved. If anything, only spending schemes will go through making the deficit harder to tackle. The UPA is not having the expected success in disinvesting, which is the key to budget balance. Worse still, it is most likely that whichever government emerges after 2014 is unlikely to grasp the nettle of raising the growth rate.

Yet this also could be a cusp. India has no structural obstacles in resuming a 9% growth rate. The constraints are contingent and political. I still hold the view that political differences in India are trivial. There is a scope for a Grand Coalition; indeed, the need for one. But personalities are in the way. Unlike China, India has no tradition of coming together to tackle a single goal, viz accelerating growth. Yet it would be the best thing.

The new BRICS are in AfricaNigeria, Mozambique, Angola. Africas growth record is impressive and if the next phase of dynamic capitalism is in Africa that should be welcome. It has resources plus a demographic advantage. After decades of misrule, good governance is being made routine. There are some very innovative things happening with e-money across Africa. Asia has had its turn; now the baton passes to Africa.

The author is a prominent economist and Labour peer