A Global Perspective

Booth's 2012 Business Forecast & Economic Outlook became a truly global event that began in Chicago and traveled to New York, London, Hong Kong, Singapore, Los Angeles, and San Francisco. Faculty panelists said 2011's Arab Spring and Japan earthquake will have aftershocks, but they were cautiously upbeat about 2012.

By Kalliope E. Dimitrakopoulos
Published: Spring 2012

Speaking to more than 1,000 business professionals at the Sheraton Chicago Hotel and Towers for the kickoff of the 2012 Business Forecast & Economic Outlook series, Randall Kroszner said two shocking events in 2011 had significant impact on the lower growth rate in the United States and in other parts of the world.

The first was the Arab Spring uprisings that began in late 2010, said Kroszner, Norman R. Bobins Professor of Economics. Although "a positive for freedom for a significant fraction of the world," he said the ensuing chain of political revolts and instability developing in countries across the Middle East and North Africa also increased uncertainty and prices in a very important part of the economy: energy.

The other, the March 2011 Japanese earthquake, tsunami, and nuclear disaster, "effectively shut down production in Japan for months," Kroszner said, and "could not help but have an important impact on the rest of the world."

But even in the midst of continuing uncertainty surrounding US fiscal policy and the sovereign debt crisis in Europe that characterized the rest of the year, Kroszner remained relatively optimistic and forecasted that the United States would not "double dip" back into recession. Instead, he predicted what he called a "sideways slide." Stronger third-quarter growth and thinning inventories make it likely that production will come back up, he said.

"The depression became the Great Depression because the Fed did not act. The depression happened because there was no liquidity," said Kroszner, who served as a governor of the Federal Reserve System from 2006 to 2009.

Inaction does not characterize the Fed today. Recent Fed actions have consisted of overtly promising to keep rates low for an extended period, until March 2013, then instituting a stimulus it calls "Operation Twist" - selling the short end of the yield curve and buying the long end. Most recently, it initiated swap arrangements with other central banks, allowing them to put deposits into the Fed and borrow money in dollars in an effort to add stability during a time when the market is near 2008 crisis levels.

Kroszner also drew an important historical comparison about Fed chairmen: "Just as [Paul] Volcker was reviled in the early 1980s and now revered for slaying the inflation dragon,"Kroszner said he believed the often-criticized Ben Bernanke would "be viewed in the long run as a hero for slaying the deflation dragon."

A Boom with Repercussions

The 2006 construction boom was part of a period of expansion that was very different relative to any other period of growth in history, said Erik Hurst, V. Duane Rath Professor of Economics and John E. Jeuck Faculty Fellow.

"In the period prior to a recession, the economy goes through some period of misallocation," he noted. When this occurs, according to Hurst, the economy must go back and "correct" its growth levels to a long-run trend, which historically has been 2 to 3 percent growth. He said he did not think a rebound in housing would cause the economy to grow. Also unlikely was a recovery based on consumption growth.

Hurst sees this having continued repercussions in unemployment - in particular that of men employed in low-skilled labor, a sector that has declined since the early 1980s. "During the last 30 years, in particular the last 10 years, there has also been a sharp decline in manufacturing," and low-skilled workers would have exited the workforce, Hurst noted. "The construction boom of the 2000s absorbed these workers."

Hurst's fear is that as construction growth lowers back to trend and there is no focus on manufacturing growth as a policy, the country might see an extended period of higher unemployment, especially for this segment of the workforce.

Encouraging Signs

Although Austan Goolsbee, Robert P. Gwinn Professor of Economics, said he believed the next 12 to 18 months are likely to remain erratic, he identified sources for optimism, such as the moderate growth pace of the US economy prior to the shocks of the Arab Spring and Japanese tsunami that Kroszner mentioned.

"If the output growth rate well exceeds productivity, you will see significant improvements in the job market - and we did see that," Goolsbee noted. "But in 2011 we slowed down, and as long as we are growing 2 percent or less, the job market will never improve. Our ultimate challenge is getting the growth rate up. It's by far the most important thing we have to do."

Goolsbee said he thought it was taking longer to recover from the recession because it was not possible to revert to an economy whose expansion was heavily weighted in residential construction and consumer spending growth.

"We need to shift back to export growth and business investment," he said. "To do that kind of shift involves changing the structure of the economy, which is a relatively slow process."

Finally, Goolsbee called the Troubled Asset Relief Program, or TARP, and financial rescue actions taken in 2008 "the most successful rescue ever in world history, with banks having paid back all the money [they borrowed]." He said it succeeded because recapitalization and transparency were forced on banks, which in turn enabled private money to come back into the system.

Eurozone in Crisis

TARP's success accentuates the disparity with Europe's attempts to resolve its crisis. "By not allowing banks to show their books and continuing to have multiple versions of rescue packages, they are undermining their credibility, which could lead to insolvency," Goolsbee said.

"Sovereign debt default - nobody is exactly sure which countries are going to default, but I guarantee you some will," said John Huizinga, Walter David "Bud" Fackler Distinguished Service Professor of Economics, who spoke on panels in London, Los Angeles, and San Francisco.

Huizinga explained that when there is concern about the size of a country's debt, it creates a repetitious cycle where markets push up interest rates, which in turn causes the debt-to-gross-domestic-product ratio to grow at an unsustainable rate. "Once the interest rate being paid on the debt is larger than a country's growth rate, that's when problems exist," said Huizinga, describing what European countries currently face.

"It's a lesson to other countries about the dangers of letting a country's debt-to-GDP ratio get too high," he said, warning the United States and Japan. "Situations like this can deteriorate quickly." He said the remedy to this situation was to focus attention on growth solutions rather than on budget solutions.

China Looms Large

As the series continued from Chicago, New York, and London to Hong Kong and Singapore, panelists offered their views in regard to one of the world's fastest growing economies: China.

Hurst's and Goolsbee's prescriptions for the American and European economies contrast sharply with China's current growth strategy. The nation's 12th five-year plan includes a shift away from manufacturing toward an economy anchored in the service sector and domestic consumption.

"Re-engineering your whole economy, from being highly externally oriented around producing goods to internally oriented where domestic demand drives it, is going to be rather difficult," said Richard Wong, AB '74, AM '74, PhD '81, founding director of the Hong Kong Centre for Economic Research and the Hong Kong Institute of Economics and Business Strategy.

China's current plan prescribes lowering its growth rate to a sustainable 7 percent between 2011 and 2015. However, forecasters see China's growth rate falling from 9.1 percent to 8.1 percent in 2012, and many are skeptical that the country will meet that longer-term goal, Wong said.

China's plan is to increase urbanization by 4 percent, create 45 million jobs in urban areas, increase minimum wages by 13 percent per annum, build 36 million low-income homes, and transform the coastal regions from being the world's factory to research-and-development hubs.

Wong highlighted one issue that may prevent China from reaching its goals. China's consumption rate as a share of GDP dropped from 46 percent to 34 percent around the year 2000. Previously it had hovered around 50 percent. "They don't consume. They just work," said Wong, who noted that investment rose from 35 percent to almost 50 percent around the same period.

Wong added that in an economy that has seen GDP growth between 10 and 11 percent for the past 30 years, it will be difficult for China to slow its economy down to 7 percent growth without dramatic structural shifts. He concluded that China will need to scale back investment significantly in order to boost domestic consumption.

Measuring Uncertainty

At the Chicago panel, Goolsbee had noted that past big recessions tended to be followed by big recoveries, and this recent one was not. "The slow recovery from the deepest recession in our lifetimes remains a bit of a puzzle," he said.

Trying to solve this puzzle, Steven Davis, William H. Abbott Professor of International Business and Economics, asked, "How do you actually measure, in a disciplined and systematic way, the amount of uncertainty of economic policy?"

Davis, who spoke on the panels in Hong Kong and Singapore, has published research on employment, wage behavior, economic fluctuations, and public policy. At the Business Forecast & Economic Outlook, he shared research about measuring economic policy uncertainty and its consequences.

Davis began with a chart that depicts about 300 events since 1980 in which the S&P 500 moved more than 2.5 percent in a single day. Using next-day news accounts, he identified a primary cause for each big stock market move. Of the 170 big daily moves that occurred between 1980 and 2007, news accounts attributed only one per year to policy-related developments.

In contrast, from 2008 to 2011, there were 119 big daily stock market moves, almost 30 per year. News accounts identified policy developments as the reason for about a dozen big moves per year - about 40 percent of all large market ups and downs in the past four years.

To quantify economic policy uncertainty and assess its impact on macroeconomic performance, Davis and his colleagues created a monthly index using news articles, disagreement among professional forecasters, and a measure of instability in the tax code. The index shows spikes during the financial crisis in 2008, where uncertainty about economic policy played a major role, as well as in July 2011 when the index peaked during the huge battle over extending the debt ceiling and amidst concerns that the US government might partially shut down.

In the end, Davis's news-based approach to economic policy uncertainty highlighted one theme: The economic and monetary policies in the United States, Europe, and Asia will be critical determinants in how successful each area is in overcoming its current economic challenges. ■

Last Updated 10/16/12