Gathering this weekend in Italy for their annual summit, the leaders of the major industrial countries seem almost indifferent to the threat of a global recession. Economic forecasts have consistently been too optimistic. The United States is sputtering. Growth is slowing dramatically in Europe. Japan is in recession. Other Asian countries have been hit hard by the U.S. slowdown. Argentina may default on its debt. The danger does not lie in any one of these developments but rather in their convergence, which could create a snowball effect of weakening global trade, confidence and stock prices. The world's leaders ignore these problems at their peril.
Welcome to globalization's darker side. Connections among economies have multiplied in ways that are only barely understood.
Early this year, Europeans thought they would largely escape the effect of the U.S. slowdown _ a judgment reflecting the small share (20 percent) of European exports going to America. The logic hasn't worked. In 2000, the euro area economy grew 3.5 percent. Now, the latest estimate for 2001 from DRI-WEFA _ a major forecasting firm _ is 1.9 percent. One reason is that more European companies have U.S. operations.
European multinational companies behave multinationally. To restore profits, they look for savings (including layoffs) everywhere. The same is true of U.S. multinationals, and the impact is multiplied by the exploding global investment. From 1995 to 1999, foreign direct investment in the United States nearly doubled to $1-trillion. More than two-thirds was European. Meanwhile, U.S. direct investment abroad was $1.1-trillion.
Nowhere are trade and investment connections greater than Asia. Computers, electronic components and telecommunications equipment represent 50 percent of Taiwan's exports, 41 percent of South Korea's, 77 percent of Singapore's and 60 percent of the Philippines', reports the Bank for International Settlements. Little wonder that these economies have reeled from the collapse of the computer and communications sectors in the United States and, increasingly, Europe.
Among economists, the consensus remains that both global and U.S. recessions will be avoided. Lower interest rates and resilient consumer spending will rescue the United States. Europe will benefit from belated interest rate cuts by the European Central Bank. Maybe. The bleaker possibility is that, without the prop of the U.S. boom, everyone flounders. Poor export demand frustrates a U.S. recovery.
Consider first Japan and Europe. Japan's prime minister, Junichiro Koizumi, promises to end his country's stagnation. The idea is to deregulate industry, spur investment, accelerate bank write-offs of bad loans and reduce the economy's reliance on government budget deficits. The trouble is that the first effect might be to deepen the recession. Lower budget deficits would curb public works spending. Richard Katz of The Oriental Economist magazine estimates that bank loan foreclosures might raise unemployment by 3-million to 4-million. As for Europe, restrictions on hiring and firing have curbed growth. Similarly, the ECB has kept interest rates up to deter inflationary wage settlements by unions and companies.
Turn next to developing countries. Even if Argentina doesn't default, the risk of investing in these countries is growing. That threatens capital flight and currency depreciation. Multinationals reduce their investment, foreign investors sell local stocks and wealthy natives shift funds into dollars. To limit currency depreciation_which worsens inflation by increasing the price of imports _ countries raise interest rates. Higher interest rates reward people for keeping their funds in the local currency, but they also depress the economy. Already, this punishing cycle is under way in Brazil, whose growth has also suffered from an electricity shortage.
Here is a recipe for global recession. No region generates strong expansion. Surplus manufacturing capacity reduces investment, prices and profits. Stock markets and trade weaken. The recipe, though not preordained, isn't implausible.
Once started, a global recession could have a fearsome political fallout. It would increase protectionist pressures, intensify the backlash against globalization, spawn global discord and threaten the survival of leaders in rich and poor countries alike. At their Italian summit, the world's most important leaders ought to discuss how to minimize the danger. Missing the opportunity, they will surely be blamed for the consequences.
Robert J. Samuelson is a columnist for Newsweek.
Washington Post Writers Group