Finance Spring 2004

Governments Must Do a Better Job of Promoting Globalization
By Jean-Philippe Cotis

The global recovery is now well engaged and already very strong. This is clearly the case in the United States and in Asia, where the Japanese economy is surprisingly vigorous. But so far the recovery has been lackluster in Western continental Europe, particularly in Germany, where domestic demand remains in the doldrums. Unfortunately, this lack of economic stamina is not just conjunctural. It also reflects deeper-seated, structural problems.

In quite a number of countries in continental Europe and elsewhere, long term economic performance has been disappointing and has left many segments of society dissatisfied. When difficulties grow, it is tempting to blame outsiders, explicitly or by default. As a result, many people have been led to believe that globalization is the root of all evil and that it is inflicting disproportionate costs on societies, while at the same time depriving sovereign governments of the policy means to redress the situation. The resulting climate of sullen resentment has helped to paralyze reform efforts.

The challenge for governments and opinion makers is to re-establish the facts and dispel misconceptions about globalization. Chief among them is the notion that globalization places draconian limitations on national policies. It has to be said loud and clear that globalization is bringing more benefits than costs, and that good national policies are more important for success than ever. National policies are indeed of utmost importance, not just because they can mitigate the negative side effects of globalization, but because domestic reforms are themselves the key to prosperity. It is certainly not because of globalization that continental Europe and Japan have just experienced a rather disappointing decade. It is mostly because of domestic stalemate.

The strong global recovery is due to a number of positive factors. Growth in international trade has greatly accelerated. The investment climate has improved, with buoyant business expectations (Chart 1), interest rates at record low levels, small risk premiums, good access to credit, and clear signs that past excesses in business investment have been worked off. In addition, the U.S. economy has benefited from higher profit margins, in a context of unusually strong productivity growth. Finally, macroeconomic policies remain expansionary in all the major OECD regions, particularly in the United States.



The Organization for Economic Cooperation and Development believes that the world recovery will continue to develop in 2004. The U.S. economy will build a strong momentum, Asia will remain buoyant and Europe should finally join in the global recovery sometime during the second semester.

Growth is also expected to become more autonomous, with final domestic demand providing momentum, while policy stimulus is being withdrawn. In the euro area, however, particularly in Germany, the recovery has yet to extend to domestic demand and take over the baton from export growth. It seems that the European recovery will be belated, with a large amount of slack still remaining in the economy.

This outlook is however subject to a number of risks and uncertainties. To take one example, the current financing of the U.S. external deficit, which relies rather heavily on Asian central banks, is somewhat fragile and could lead to a further sharp depreciation of the dollar, associated with a strong increase in long term interest rates. This would be bad for investment worldwide. And it could be very disturbing for the European recovery, which is still at present relying on exports while domestic demand remains timid. Oil prices could also weigh down on activity should their rise continue over the next quarters.

Given the strength of the world economy, the time has come to start tightening macroeconomic policies. For fiscal policy, the question will be when to begin consolidation and how quickly to move. In the United States, where the recovery is expected to remain strong, there will be a need for an early and rapid consolidation. In the euro area and Japan, however, a more gradual but prolonged adjustment is called for, with more ambitious consolidation taking place as soon as it is clear that the economy is bouncing back.

It is of the utmost importance that all large European countries stick to their budgetary commitments. In a context of world recovery there should be no more excuse for slippage and delays. It will be enough of a challenge to meet the pressures arising from ageing. We must not make this challenge worse by burdening public accounts with persistent deficits.

For monetary policy, in a context of low inflationary pressures, central banks have some leeway to remain accommodative, especially if some real consolidation is achieved on the fiscal side. At some point the monetary stance will also need to tighten, but not at the same time in all the OECD countries.

In the United States, where monetary policy is very expansionary and has been for a long time, there is a good case to start tightening around mid-2004. In Japan, where complete victory over deflation is not yet achieved, the current strategy of aggressive easing pursued by the Bank of Japan looks appropriate. And in the euro area, with domestic demand weak and price stability well established, notwithstanding the recent rises in oil prices, further monetary easing may help to underpin the recovery.

In addition to its current conjunctural difficulties, continental Europe is suffering from deep-seated, far-reaching problems. Long-term growth of GDP per capita remains weak. Indeed Europe stopped converging with higher U.S. levels during the 1980s and fell back in relative terms during the 1990s. It is disappointing that per capita incomes are today 30 percent lower in the European Union than in the United States. Sadly enough, this is precisely the size of the gap that prevailed in 1970. (Chart 2)

The two principal sources of weakness in Europe are the low level of labor utilization and relatively weak productivity. That European productivity is lagging behind may look surprising, knowing the strong official productivity figures available for France, Italy and Germany. But these productivity statistics are too flattering and have to be interpreted in the context of many unskilled Europeans being out of work.

Continental Europe is also suffering from a very clear lack of resilience in the face of conjunctural shocks. Let us look, for example, at how Continental Europe has reacted to the U.S. slowdown over the past three years, in comparison with the more successful English-speaking countries such as Australia, Canada, Ireland, New Zealand and the United Kingdom.

Surprisingly perhaps, the globalized part of the economy, that is to say exports and business investment, was not hit harder in Europe than elsewhere. In continental Europe, however, there was an abrupt weakening in household spending, which did not occur in the most successful countries. So, the weak spot in Europe was precisely that part of the economy that is reputedly the most insulated and stable. The group of more successful and resilient countries also ran relatively prudent macroeconomic policies, which were not particularly activist. In a nutshell, continental Europe is suffering from relatively weak growth prospects in the long run and very fragile domestic demand in the short run. But this can hardly be blamed on globalization.

On the contrary, Europe's current problems are clearly linked to structural weaknesses and difficulties in implementing well identified and badly needed domestic reforms, in such areas as pension systems, tax and benefits policies, tertiary education, research and development, product and financial market integration and labor market institutions.

Globalization is presenting us with many challenges, ranging from the management of the world trading system to the preservation of global public goods and the fight against global warming. But one of the most urgent challenges is the need to "de-dramatize" globalization in the eyes of European public opinion and to increase the sense of ownership in domestic reforms.

There is indeed a gap between expert knowledge of globalization and public perceptions. OECD economists know from their research that globalization has a positive impact on growth. Increased trade and investment flows permit greater specialization and larger markets. This brings both efficiency gains and broader choices. And, according to our empirical work, an increase in trade exposure equivalent to 10 percent of GDP raises output in the long run by about four percent. To economists, it is obvious that globalization is good for growth. But it has still proved difficult to get this message across to the public at large.

That there is a perception problem about globalization in Europe is beyond doubt. According to one survey, for instance, more than 50 percent of Europeans think that globalization is bad for employment, a figure that rises to 70 percent in France, where the sentiment is strongest. There are various explanations for these fearful feelings about globalization. One of them is a tendency by many opinion makers to single out the costs of globalization while disregarding its benefits, so as to illustrate what they consider to be the fundamental flaws of market economics.

It is striking that most books on globalization available in continental Europe have very alarmist titles. In contrast, in the United States, and more generally in English-speaking countries, some book titles also mention that globalization may be an opportunity. This Transatlantic difference, however, may not last, given that political debate in the United States has recently focused more on the dangers of international trade.

Altogether, the critics of globalization in Europe and elsewhere claim it is detrimental to social justice and causes financial volatility as well as environmental degradation. In the United States, in the shape of "job outsourcing," it was blamed for the unusually slow growth of employment through 2003 and the beginning of 2004.

While these views identify some genuine problems, they fail to realize how little connected they are to globalization. And critics of outsourcing do not look carefully enough at empirical evidence. Technological progress and international competition are continually leading to new employment opportunities in some sectors and job losses in others.

In the United States, some 15 million jobs ­ more than one in ten ­ disappear every year. Yet, only very few people lose their jobs to outsourcing. U.S. survey data suggest that over the past three years only one percent of extended layoffs have been caused by re-locations offshore. In addition, it should be remembered that over time employment growth is positive, implying that more jobs are created than destroyed. Some of these new jobs result from technical progress and international trade through a variety of channels, for instance the outsourcing of jobs by other countries to the United States and higher U.S. purchasing power.

In the short run, however, job turnover is not costless and may disproportionately affect certain regions, sectors and companies. Governments have a role to play in helping the losers.What is needed is a good safety net, with transferable pension rights, good education and training policies to help retool the labor force, and employment protection that does not inhibit the hiring of new staff.

It is no coincidence that countries that have implemented far-reaching structural reforms, such as Australia, Canada and, to some extent, the Scandinavian nations, have generally reaped the gains from closer economic integration. These economies also tend to be more resilient to shocks. And they serve as a salient reminder that there is no reason to be fatalistic about the power of government to pursue domestic policy reforms.

To sum up, globalization is an ongoing challenge facing all governments. It provides a wake-up call to governments that they must put the right policies in place. These policies, if implemented in a coherent manner, will lead to higher living standards and employment. These are the rewards of structural reforms. They must be clearly and convincingly articulated. Governments cannot afford to hide behind globalization as a scapegoat for policy reform inertia. Passivity is not an option.

Jean-Phillipe Cotis is Chief Economist and Head of the Economics Department at the Organization for Economic Cooperation and Development in Paris, a position he has held since 2001. He was previously Director of the Economics Department at the French Ministry of Economy, Finance and Industry, and Economic Advisor to the Minister. He served as chairman of the Economic Policy Committee of the European Union from 2001 to 2002, and of the OECD's Working Party No.1. An economist at the IMF from 1986 to 1988, his research has mainly concerned labor markets, macroeconomic policies and taxation.

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