Eurasia Group's weekly selection of essential reading for the political risk junkie -- presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup or @IanBremmer.
China has been all over the news this week, with the New York Times hacking episode dominating headlines. But recent stories related to China venture much further than cyberspace. This week's must-reads has a China theme.
1. "The resource race: China
dips toes in Arctic waters"
Christoph Seidler, Spiegel Online
This piece outlines China's new ventures to the Arctic -- and how China's diplomatic tactics are shifting.
2. "China's love affair with
cars chokes city air"
Louise Walt, Associated Press
Over the last decade, the automobile industry has skyrocketed in China. Last year, 13 million cars were sold. But what kind of environmental impact will such a rapid shift have?
3. "Making room"
In 2010, there were roughly 4,000 cities with populations of 100,000 or more. (China had about 400 of those). But between 2010 and 2050, the UN anticipates that the world's urban population will double. This piece reviews a new book by Shlomo Angel called Planet of Cities -- the book predicts how future urbanization will play out. Here's an interesting rule of thumb: usually, a country's biggest cities break down such that the largest city has twice the population of the second largest, three times that of the third largest...etc.
4. "Chinese labour pool
begins to drain"
Jamil Anderlini and Ed Crooks, Financial Times
China's working age population unexpectedly shrank last year -- a trend that wasn't meant to begin until later this decade. What do China's shifting demographics mean for the economy?
5. "Mexico: the new China"
Chris Anderson, The New York Times
Is cheaper always better? This piece highlights some of the advantages of using Mexican manufacturing from an American business perspective. Anderson argues that it allows for more product evolution, innovation, and customization -- and Chinese labor is getting less and less cheap.
Note: Today is the second in a series of posts that detail Eurasia Group's Top Risks for 2013.
As their people grow bolder in their quest for information, China's leaders will only tighten the restrictions they place on cyberspace. China is, in fact, embarking on a worrying experiment: It is the only major power that is attempting to preserve an authoritarian system in the information age. This gigantic task will demand a great deal of leaders' attention, raise tensions among the Chinese people, and reverberate outside of China's borders through the country's foreign policy.
China's Great Firewall and unpredictable censorship regime have more or less enabled its leaders to manipulate the information accessible to its citizens. But these tools are fast becoming insufficient, a fact made clear by strikes at a major Chinese newspaper this week. China's internet users stand at more than half a billion and counting. Growing demands for transparency and information leaks that embarrass the government are inevitable, as evidenced by the public's growing awareness of high-level corruption scandals.
The Communist Party appears poised to implement a new phase of information control that is part reactive and part proactive. On the reactive side, the government has begun to disrupt virtual private networks used by many foreigners, and even some Chinese, to circumvent the country's firewall. The government will proactively attempt to capitalize on technological tools by using the internet and social media such as Weibo (China's version of Twitter) to convey its own messaging.
The friction between the government's attempts at self-preservation and the population's desire for more transparency will be the greatest political challenge for China in 2013. While the stability of the government is unlikely to be shaken in 2013, this internal conflict will distract leaders and encourage them to deflect public anger outward. Finding foreign scapegoats is a time-honored tactic that the Communist Party is likely to repeat this year.
There are plenty of foreign targets to turn to. Territorial tensions are high and are only exacerbated by the U.S. pivot to Asia, which has emboldened countries such as the Philippines to more aggressively push their interests. The largest risk is an increase in nationalism from China toward Japan, especially given the growing tension surrounding outstanding territorial disputes between the two countries.
Ultimately, though, China's attempts to limit information run counter to its stated desire to develop an innovative economy. How can China's handful of vibrant IT firms and internet giants become global competitors while operating under a regime that restricts online information? How can China become a dominant player in the global economy if it is disconnected from the global information society? These are inherent contradictions that the new Communist Party leadership will have to resolve.
On Monday, we'll profile Risk #3: Arab Summer.
Note: Today is the first in a series of posts that detail Eurasia Group's Top Risks for 2013.
Since the onset of the financial crisis in 2008, investors and companies have focused mainly on risks in developed world markets. But as conditions in the U.S. and Europe continue to improve in 2013, the most worrisome risks will again come from emerging market countries. These countries are fundamentally less stable than their developed world counterparts, and some of their governments used a period of favorable commodities prices and the benefits from earlier reform to avoid the tough choices needed to reach the next stage of their political and economic development.
Some of these emerging market nations face more difficult challenges than others, and much depends on the degree of political capital each leader will have in order to make unpopular but necessary changes. These countries can be divided into three broad categories according to the complexity and immediacy of the risks they face and the longer-term upside they offer.
The first category includes the best bets:
The second category of emerging market economies are at risk of considerable volatility.
Lastly, there are the underperformers, those countries where risks will overshadow returns.
On Friday, we'll profile Risk #2: China vs Information.
HOANG DINH NAM/AFP/Getty Images
By Michal Meidan and Carsten Nickel
There are many reasons why China's economy has begun to cool, but the dramatic slowdown within the European Union, China's largest trade partner, is among the most important. Fears for Europe's growth and stability weigh heavily in Beijing, and China's risk-averse leaders are willing to invest in Europe's recovery.
But Beijing won't risk throwing good money after bad with substantial bailouts for risky peripherals like Spain, Italy or Greece. That would play badly inside China, where public perception that government is bailing out wealthy Europeans during a slowdown at home wouldn't play well. Greek haircuts earlier this year left Chinese investors with huge losses, and to invest in the European Financial Stability Facility (Europe's current bailout fund) is to form closer ties with meddlesome bureaucrats in Brussels.
Instead, China is increasing its direct investment in Germany, still Europe's economic engine, and, by extension, in Berlin's ability to manage crises and restore the continent's growth. That's good news for German Chancellor Angela Merkel, who sees the strategic importance of improving relations with the world's other leading manufacturing-dependent surplus economy. China has become Germany's third-largest export market behind France and the United States, and with demand among Germany's neighbors unlikely to increase anytime soon, German manufacturers will grow increasingly dependent on China and its markets.
Economic ties between China and Germany began to tighten following the onset of the financial crisis in 2008 as demand generated by the Chinese stimulus plan became an important source of Germany's recovery. Closer ties with German automakers and producers of renewable energy help Chinese firms develop new technologies and climb the value chain.
is a downside for Germany. Expanded commercial ties will force Merkel's
government to contend with domestic concerns that China's labor practices fall
far short of acceptable standards and that German companies doing new business
in China will have their intellectual property stolen. But Chinese purchases of
German Bunds will help Merkel ease domestic fears that German support for
Eurozone weaklings will sap the country's strength. That's why Merkel's once
vocal criticism of China's human rights record has all but disappeared -- and why Berlin,
unlike European institutions in Brussels, has yet to demand equal access to Chinese
That's crucial for China. Beijing will continue to pay lip service to its ties with EU institutions, but growing ties between Beijing and Berlin will complicate Brussels' efforts to develop a common foreign and trade policy toward China, increasing Beijing's bargaining power with individual European partners.
Today, when China's leaders look toward Europe's core, they see a weakened France, a marginalized Britain, and a rising Germany. By betting on Berlin, China is hoping that Germany will use its increasingly decisive role in EU decision-making to provide China with market economy status, and the commercial advantages that come with it, and even to help lift Europe's arms embargo on Beijing. For its part, Germany is hoping ties with China can boost growth at a moment when it's badly needed.
For the moment, it's an increasingly profitable partnership.
Michal Meidan is an analyst in Eurasia Group's Asia practice. Carsten Nickel is an analyst in the firm's Europe practice.
Sean Gallup/Getty Images
By Daniel Kerner
Argentina is once again rattling the nerves of foreign investors. The country that has been struggling to move on after its 2001 default and checkered economic history has recently nationalized the country's largest private company, Repsol's YPF, without any signs of providing compensation. Additionally, there have been growing rumors and divergent signals that the government might "pesify" its debt obligations -- in other words, convert dollar-denominated debt into the less valuable local currency -- to contain the outflow of dollars.
Government officials have denied such rumors, knowing that debt is a very sensitive issue for its own voters. Indeed, the near-term probability of debt pesification seems low given that the government is, in part, imposing tough foreign exchange restrictions so that it has enough reserves to meet debt payments. That being said, the risk will probably increase over time. Economic dynamics will likely worsen in the next few months, and the government is likely to double down on interventionist measures even as economic distortions grow.
Argentina has experienced high rates of economic growth since 2003 (with the exception of 2009), but in a context of growing macroeconomic problems. Now, with economic growth faltering, and the central bank increasingly financing the treasury, Argentina seems to be headed toward a negative equilibrium of low growth and high inflation. But fear of following more orthodox policy prescriptions that, in the government's view, caused the last crisis (and Europe's recent troubles), may be generating the next economic crisis.
Financial investors clearly have a reason to be concerned. Argentina still has debt in default and has been tweaking official statistics in part to pay less debt. The paradox, however, is that the government is imposing trade and foreign exchange restrictions precisely to have enough dollars to meet its debt obligations. To some extent, this is because the effects and memory of the 2001 debt default are still alive. Fernandez de Kirchner's government is a product of the economic crisis, and during her presidency and that of her husband, the late Nestor Kirchner (2003-2005), the government was willing to take interventionist actions to service the debt for fear that financial troubles could cause them political troubles, even if these measures are now generating inflation and a sharp economic slowdown. In fact, the memory of the crisis can also be seen in the government's obsession with maximizing short-term growth and consumption, and in its reluctance to implement needed macroeconomic adjustments (especially if they are seen as orthodox measures).
At the center of the problems is rising inflation. Official inflation is at 9.9 percent, but the credibility of those figures has been questioned since 2007 (private estimates put inflation above 25 percent). Inflation first picked up following Argentina's 2002 devaluation and has been rising over the past few years due to expansionary fiscal and monetary policies. In contrast to most of its neighbors where independent central banks actively fight inflation, the government has been increasingly relying on the central bank to finance the treasury, and even reformed the bank's charter earlier this year to gain further support.
High inflation, and the government's reluctance to let the currency depreciate substantially, has led to a rapid increase in imports and capital flight ($21 billion in 2011), all of which have put pressure on the currency. Low investment in the energy sector, a result of low prices and interventionist policies, has led to ballooning energy imports (which increased by 113 percent in 2011). The government responded to the deterioration in the external accounts by restricting purchases of dollars, limiting imports substantially, and nationalizing the largest energy company, all measures that have aggravated the country's problems.
Argentina seems to be caught in economic limbo. It is aware that making its debt payments is of paramount importance, but is unwilling to adopt the economic policies that would make it easier to do so without causing more economic damage. Foreign investors are right to be experiencing flashbacks.
Daniel Kerner is an analyst in Eurasia Group's Latin America practice.
JUAN MABROMATA/AFP/Getty Images
By Scott Seaman and Stephen Majors
Many Japan watchers -- and the market -- are hoping for a breakthrough in Prime Minister Yoshihiko Noda's efforts to secure passage of a consumption tax increase. The general expectation is that raising the tax from 5 percent to 8 percent in April 2014, and then again to 10 percent in October 2015, wouldn't just be a solid step forward in addressing Japan's ballooning public debt, which is projected to reach 239 percent of GDP by year's end. It would also demonstrate that Japan's political parties are able to work through their differences to tackle tough problems in a country that has had seven prime ministers in the past six years.
But this view wrongly focuses on a narrow, short-term outcome rather than on the broader political malaise such a victory could prolong -- which, in Japan's case, is the most salient factor for long-term reforms. The passage of the tax hike is not necessarily a good sign for the country's ability to tackle its many pressing problems unless it leads to snap elections and a major realignment of Japan's sclerotic party system. The best outcome would be the failure of the tax hike measure, followed by Noda's call for a snap election; or the passage of the hike based on Noda's agreement with the opposition Liberal Democratic Party (LDP) that he would call an election in return for their cooperation. Outside of these two scenarios, the party realignment that is necessary for Japan to make deep economic reforms and boost competitiveness is very unlikely to happen.
Without major party system realignment, political gridlock on most reforms would persist, undermining medium- to long-term prospects for deeper economic restructuring. A core problem of Japan's political system is that the ruling Democratic Party of Japan (DPJ) and the LDP are both characterized by deep internal schisms over greater openness to economic competition and trade, as well as on fiscal and social welfare reform. Such internal cleavages have blurred distinctions between these parties and made maintaining party discipline and cohesion almost impossible. In addition, a "twisted" Diet (Japan's parliament) in which the DPJ controls the lower house, but lacks a majority in the upper house, allows opposition parties to block legislation with ease. The policy gridlock that often results has contributed to a loss of public support for parties of every stripe and a general sense that Japan's politics is essentially dysfunctional.
Noda has set a deadline to bring legislation for the tax hike to a vote in the lower house of the Diet before the end of the current session on 21 June. Strong opposition outside -- and inside -- the DPJ keeps the odds of enacting legislation for the hike during the current Diet session low. Despite the challenges, Noda may still find a way through threats and horse-trading to pass the increase. Numerous members of the DPJ, LDP, and other parties feel electorally vulnerable and would prefer to avoid a near-term snap election, strengthening their desire to pursue inter- and intra-party compromises. If Noda's government passes the hike without a snap election, markets will likely view this positively based on the argument that any success reduces the risk of a rise in Japanese bond yields and provides a signal that Japan's prospects for better fiscal management have improved.
But focusing on the short-term market spike in such a scenario would risk overlooking the larger implications of successful passage of the hike. Beneath it would lay the perpetuation of a largely dysfunctional status quo. Party system breakdown would be traumatic, and any realignment that follows would be fraught with uncertainty. But if it sets the stage for reform-minded politicians from the DPJ, LDP, and other parties to coalesce into a single party with a majority in both houses of the Diet, the outlook for future reform efforts would be brighter.
Scott Seaman is an analyst in Eurasia Group's Asia practice. Stephen Majors is an editor with Eurasia Group.
By Preston Keat
There is a new optimism in the Eurozone, but it may be masking some serious risks.
In a moment of crisis this spring, representatives of the 16 Eurozone governments came together to take dramatic action. Greece faced imminent financial collapse. Spain, Portugal, and Italy looked to be next in line. The Eurozone committed substantial sums of money, markets stabilized, and disaster was averted. Yet, Europe can no longer ignore the reality that the days of slow but steady Eurozone "convergence" are finished -- possibly forever.
Gone are the days when traders could ignore big differences in Greek and German economic policies as they invest in the two countries' sovereign debt. Prospective Eurozone members from Eastern Europe were once treated with little differentiation, despite wide variation in the credibility and transparency of their policymaking. The rule was for lower costs of capital for current members and Eurozone hopefuls alike, regulatory and legal integration, and diminishing attention to differences in national-level economic policymaking.
In the new Europe, the consensus favors belt-tightening. Governments must spend less money, collect more revenue, and guard against inflation. If governments fall of the wagon, it is feared, Europe's single currency will again be in serious trouble.
THOMAS LOHNES/AFP/Getty Images
By Roberto Herrera-Lim
Cast as "China-lite," Asia's next major export tiger, Vietnam plays the part with gusto. Its bureaucrats look north to learn China's way of growth. And at first glance Vietnam seems perfect for the role -- affordable labor and plenty of both public and private investment (foreign and domestic) in everything from office buildings and new industrial zones to oil refineries and deepwater ports.
But when Hanoi decided in August to devalue Vietnam's currency, it demonstrated that following China's path to prosperity just isn't that easy. Investors are now taking a step back to watch carefully as Vietnam wrestles with inflation, large trade and balance of payment deficits, and a frothy urban real estate market. They also worry over longer-term problems like official corruption, bureaucratic confusion, shortages of skilled workers, and large gaps in infrastructure investment.
Maybe China is the wrong model. Beijing is wrestling with some of these same problems and makes plenty of mistakes along the way, but China's enormous economy and its access to capital provide advantages that little Vietnam -- and maybe a lot of other small frontier economies -- can't match. China's size and advantages of scale have so far helped Beijing absorb many a self-inflicted blow over the past two decades.
The 11 people arrested and accused of spying for Russia have titillated the tabloids and reminded Cold War veterans of the good old days. But they won't do much damage to U.S.-Russian relations. In fact, the two governments are getting along much better at the moment. There are three major reasons for this, and all of them have to do with the view from the Kremlin.
recently ailing economy is now feeling much better. The financial crisis
inflicted more damage on Russia
than on most other emerging markets, in part because of a steep drop in oil
prices. When Obama first proposed a "reset" in U.S.-Russian relations, Moscow was hemorrhaging
reserves, and Kremlin officials hadn't arrived at any clear idea on what to do
about it. Prime Minister Vladimir Putin was traveling the country assuring local workers
that complacent oligarchs, not state officials, were to blame for the
volatility, and that their government would ensure that all would again be
well. President Dmitry Medvedev and his more western-oriented advisors were
beginning to look like convenient scapegoats should the public become restive
and Putin run out of businessmen to punish.
Things have changed. The economy has picked up thanks to some skillful economic management and a rise in oil prices out of the danger zone.
is feeling much better about its neighborhood. The Orange Revolution is now a
distant memory. In 2004, a presidential election in Ukraine lifted the Putin-endorsed
Viktor Yanukovych over Viktor Yushchenko. But Ukrainian nationalists and
several Western governments charged fraud, and the race was re-run. Yushchenko
won the do-over, fueling suspicion and hostility in Moscow. But his leadership earned little
public confidence during his five-year tenure, and Ukraine's latest election elevated
Yanukovych, who has now taken his country's bid to join NATO off the table for the foreseeable future.
Alex Wong/Getty Images
in many parts of China have made international headlines in recent weeks by
demanding higher wages -- and getting them. As more of them get what they want,
others will be encouraged to go the same route. Is the world's factory about to
go out of business? Not quite yet, but China's government has a
complicated new management problem.
The surge in worker anger and a wave of wage hikes in companies ranging from
electronics giant Foxconn to fast-food icon Kentucky Fried Chicken have generated talk about the end of cheap labor in China and the birth of an independent labor movement. That's overstated-or at least premature. Higher labor costs are an inevitable result of rising living standards and expectations, a long-term trend that can't be blamed on one Honda plant. An ageing population (in part the result of the one-child policy), the urbanization of huge numbers of workers, as well as Beijing's long-term policy plans to boost the declining share of income in China's GDP had set the stage for a gradual rise in labor costs long before the recent wave of strikes. With wages stagnant for most of the economic crisis, many local governments have introduced minimum wage hikes ranging from 5 percent to 20 percent in recent months. But the trend toward country-wide wage increases will be gradual. For now, there are still enough workers looking for jobs along the coast and in the countryside to keep labor costs manageable for many producers.
The more interesting part of the labor dispute story comes from the changing
nature of China's workforce. The country's economic boom has gradually raised expectations among Chinese workers for a better life. Opportunities to get an education (or provide one for their children), to buy a home, and to afford once unobtainable consumer goods have changed the way that millions of Chinese workers imagine their future. On an unprecedented scale, savvy workers are using the Internet and cell phones to find out what's happening in other factories and towns. They are increasingly aware of their rights and of the existing legislation designed to protect them. They're becoming much more assertive in demanding that their rights be protected.
So far, Beijing has tolerated these worker movements. Premier Wen Jiabao, known to many as "Grandpa Wen," recently spoke in support of the migrant workers who make up the bulk of China's unskilled labor. He insisted that they deserved to be "cared for, protected and respected." As long as labor disputes don't take on an overtly political tone, Beijing will leave it to local governments to deal with them. But one of the Honda strikes came dangerously close to testing the limits when, according to some accounts, workers demanded the right to form independent labor unions.
Here's where things could become more confrontational. China's formal trade union, the All China Federation of Trade Unions (ACFTU), is the only union that the government tolerates. But ACFTU doesn't inspire much confidence in the workers it was created to represent. Its main goal is to unionize most, if not all, of China's foreign-invested firms, and it tends to limit its role to mediating disputes between management and workers. Since its operation are approved by management -- and often staffed with managers -- workers tend to stake their claims independently of it. Some workers are even looking for something a bit more genuinely independent to represent their interests and protect their rights.
How will Beijing respond to these new pressures? First, it will likely keep the pressure on local governments to manage labor problems effectively, whether by brokering concessions, intimidating those who make the most aggressive demands, or both. Second, it could seek to empower ACFTU to play a more assertive role in representing workers interests, a goal that some ACFTU
representatives share. Beijing would rather ensure that its trade union can play its role more effectively than to allow for the creation of labor unions it can't completely control.
For the moment, the world's factory will continue humming along, though with
a few more jolts and bursts. But this is a story worth following as the Chinese leadership adapts to the challenges of navigating an increasingly complex political landscape.
Michal Meidan is an analyst in Eurasia Group's Asia practice.
MIKE CLARKE/AFP/Getty Images
I'm seeing a lot of Russians in Davos this year, but surprisingly little Russia. It's hard to say if it's a conscious decision by the Russian government, but if so, it strikes me as a pretty sound strategy. After all, Russia as a topic generally comes across as a negative in global circles--revisionist geopolitics, resource nationalism, and strongly authoritarian (albeit charismatic, in a fashion) domestic leadership. Instead, there are a healthy number of Russian executives going about their business, presenting on panels along with colleagues from other countries, and generally integrating well. It's probably their best Davos in a good long while.
The Russians have nothing on the Japanese execs, who are here in serious force. Though absolutely none of whom are actually talking about Japan. Indeed, the only attendee I could find giving a bullish Japan story is Pepsi CEO Indra Nooyi, who apparently is making money there cans over fist. For everyone else, it's a story of a dwindling population and flat consumption, but world-class technology, strong regulatory structure, and top-notch management. Japan's model apparently is to become a bigger Singapore.
Speaking of Singapore, a sad piece of trivia I just heard: after lots of lobbying and prodding, an Armenian friend of mine (full disclosure: my mum's also Armenian) recently got Singaporean minister and mentor Lee Kuan Yew to spend three days in Armenia. But the Armenian government initially didn't want to meet with him because they didn't know who he was. Land-locked, no resources to speak of, and apparently they don't read the paper. Oy.
Ian Bremmer will be blogging from Davos this week sending reports and commentary from inside the World Economic Forum.
PIERRE VERDY/AFP/Getty Images
Thus far, the Obama administration isn't making much of a showing. Undersecretary of State Bob Hormats did a strong job on yesterday's U.S.-China panel. But there's little coordination and not much of a message. If Secretary of State Clinton is too busy, why not send Vice President Biden? Combined with perfunctory foreign policy mention in the State of the Union, I'd suspect it's a feeling that anything but domestic issues isn't going to play well politically. That's not the strategy I'd be going with.
So for the American delegation, it's the U.S. private sector that's leading the charge here. And the omnipresent Barney Frank -- who yesterday told a private industry group to stop listening to what congress says, and look at actual policies ... do they have anything to complain about? Heads nod reasonably sagely.
Meanwhile, criticism of imminent political explosion grows as the nights wear on. Rogue economist/historian/documentarian Niall Ferguson, distinctly unshaven (proffered excuse--he forgot his razor on his flight from Delhi), wagered me $100 that the United States would have a new Secretary of Treasury by June 1st this year. Wager accepted. Howard Lutnick of Cantor Fitzgerald said he'd go $100 for Sept. 1. The bankers are always pushing it.
Ian Bremmer will be blogging from Davos this week sending reports and commentary from inside the World Economic Forum.
ERIC FEFERBERG / AFP / Getty Images
By Eurasia Group analyst Courtney Rickert
Amid headlines that the global economic crisis has stabilized, an important question arises: Which countries' economies will recover most quickly, and which recoveries will be the most sustainable? The key to finding an answer lies in understanding how countries were exposed to the global downturn and assessing their policy responses. Countries that choose to adjust to the changed global economic environment will come out on top in the long term.
While all internationally integrated economies have suffered growth declines, some economies entered the recession in a better position than others. Part of this divergence is a result of the quality of government policies, such as balanced fiscal positions and low inflation. Other key factors in determining a country's exposure to the crisis are trade imbalances and overinvestment in select sectors, such as real estate, in the period leading up to the global financial crisis.
Countries that had persistent trade deficits -- such as the US-financed them by borrowing heavily from abroad. Frequently, international borrowing fed domestic consumption far more than investment. This excess consumption contributed to bubbles during the boom years -- notably in financial assets and real estate-that have since popped. These economies have been slower to stabilize, but the housing and retail markets are naturally adjusting as home prices fall, banks become more prudent, and consumers buy less. In these cases, there is little need for long-term adjustments to macroeconomic policies.
On the other hand, government policy choices will play an important role in countries that sustained trade surpluses, such as China, Germany, and Japan, because these surpluses were a result of government policies that promoted exports. Their economies have been hard hit by declining global demand-particularly in the US. Although government stimulus spending has propped up their economies in the short term, China, Germany, and Japan will face a fundamentally different global market in the long term -- one that is unlikely to revert to the pre-crisis status quo levels of global demand. Governments in these countries will have to choose whether to reorient their economies away from export dependence or try to muddle through and hope for a return of foreign demand.
Effective policy responses in all countries have required crisis stabilization, the cleanup of sectors that experienced overinvestment, and adjustment to the rapidly shifting global flow of funds and goods. Even the best-run governments will face difficulty managing these activities smoothly, but many are demonstrating the ability and willingness to do so. Below are snapshots of policy responses in the four largest economies: the United States., Japan, China, and Germany.
The United States had a large trade deficit during the expansionary period, allowing it to adjust relatively easily to declining global demand. However, as a result of international capital inflows, it also had significant overinvestment in financial assets and real estate. The Obama administration responded relatively aggressively to the crisis by taking action to clean up the financial sector and implementing a $787 billion fiscal stimulus plan, but spending has been slow to materialize. The US economy is forecast to contract by 2.6% in 2009 and show only minimal growth in 2010, as individuals and firms paying down their debts remain a drag on economic growth. But compared to the major trade surplus countries, the United States' relatively fluid economy will likely to adjust to the new global environment more smoothly and rapidly.
Japan's exposure to the current crisis has been exacerbated by its efforts to sustain trade surpluses, but its economy had already been adjusting before the crisis began, with production increasingly moving overseas. Moreover, when the global decline in demand hit, Japanese firms decreased production and rapidly leveled off at much lower output. In addition, the 30 August elections are expected to displace the long-ruling Liberal Democratic Party (LDP), bringing to power a government that is more interested in protecting the interests of consumers rather than producers. This situation is reducing Japan's dependence on exports, providing a more stable base for growth.
The global slowdown has hurt demand for Chinese goods and threatened the vitality of China's export-oriented economic growth. While exports are unlikely to return to their previous levels in the near to medium term, Beijing's massive stimulus spending, relaxed monetary policy, and export promotion will partially counter the collapse in demand. If China is to secure long-term growth, however, efforts to rebalance the economy toward greater domestic consumption -- by putting more income in workers' pockets-must be considered.
The export orientation of the German economy and tight integration with the wider European economy limits the government's ability to stimulate domestic demand. Moreover, liabilities in the banking sector are worrying. While the government has fiscal room to maneuver, focus on the upcoming election and fears about the cost of potential interventions in both the real and financial sector have constrained Berlin. Most importantly, the government is averse to policies that would lead to a structural change in the country's export orientation. While this could begin to erode after the 27 September elections, any shift in German policy will be limited by concerns about government debt levels.
YOSHIKAZU TSUNO/AFP/Getty Images
The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.