The Economic Fundamentals of 2013

Nouriel Roubini

Jan. 21, 2013

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NEW YORK – The global economy this year will exhibit some similarities with the conditions that prevailed in 2012. No surprise there: we face another year in which global growth will average about 3%, but with a multi-speed recovery – a sub-par, below-trend annual rate of 1% in the advanced economies, and close-to-trend rates of 5% in emerging markets. But there will be some important differences as well.
Painful deleveragingless spending and more saving to reduce debt and leverageremains ongoing in most advanced economies, which implies slow economic growth. But fiscal austerity will envelop most advanced economies this year, rather than just the eurozone periphery and the United Kingdom.

Indeed, austerity is spreading to the core of the eurozone, the United States, and other advanced economies (with the exception of Japan). Given synchronized fiscal retrenchment in most advanced economies, another year of mediocre growth could give way to outright contraction in some countries.
With growth anemic in most advanced economies, the rally in risky assets that began in the second half of 2012 has not been driven by improved fundamentals, but rather by fresh rounds of unconventional monetary policy. Most major advanced economies’ central banks – the European Central Bank, the US Federal Reserve, the Bank of England, and the Swiss National Bank – have engaged in some form of quantitative easing, and they are now likely to be joined by the Bank of Japan, which is being pushed toward more unconventional policies by Prime Minister Shinzo Abe’s new government.
Moreover, several risks lie ahead. First, America’s mini-deal on taxes has not steered it fully away from the fiscal cliff. Sooner or later, another ugly fight will take place on the debt ceiling, the delayed sequester of spending, and a congressionalcontinuing spending resolution” (an agreement to allow the government to continue functioning in the absence of an appropriations law). 

Markets may become spooked by another fiscal cliffhanger. And even the current mini-deal implies a significant amount of drag – about 1.4% of GDP – on an economy that has grown at barely a 2% rate over the last few quarters.
Second, while the ECB’s actions have reduced tail risks in the eurozone – a Greek exit and/or loss of market access for Italy and Spain – the monetary union’s fundamental problems have not been resolved. Together with political uncertainty, they will re-emerge with full force in the second half of the year.
After all, stagnation and outright recessionexacerbated by front-loaded fiscal austerity, a strong euro, and an ongoing credit crunchremain Europe’s norm. As a result, large – and potentially unsustainablestocks of private and public debt remain. Moreover, given aging populations and low productivity growth, potential output is likely to be eroded in the absence of more aggressive structural reforms to boost competitiveness, leaving the private sector no reason to finance chronic current-account deficits.
Third, China has had to rely on another round of monetary, fiscal, and credit stimulus to prop up an unbalanced and unsustainable growth model based on excessive exports and fixed investment, high saving, and low consumption. By the second half of the year, the investment bust in real estate, infrastructure, and industrial capacity will accelerate. And, because the country’s new leadership – which is conservative, gradualist, and consensus-driven – is unlikely to speed up implementation of reforms needed to increase household income and reduce precautionary saving, consumption as a share of GDP will not rise fast enough to compensate. So the risk of a hard landing will rise by the end of this year.
Fourth, many emerging markets – including the BRICs (Brazil, Russia, India, and China), but also many others – are now experiencing decelerating growth. Their “state capitalism” – a large role for state-owned companies; an even larger role for state-owned banks; resource nationalism; import-substitution industrialization; and financial protectionism and controls on foreign direct investment – is the heart of the problem. Whether they will embrace reforms aimed at boosting the private sector’s role in economic growth remains to be seen.
Finally, serious geopolitical risks loom large. The entire greater Middle East – from the Maghreb to Afghanistan and Pakistan – is socially, economically, and politically unstable. Indeed, the Arab Spring is turning into an Arab Winter.

While an outright military conflict between Israel and the US on one side and Iran on the other side remains unlikely, it is clear that negotiations and sanctions will not induce Iran’s leaders to abandon efforts to develop nuclear weapons. With Israel refusing to accept a nuclear-armed Iran, and its patience wearing thin, the drums of actual war will beat harder. The fear premium in oil markets may significantly rise and increase oil prices by 20%, leading to negative growth effects in the US, Europe, Japan, China, India and all other advanced economies and emerging markets that are net oil importers.

While the chance of a perfect storm – with all of these risks materializing in their most virulent form – is low, any one of them alone would be enough to stall the global economy and tip it into recession. And while they may not all emerge in the most extreme way, each is or will be appearing in some form. As 2013 begins, the downside risks to the global economy are gathering force.
Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

January 20, 2013 5:43 pm
Europe: An uneven entente
France must contend with Germany’s growing predominance and its differing vision for European integration
Late French President Francois Mitterrand and German Chancellor Helmut Kohl stand hand in hand©AP
The odd couple: François Mitterrand and Helmut Kohl link hands at the cemetery beside the battlefield of Verdun at a meeting in 1984

One picture sums it up: Helmut Kohl and François Mitterrand holding hands in the Douaumont cemetery in 1984, beside the first world war battlefield of Verdun, where nearly 800,000 French and German soldiers died in pointless slaughter fighting for a few square miles of mud in 1916.

Two middle-aged men in winter overcoats, the German chancellor towering over the French president, they look ill-sorted and slightly uncomfortable. Yet clasping hands, they are determined to demonstrate their shared emotion at this symbolic moment of national reconciliation.


The close political and personal alliance between Mr Kohl and Mr Mitterrandthrough the end of the cold war, German reunification, and the negotiation of the Maastricht treaty that decided on the euro as a common currency – was founded on that common understanding. The German conservative and French socialist were the odd couple who personified the Franco-German partnership.

This week, the two countries celebrate the 50th anniversary of the Elysée treaty, the document that laid the foundation for their close co-operation on building an integrated European Union, and for the transformation of two hostile neighbours and traditional foes into close allies.

The French and German parliaments will meet in a joint session in the Berlin Reichstag on Tuesday, and the two governments will meet in the office of Angela Merkel, German chancellor. Ms Merkel and François Hollande, French president, will make formal speeches and the parliaments will issue a declaration of mutual understanding and admiration.

Yet for all the pomp, 50 years after the treaty was signed by Konrad Adenauer and Charles de Gaulle in 1963, questions are being asked about the vitality of the partnership.

France’s Le Monde newspaper dared to call Tuesday’s celebrations a “festival of hypocrisy”, suggesting that political relations between Ms Merkel and Mr Hollande were poisonous and mutual suspicion was rife.

Other analysts, especially in France, worry about the imbalance of power that has emerged since the reunification of Germany in 1990 and the powerful performance of the German economy in contrast to that of France, especially since the outbreak of the global financial crisis.

Jacques Delors, former president of the European Commission and godfather of the euro, pulls no punches. What is striking is that economically Germany dominates, and France suffers a lot because of its debt and insufficient competitiveness – and so the relationship is unbalanced,” he says.

Both Nicolas Sarkozy, former president, and Mr Hollande have tried to compensate, he says, but “the eurozone crisis has evolved in rhythm with the decisions – and lack of decisions – of Ms Merkel. It is not nice to say so, but that is how it is.”

Claire Demesmay, head of the programme on Franco-German relations at the German Council on Foreign Relations (DGAP) in Berlin, calls it a “double decoupling”. “There has been an imbalance since the fall of the Wall and German reunification,” she says. “The original balance was between a France that was strong in foreign policy, and Germany that was a political dwarf, but an economic giant.

“The end of the cold war removed France’s special position. To be a nuclear power did not mean so much. So France lost political influence, while it didn’t gain economic power. Germany has gained political power with unification, and economic influence too, with the opening up of eastern Europe.”
Anne-Marie Le Gloannec, lecturer at Sciences Po university in Paris, sees a suspicion of Germany’s new-found prowess fuelling French wariness about its historic enemy.

Trust is a currency that is getting thinner and thinner,” she says. German impatience with the French, and French irritation over German pre-eminence, is there more than ever. States do not have feelings, but social and political relations are based on trust. It is an absolutely necessary currency for things to function.”

Yet participants in the bilateral relationship insist that it was ever thus. The Franco-German partnership has always been far more of a roller-coaster ride of political opposites, than a smoothly functioning motor of European integration.

When the Elysée treaty was signed by Mr Adenauer and Gen de Gaulle in January 1963, it attempted to reconcile two very different world views, and two very different cultures. Chancellor Adenauer’s vision was of a federal Europe with strong supra-national institutions. Gen de Gaulle favoured a “Europe des patries” in which the nation states would remain the dominant players.

Indeed, the French leader saw the alliance with Germany as a counterweight to the dominant role of the US in Europe. But when Mr Adenauer presented the treaty to the German Bundestag, he faced a fierce backlash from Atlanticists in his own party who mistrusted the Gaullist strategy. They insisted on writing a preamble to the treaty, underlining the vital role of the Atlantic alliance, beside the Franco-German partnership. President de Gaulle was furious. “If this is a marriage contract, then I am still a virgin,” he supposedly retorted.

The treaty consists of two pillars. One is bureaucratic, committing both governments to a series of regular meetings, from heads of government down to civil servants. The other is cultural, starting a whole series of school and student exchanges, town twinnings and the promotion of learning each other’s languages.

The former has ensured that, regardless of the political persuasion of governments in Berlin and Paris, meetings carry on to forge common European positions.

“The first question we always ask about any European policy is: what does Paris say?” says Michael Link, German state minister for Europe. “We seek Franco-German compromises, not to tell Europe what to do, but to make solutions more likely.”

France’s Valéry Giscard d’Estaing looks back on his presidency of 1974-1981, when he and German Chancellor Helmut Schmidt battled the economic crises of the 1970s, as a model for relations between the two countries.

“It was a golden age,” he tells the FT in his wood-panelled office in his elegant Paris apartment. “We consulted one another every week. If you look at the papers and documents of the time, there was not a single expression of dissent.

“We both had been in the war. Helmut Schmidt was in the German army, I was in the American army. We shot at each other. We had an experience that was not conducive to [friendship]. But despite or because of that, we had a full understanding for each other’s politics.”

Now a sprightly 86-year-old, Mr Giscard d’Estaing is certain that the Franco-German relationship will last.

“It is enough to read the history books of the last two centuries to understand that the French-German rapprochement is now irreversible,” he says. “There is no event, no person, who can put it in danger. It can be more or less productive, but it can’t be called into question.”

. . .

Yet the Giscard-Schmidt era of co-operation is exceptional for having run so smoothly.

On economic policy, the nations are often far apart. Germany has always been committed to an independent central bank, for example, whether it is the German Bundesbank, or the European Central Bank. Paris has constantly sought political control over monetary policy. It has been one of the tensions complicating crisis management in the eurozone.

The original treaty failed to incorporate any reference to economic policy co-ordination, because the differences were seen as too great. France was too committed to preserving the role of the state, and Germany to the promotion of the market economy. Fifty years later, such fundamental differences in outlook remain unreconciled.

Gérard Errera, former secretary-general of the French foreign ministry, sees it as a constant tension: “The constraint on the Franco-German relationship is that we are different on everything – our institutions, our history, our culture – and we don’t always understand each other. Yet, we have to agree to make Europe work. So it always requires huge efforts to achieve compromises.”

A senior German diplomat sees it in much the same way: “Franco-German co-operation is counterintuitive. There is a common misperception that France and Germany are doing things together because we want to.

That’s rubbish,” he says. “We are different on every choice of substance between us, whether it is free trade versus protectionism, creating a strategic defence industry or being complementary with the Americans, or what we put on the table: beer or wine.

“But only if these two starting points can be reconciled is there a chance of moving Europe forwards.”

Joachim Fritz-Vannahme, head of the Future of Europe project at the Bertelsmann Foundation, says that “the strength of the relationship comes not from having identical positions, but from the differences. Once you know about the differences, you can approach how to reconcile your positions.

“You have a president of France who says we need a social Europefairer and showing more solidarity. You have Ms Merkel and the Germans saying we will never get there if we don’t have fiscal discipline: solidity first. If you combine solidity with solidarity, you have the principles of a better Europe.”

Bruno Le Maire, German-speaking former European affairs minister under Mr Sarkozy, cautions that France’s economic weakness has undermined confidence in Berlin.

France has got to regain credibility with Germany and that only comes through the economy,” he says, “fixing growth, unemployment and the debt. Nothing works without this.”

A senior French official argues that the process has started. “It is true there is an economic imbalance,” he says.

France has lost 10 years. Germany reformed, now we are doing it in much more difficult conditions. But the balance in the relationship is not just in the economy.”

Ulrike Guérot of the European Council on Foreign Relations sees the pressure on both countries to restore the “symmetry of asymmetry”. Each country has strengths and weaknesses,” she says. “If they want to re-establish the symmetry, they must stop the discourse that only France can learn from Germany. We can learn from the French a better family policy, and they can learn from our apprenticeship training.”

But the real challenge is to agree a common vision of the route to closer economic and political integration in the eurozone, she says. On that score, Germany is still committed to a morefederalEurope, with strong common institutions, and France to a moreintergovernmentalEurope, with the nation state paramount.

Fifty years after the Elysée treaty was signed, they still have not agreed on that fundamental question.

Copyright The Financial Times Limited 2013.

Special report: Outsourcing and offshoring

EARLY NEXT MONTH local dignitaries will gather for a ribbon-cutting ceremony at a facility in Whitsett, North Carolina. A new production line will start to roll and the seemingly impossible will happen: America will start making personal computers again. Mass-market computer production had been withering away for the past 30 years, and the vast majority of laptops have always been made in Asia. Dell shut two big American factories in 2008 and 2010 in a big shift to China, and HP now makes only a small number of business desktops at home.

The new manufacturing facility is being built not by an American company but by Lenovo, a highly successful Chinese technology group. Founded in 1984 by 11 engineers from the Chinese Academy of Sciences, it bought IBM’s ThinkPad personal-computer business in 2005 and is now by some measures the world’s biggest PC-maker, just ahead of HP, and the fastest-growing.

Lenovo’s move marks the latest twist in a globalisation story that has been running since the 1980s. The original idea behind offshoring was that Western firms with high labour costs could make huge savings by sending work to countries where wages were much lower. Offshoring means moving work and jobs outside the country where a company is based. It can also involve outsourcing, which means sending work to outside contractors. These can be either in the home country or abroad, but in offshoring they are based overseas. For several decades that strategy worked, often brilliantly. But now companies are rethinking their global footprints.

The first and most important reason is that the global labourarbitrage” that sent companies rushing overseas is running out. Wages in China and India have been going up by 10-20% a year for the past decade, whereas manufacturing pay in America and Europe has barely budged. Other countries, including Vietnam, Indonesia and the Philippines, still offer low wages, but not China’s scale, efficiency and supply chains.
There are still big gaps between wages in different parts of the world, but other factors such as transport costs increasingly offset them. Lenovo’s labour costs in North Carolina will still be higher than in its factories in China and Mexico, but the gap has narrowed substantially, so it is no longer a clinching reason for manufacturing in emerging markets. With more automation, says David Schmoock, Lenovo’s president for North America, labour’s share of total costs is shrinking anyway.

Second, many American firms now realise that they went too far in sending work abroad and need to bring some of it home again, a process inelegantly termedreshoring”. Well-known companies such as Google, General Electric, Caterpillar and Ford Motor Company are bringing some of their production back to America or adding new capacity there. In December Apple said it would start making a line of its Mac computers in America later this year.

Choosing the right location for producing a good or a service is an inexact science, and many companies got it wrong. Michael Porter, Harvard Business School’s guru on competitive strategy, says that just as companies pursued many unpromising mergers and acquisitions until painful experience brought greater discipline to the field, a lot of chief executives offshored too quickly and too much. In Europe there was never as much enthusiasm for offshoring as in America in the first place, and the small number of companies that did it are in no rush to return.

Firms are now discovering all the disadvantages of distance. The cost of shipping heavy goods halfway around the world by sea has been rising sharply, and goods spend weeks in transit. They have also found that manufacturing somewhere cheap and far away but keeping research and development at home can have a negative effect on innovation. One answer to this would be to move the R&D too, but that has other drawbacks: the threat of losing valuable intellectual property in far-off places looms ever larger. And a succession of wars and natural disasters in the past decade has highlighted the risk that supply chains a long way from home may become disrupted.

Third, firms are rapidly moving away from the model of manufacturing everything in one low-cost place to supply the rest of the world. China is no longer seen as a cheap manufacturing base but as a huge new market.
Increasingly, the main reason for multinationals to move production is to be close to customers in big new markets. This is not offshoring in the sense the word has been used for the past three decades; instead, it is beingonshore” in new places. Peter Löscher, the chief executive of Siemens, a German engineering firm, recently commented that the notion of offshoring is in any case an odd one for a truly international company. The “home shore” for Siemens, he said, is now as much China and India as it is Germany or America.

Companies now want to be in, or close to, each of their biggest markets, making customised products and responding quickly to changing local demand. Pierre Beaudoin, chief executive of Bombardier, a Canadian maker of aeroplanes and trains, says the firm used to focus on cost savings made by sending jobs abroad; now Bombardier is in China for the sake of China.

Lenovo, as a Chinese company, has its own factories in China. The reason it is moving some production to America is that it will be able to customise its computers for American customers and respond quickly to them. If it made them in China they would spend six weeks on a ship, says Mr Schmoock.

Under this logic, America and Europe, with their big domestic markets, should be able to attract plenty of new investment as companies look for a bigger local presence in places around the world. It is not just Western firms bringing some of their production home; there is also a wave of emerging-market champions such as Lenovo, or the Tata Group, which is making Range Rover cars near Liverpool, that are coming to invest in brands, capacity and workers in the West.

Such changes are happening not only in manufacturing but increasingly in services too. Companies may either outsource IT and back-office work to other companies, which could be in the same country or abroad, or offshore it to their own centres overseas. Software programming, call centres and data-centre management were the first tasks to move, followed by more complex ones such as medical diagnoses and analytics for investment banks.

As in manufacturing, the labour-cost arbitrage in services is rapidly eroding, leaving firms with all the drawbacks of distance and ever fewer cost savings to make up for them. There has been widespread disappointment with outsourcing information technology and the routine back-office tasks that used to be done in-house. Some activities that used to be considered peripheral to a company’s profits, such as data management, are now seen as essential, so they are less likely to be entrusted to a third-party supplier thousands of miles away.

Coming full circle

Even General Electric is reversing its course in some important areas of its business. In the 1990s it had pioneered the offshoring of services, setting up one of the very firstcaptive”, or fully owned, offshore service centres in Gurgaon in 1997. Up until last year around half of GE’s information-technology work was being done outside the company, mostly in India, but the company found that it was losing too much technical expertise and that its IT department was not responding quickly enough to changing technology needs. It is now adding hundreds of IT engineers at a new centre in Van Buren Township in Michigan.

This special report will examine the changing economics of offshoring in the corporate world. It will show that offshoring in its traditional sense, in search of cheaper labour anywhere on the globe, is maturing, tailing off and to some extent being reversed. Multinationals will certainly not become any less global as a result, but they will distribute their activities more evenly and selectively around the world, taking heed of a far broader range of variables than labour costs alone.

That offers a huge opportunity for rich countries and their workers to win back some of the industries and activities they have lost over the past few decades. Paradoxically, the narrowing wage gap increases the pressure on politicians. With labour-cost differentials narrowing rapidly, it is no longer possible to point at rock-bottom wages in emerging markets as the reason why the rich world is losing out. Developed countries will have to compete hard on factors beyond labour costs. The most important of these are world-class skills and training, along with flexibility and motivation of workers, extensive clusters of suppliers and sensible regulation.