In a Time of Crisis

In a Time of Crisis

by Daniel K. Eisenbud | photography by Jordan Hollender

Medium- and long-term monetary issues, says Conference Board chief economist Bart van Ark, are as crucial to address now as are short-term consequences.

The global economy is experiencing an unprecedented perfect storm. Markets have tumbled, the financial industry has imploded, corporate profits are down, unemployment is up, consumer confidence is at historic lows, and investors are utterly disillusioned. Even the most sanguine observers aren’t assuaged by the promise of a reconciliatory “Yes we can!” political shift.

Bart van Ark, The Conference Board’s chief economist, has his hands full trying to make sense of it all. As an internationally recognized expert in global comparative studies of economic performance, productivity, and innovation, he not only provides perspective on what the U.S. and global economies can expect in 2009 but also explains why all may not be as dark as it seems when looking beyond.

Van Ark spoke with TCB Review senior editor Daniel K. Eisenbud at the Board’s New York offices.

Will things get easier in the United States anytime soon?
Not soon, no. I agree with the consensus that we have a good chance of getting out of negative- growth territory, which we are in now, by the second half of 2009. By that time, we will have had a full year of no growth. This is not just a typical short business-cycle dip. There are many underlying structural problems — notably, the credit crisis and the huge imbalances between spending, saving, and borrowing within the U.S. economy and globally. These problems will take substantial time to resolve.

We at The Conference Board recently deepened our recession forecast for the U.S. economy, for three reasons. One reason is that consumer spending in the fourth quarter showed no sign of stabilizing following the huge decline in the third quarter. The shock effects of the financial-market troubles last October, and the fact that we still haven’t seen the housing market bottom out, have made consumers very cautious. A second reason is that capital spending began to turn sharply negative in the fourth quarter. Businesses clearly have shelved investment plans to wait out the storm. Capital spending will likely remain negative in the first and second quarters before getting out of negative territory later in 2009. And a third reason is that because of the slowdown of global growth, export growth — which was one of the few bright spots in the first half of 2008 — needs to be adjusted downward.

Inflation pretty much disappeared during the fourth quarter of 2008, almost entirely due to oil and gas prices coming down. But this will not give much relief, as it will probably be a windfall for a few quarters at best, and we won’t see consumption boosted much by it. I would expect to see inflation go back up to 2 percent or maybe even 3 percent sooner rather than later.

Is the housing market still the most important factor in the downturn?
The housing market has been slowing for almost three years. Housing starts were at over 2.2 million units per month in early 2006; higher numbers were only seen back in the early 1970s. Now housing starts are collapsing to perhaps the lowest number ever — below 650,000 units by mid-2009. Prices will continue to show a downward trend, and this will put more homeowners in financial difficulty, particularly in the current economic environment. The only ways out of this are cheaper mortgages and, more importantly, mortgages that are easier to get.

Credit standards have tightened enormously, and we see this not only in housing but in credit cards, auto loans, and personal loans. Things may ease up a little, since interbank lending rates have come down from the extreme levels of last October, but they remain very high, and the concerns of the banks are very substantial. Many of them are on liquidity lifelines from the governments right now, making them extremely risk-averse.

Banks being in trouble, of course, raises the specter of the Great Depression. is a comparison to today’s crisis fair?
Part of it is fair — any financial crisis is characterized by a massive systemic failure. We’ve had a few of those between the Great Depression and now, but the current crisis is particularly serious because of the large contagion effects that have spread rapidly throughout the global system — not only in the United States, as was the case in the 1930s, but around the world. So from the viewpoint of global contagion, this episode is at least as serious as during the Depression.

There are two fundamental differences, though. First, the world economy today — particularly the advanced economies — has a much higher living standard than was the case in the 1930s, or even in the 1970s and 1980s. The number of people falling back into poverty is low compared to the Depression, notwithstanding the huge financial problems that an increasing number of households face. Additionally, the doubledigit unemployment that we were seeing at that time, or even back in 1982 and 1983, does not compare to the projected 8.3 percent unemployment level we forecast by the end of 2009.

Another difference between this and previous times is that, whether one agrees with it or not, the government stepped in very early in this crisis. In the 1930s, it took the government three or four years to intervene. Until that time, they basically left the resolution of the crisis to the markets.

Do you see a clear role for government in resolving this crisis?
I think the main lesson of the Great Depression — which is that governments need to act quickly to help stem such a crisis — has been taken to heart. But we haven’t experienced such massive interventions before. I am concerned about how to make the unwinding of all this government involvement happen in an orderly way — both from the perspective of how to deal with the huge deficits that we are building up and from the viewpoint of how to see markets get their stakes back.

Do November’s election results change anything?
 Not for the immediate future. Any president elect would have faced the same very dire economic environment, and turning things around quickly is unlikely in the current situation. President Obama’s economic team has some really tough questions to work on. They need to determine whether there will be a fiscal stimulus plan and, if so, who will benefit from it — is it going to primarily be consumers, business, or government investments? They need to radically redesign the financial architecture. They need to redefine their leadership role in international negotiations. These are not easy challenges to face.

Also, given the fact that the budget deficit is already very large, the new administration cannot afford many new big-ticket items. I don’t think we are likely to see a quick “Roosevelt effect” — at that time, in the 1930s, it also took several years before the U.S. economy was back on track. The recovery will need to come from exploiting the long-term growth potential of the economy.

So the recession could linger until new growth opportunities bear fruit?
Exactly. It’s one of those terrible catch-22 situations in which both the financial and the non-financial sector need to move . . . but won’t as long as the other stays put. As credit markets remain choked, new growth opportunities cannot be exploited. So businesses do not invest, consumers do not spend, and jobs get lost. As investors and consumers decide to wait this out, the unwinding of the financial crisis is only going to take longer. The large amounts of liquidity that have been pumped into the economy will not take effect as long as banks are holding themselves back, and there will be fewer incentives to devise a more workable financial architecture.

If some confidence and trust could be restored between the various parts of the economy — notably between financial institutions and corporations — we may see investment pick up. That’s when we may see things improving in the second half of 2009. But if that does not happen, it will take several more years of slow growth before we are back on our feet. The challenge is bigger now than, for example, during the 1980s as the problems are more global.

Is the global recession already a reality too?
It depends on how you define recession. On an annual basis, the world economy grew nearly 4 percent in 2008, so we are not falling off a cliff. But we have seen growth come down rapidly from the extraordinarily fast growth of 5 percent in 2006 and 2007. There certainly are cyclical elements to this slowdown, as some economies, notably in Europe, were beginning to reach their supply capacity, which determines what we call their current potential output growth rate. But the financial-market crisis has created a lot of uncertainty, which has impacted business sentiment and consumer confidence and created a negative spiral. Both Europe and the United States showed a significant contraction in the fourth quarter. The emerging economies are also slowing down on exports and foreign direct investment — maybe by two percentage points — but because of their high growth rates of domestic investment and consumption, they’re not actually contracting.

What does this mean for global growth in 2009 and beyond?
In 2009, we are going to lose at least another full percentage point in global growth, down to under 3 percent. But if the domestic markets in emerging economies slow down more than anticipated, it could be more. That’s what I am most worried about, as the emerging economies currently pull the train for more than 90 percent of all the global growth that is left. What’s more, that could mean we might be looking at several years of slow growth. And, importantly, in these countries we see large groups of low-income households that are on the brink of becoming part of the middle class, for which the likelihood of falling back into absolute poverty is substantial if their economies seriously slow down. That’s not a good prospect, and we need to look for ways to avoid it. The question is whether emerging economies have the ability to cushion some of these problems internally. In the case of China, the central government has been actively trying to soften some of the effects of the current crisis on the domestic sector by providing larger amounts of liquidity, and by launching a $586 billion spending program on railways, airports, and other infrastructure, as well as on social-welfare projects. They have the capital to do that, and it will pay off more quickly in emerging economies than in advanced ones. So in that sense, I remain optimistic about the emerging economies.

You stress the need to focus on the medium and long term. What lessons can this crisis teach us?
The most important lesson remains a positive one: The past ten to fifteen years of very rapid growth have shown that capitalism and the role of market forces fundamentally stimulate economic growth and development worldwide. What led to the 2008 crisis is not a new phenomenon: Books have been written about this. In a nutshell, a long-term economic growth phase — which may last between two and four decades — is originally supported by an increase in financial capital. Once such a growth phase matures, finance tends to create tools to raise earnings beyond what the underlying collateral suggests things are worth.

Instead of providing the lubricant for the global growth engine, finance has become a goal in itself. Indeed, finance activity has become a major source of income, not just for banks and non-financial institutions but also for the businesses in the real economy — suggesting that returns on such activities became higher than returns on the core business of many non-financial industries.

Why did so many people miscalculate and make the same wrong gamble?
 I think it’s part of the nature of this kind of crises. In hindsight, it seems that overleveraging and extreme risk-spreading ran way ahead of what could be carried in the real world. While there is not much new to that story, the problem always emerges somewhat differently. We may have seen the problems arising by looking at the numbers — which we did, for example, in housing and in the global imbalances in capital shortages and surpluses — and many have speculated about many possible elephants in the room. But the party went on too long, supported by globalization, insufficient oversight, and loose monetary policy. Many can say they saw some of this coming. But it was too difficult to get out of the room until the real elephant started moving, and everything ran away at the same time.

So how do we begin climbing back toward long-term sustainable growth? First and foremost, we need to restore confidence in the economy — confidence and trust. The breakdown of trust in the financial sector is of course an acute problem, and is being addressed. But there are deeper issues between the financial and the nonfinancial sectors, and between society and business. Any government — whether it’s the new U.S. administration or any current government in Europe, Asia, or another region — needs to work on that, and it requires some serious self-reflection. The second important action is to accelerate the technology and innovation agenda to speed up our chance to enter a new growth phase. Information and communication technology have created huge productivity benefits for business, government, and society around the world, but I don’t think it has run its course yet. The Conference Board just started a large project with Telefónica in Spain to study the economic, social, and cultural effects of communication technologies. Obviously, there are also huge opportunities to step up the efforts for a sustainable growth agenda, which integrates environmental technology with innovations in ICT, bioenergy, and other technology areas. Businesses can play a huge role in seizing these opportunities now. The third matter is that the globalization that has been evolving over the past decade or so — and has helped capital and labor flow to the most productive and efficient uses in the world — must continue its course. A return to inward-looking policies will destroy more economic value than the current financial crisis.

How will coordination in this global economic environment take effect?
 There will be calls for more international coordination on trade, global finance, migration, and climate issues. Some kind of regulatory or oversight framework may be unavoidable, but it will be a big challenge to make it practical and workable. An important lesson from the current crisis is that transparency and clarity are needed, given the greater complexity of global relationships. This is also a particularly appropriate time to address the role of emerging economies in international forums. We need clearer rules of the game to create a level playing field.

But the game itself has radically changed — and the rules are changing too. Won’t it simply mean more regulations and government intervention?
There’s going to be a lot of debate about this, but I cannot imagine that after so many years of benefiting from globalization, the ultimate outcome can be anything else than support for global markets and competition. The legitimization for government intervention is the existence of externalities, meaning that the actions of one party make another better or worse off by changing their utility or cost. Without transparency, externalities can easily turn negative, as markets cannot price the cost incurred. Governments are there to provide the environment in which the rules will be established and need to be adhered to. But in the end, it is the market players who have to play the game. It’s going to be a while until that debate settles down.

Going back to the United States, what are the opportunities for employment?
In the short run, there is not all that much good news. Government jobs and services, like health and education, will continue to grow at a reasonable rate even in the midst of the economic crisis — and any stimulation program might even help. But the increasing budget deficit reduces the potential. It is also likely that sectors that are benefiting from investment in emerging economies, such as industries that produce construction materials and machinery, will be able to limit employment losses. The other piece of good news is that U.S. companies have become hugely productive, so there is little fat. In particular, companies will be cautious in slashing high-skill jobs too quickly.

Are workers again becoming our most precious asset?
I think they have always been, but we will come to realize this more strongly than ever once we get out of this crisis. Workers embody what we may call human capital, which in the long run is no doubt the scarcest asset for virtually any company. It’s a matter of resolving a mismatch in supply and demand. The United States and other advanced economies are seeing their baby-boom generation retiring, and there is too little supply, particularly in high-skill jobs. The education system is trying to adjust, but the impact on the labor market is slow. Meanwhile, skilled workers from emerging economies will find more opportunities at home.

As a result, the cost of high-skilled labor may increase a lot — another source of underlying inflation in the long run.

So investment in tangible capital, such as structures and machinery, is much needed to get the economy in a recovery mode. But investment in human capital, including health and education — and other types of intangible capital, such as knowledge and organization capital — is the only recipe to get back on track. These may sound like issues for the long run, but they deserve as much attention today as the immediate problems on our plate.