Reflections on the most urgent economic issues facing the G7
Q. What are the most important economic issues that G7 leaders should address at their Charlevoix Summit this year?
A. There are a few major question marks in what is otherwise a promising outlook. First, there is the very difficult question of how we pull out of a zero interest rate policy. We have found in the United States that it was relatively easy to go into the zero interest rate policy framework. Pulling out is fraught with dangers as financial markets may misinterpret the moves of the central banks.
Second, there is rising concern over where the international trading system is going. This is partly on the realisation, which several countries are slowly coming to, that perhaps China’s membership in the World Trade Organization (WTO) was premature. There is a rising realisation – in Japan, in the United States and maybe in Europe and elsewhere – that we moved too soon. This is partly brought to the surface by the undiplomatic comments of President Donald Trump. But it brings up many interesting questions, as the substance of many of the issues he raises are on target: intellectual property rights, cyber warfare, intrusion into markets through dumping, and several pricing mechanisms that undermine the framework and system. All of us who were free traders are coming to understand that there is something to the argument that free trade without some degree of fairness is not good for the world trade system. There are various side issues, some more philosophical but still worthy of G7 leaders discussing among themselves, about where they would like the trading system to move over the medium and longer term.
Third, when there is a synchronised economic upturn among the G7 members, as there currently is, how much pressure does this put on commodity markets? What is the potential effect on rising commodity prices?
These three issues the G7 leaders could usefully discuss in order to establish a better understanding among their countries.
Q. What are the major risks to the substantial, reliable economic growth now under way across all G7 countries?
A. I am underwhelmed by the focus on economic issues of the current set of G7 leaders. Among the seven there are few leaders who have the experience or history of focusing on economic questions. This is partly because things are going well at the moment in their economies. Five of the seven, including the US, Canada, France and Japan, have not focused much on macroeconomic issues. I am not sure they are well positioned for such a discussion, although if appropriately briefed and brought up to speed, they could be.
Q. How serious are the threats to current economic growth from a so-called trade war, growing government fiscal deficits and debts, or unduly rapid monetary policy normalisation?
A. I reject the phrase ‘trade war’. It adds to the ongoing discussion a level of tension that is uncalled for. There is now a reflection on existing trade arrangements. If you look at the discussions on the North American Free Trade Agreement (NAFTA), there were clearly areas that needed updating, to say the least. Those discussions, which perhaps started from the wrong level of discourse, are now moving in a positive direction to correct some of the earlier errors or things left out. The level of discussion between the United States and some of our trading partners and China is near the level of the old ones over US-Japan irritations. This is more risky. China’s potential as a major economy is on the upswing, whereas we all knew to some extent that Japan in the 1970s and 1980s was on a downswing, so the magnitude of the US-Japanese disagreements were not going to upset the global economy. Today, China can affect macroeconomic conditions and set incorrect expectations for the global economy.
Q: On trade, would it be good for the United States to join an appropriately modified Comprehensive Progressive Trans-Pacific Partnership (CPTPP)?
A. It would be wonderful if the United States would re-enter the discussions and be accepted by the other members. But I am not sure the G7 has a role in regional trade discussions. I am not sure that we would find the Europeans anxious to join pushing the United States into what it might perceive as a trading bloc. On the sidelines of the summit, the Canadians and Japanese could move the process along. Trudeau could set the stage for that in his bilaterals with Shinzo Abe and Donald Trump, which could be an occasion for Canada and Japan welcoming the United States to join the CPTPP.
Q: How serious is the risk of the growing fiscal deficits and debt in most G7 members?
A. In the near term, it is not very serious. In the medium term, it is quite serious. In the longer term, it is devastating if not addressed. It is always humorous to see how political parties shift sides. In the United States, we now hear from the Democrats about how horrible deficit spending is, whereas the Republicans are now turning a blind eye. It is appalling that we returned to a trillion dollar deficit so quickly. We doubled the national debt in the eight years of the Obama administration. Many commentators took the view that this was dangerous. We are now back on track to doing more damage in a short period. The question is one of dynamic scoring. There is a clearly a view among most economists that tax reform can have positive impacts on future growth. So the outlook is not as stark as the latest Congressional Budget Office projection that is based on the assumption that tax reductions have no effect on growth. Still, trillion dollar deficits are outlandish and need to be pulled back. An increasingly small portion of US government total spending is discretionary. It is entitlements that capture the larger share of spending. Without entitlement reform, there is little that can be done to control the rising trajectory of US deficits.
Q: Is there a risk that rising US interest rates might pull money out of emerging economies and bring the world an emerging market financial crisis?
A. That is a good point. It has been a blessing in disguise for the emerging markets for almost a decade to have had zero interest rates in the established economies. That has brought a windfall in their low interest rate borrowings and access to funds that they would not otherwise have easy access to. The return to a normalisation of interest rates in the United States will make borrowing by developing countries either more expensive or less available. They will have to pay higher interest rates or decide to borrow less. It is not the speed but the unevenness of the normalisation and market reactions to that approach. We could move smartly towards more normal interest rates if there was a normal path of monetary policy and we stuck to it. One problem is that the Federal Reserve’s approach has been a bit ‘start and stop’. If markets started to react, they pulled back. Instead of committing to a path and sticking with it, the Fed added confusion to the markets as to how serious they were about returning to normal interest rates. It is more a question of the predictability than the speed of the movement. Russia’s wobbling economy has little to do with financial markets themselves.
Q: What should G7 leaders do at Charlevoix to reduce the risks?
A. This is hard to answer. Much of what we have discussed is more medium than near term. The focus this year should be less of direct policy relevance to today’s issues than structural in terms of medium-term developments in the global economy. Do their statements have much teeth or effectiveness if they are not attached to a set of policy changes? The years in which they had significant effects were when G7 members made generalised commitments they all agreed and then identified specific policies or moves they each committed to. A market response in a stabilising way requires a concrete policy enactment. This year, G7 leaders could focus on globalised free and fair trade. They need to commit to working with the WTO to solve several current irritants. They could commit to sharing cybersecurity information to protect technology and protect business secrets from outside attempts to steal them. Thus there are a few things they could commit to that would be helpful now.
Q: What could G7 leaders do to make economic growth more inclusive?
A. It is most important to go back and read the communiqués on structural reform of the Organisation for Economic Co-operation and Development from the mid-1980s. Ministers realised that there were serious labour market rigidities in Europe that had negative effects on working-class incomes. Labour market rigidities needed to be reduced so that wages could rise according to the work ethic and productivity changes and not just to a broad set of overall policies. One factor in the increasing disparity of income levels has been the failure of wage growth in the lower sector of the economy. Incomes, whether from wages, bonuses or stock market wealth gains, have been market driven, whereas income levels at the low end have not. We need to review social service policies to see if they stand in the way of the work effort. There also needs to be a commitment to broader education reform. We need to get away from the idea that everyone should go to college. We need to bring back the old idea of vocational training. Many jobs are going unfilled in the United States because of a lack of training in skilled blue-collar jobs – in electrical and auto repair, and plumbing for example – that do not require college degrees. People think college is good for everybody. But students then come out of college without the skills that match the jobs that are open and cannot find employment. Any electrician or plumber will say that their hardest task is finding labour. Their incomes are quite good and comfortable, and yet they cannot find younger people to move into the professions. We need to take a broader view of education and not send people to college for the wrong reasons. We have convinced third-rate students to go to third-rate schools and get third-rate degrees and they come out and cannot understand why they cannot find first-class jobs.
Q. How can G7 leaders shape their economic growth in ways that enhance gender equality?
A. It is very difficult to target policies that will be pro growth, pro free market and pro income raising but that also target only a segment of the population. It is very difficult to develop macro-level policies to do this. You can work on legal policies to eliminate discrimination and to training ethics in individuals.
