Crisis of Interconnected Economies

There’s trouble in the global village.

Argentina is in crisis, facing currency devaluation or debt restructuring or job and wage cuts for its workers--at a time when unemployment is already 16%. Brazil and all of Latin America--and developing countries everywhere--will be affected by the way Argentina resolves its problems.

In Asia, Japan’s giant economy is in recession again and Singapore’s economy is dipping toward negative growth. Only China is holding up reasonably well. Asia’s economies once were seen as potential growth markets for world prosperity. But so far the potential remains dormant.

In Europe, leading countries are surprised at the weakness of their economies. Many experts thought the 15 European Union economies wouldn’t be affected by a U.S. slowdown. But Germany’s economy is slowing to a crawl, France, the Netherlands, Italy and others are worried about slower growth, and the euro continues to fall against the U.S. dollar, as it has since the currency’s introduction in 1999.

Which only goes to show how interconnected and confusing is today’s global economy. Even European experts hadn’t recognized how dependent the old Continent has become on earnings from the U.S.

In the last five years, European companies have invested almost $900 billion in buying U.S. companies and building U.S. factories and operations. Those companies’ profits now are down because the U.S. economy has slowed, and that is forcing cutbacks at corporate headquarters back in Europe.

Meanwhile, in the United States, experts estimate that economic growth will be only 1.5% this year compared with 5% last year, and that represents a worrisome reduction of economic activity. A 1% difference in U.S. growth means $100 billion in economic activity, or enough to create 3 million decent-paying jobs.

What is happening is that the U.S. slowdown has hobbled all the other economies, and their slow growth in turn has reduced the pace and prosperity of the U.S. economy. The threat is that the world economy will suffer years of slower growth, with reduced opportunity but mounting social problems.

This is the second crisis of globalization. The first was the Asian crisis of 1997 followed by the Russian collapse in 1998. The world came through at that time because the U.S. economy was growing rapidly thanks to investment in new technology, and that made work for producers of goods and services the world over.

Today’s crisis is producing a slowdown in world trade, which has become far more important to every country. Global trade now accounts for 25% of the world’s total economic output, reckons economist Stephen Roach of Morgan Stanley Dean Witter. That’s double trade’s importance in the 1970s, the last time a global recession loomed--due to high energy prices, which also are a factor today.

The immediate solution to today’s problems is once again the U.S. economy. If U.S. growth revives by the fall and carries into next year, the rest of the world’s economies have a chance to reform and grow.

But by the same token, the rest of the world needs to reform and grow if the U.S. economy is to prosper long-term.

It may seem unlikely that Argentina, a country of 36 million with an economy totaling $300 billion in annual output--3% of the U.S. total--could seriously affect the vast world.

But large and small are interconnected now. Argentina, in 1991, pegged the value of its peso to the U.S. dollar in an attempt to curb inflation. But Argentina’s trade in beef and other products is more with Europe, in addition to neighboring Brazil, than with the U.S. So, as the dollar has risen against the euro in the last two years, Argentina’s goods have become expensive and less competitive in Europe. That has led to troubles in Argentina’s fragile economy, and now it faces hard choices.

If it restructures debt, forcing bankers and global investors to take losses, all developing countries will be under a cloud in world capital markets. Brazil could fall into recession. South Africa’s struggles to grow and help the entire continent could be stunted.

If Argentina devalues its peso, cutting it away from the dollar, the effect on Brazil and the rest of Latin America will be even more severe as Argentina’s own people see living standards dashed and foreign investors pull back from all of Latin America, predicts economist David Malpass of investment firm Bear, Stearns & Co.

What Argentina really needs to do is reduce the numbers of its workers in unproductive government jobs, educate its work force and increase productivity and economic growth. That’s a tall order, of course, and one that applies to almost all countries. Still, change must begin sometime. Perhaps this crisis will provoke it.

Change is overdue in far more important economies. Japan, after a decade of low growth and recession, is still balking at reforming its economy because its government refuses to allow write-offs of bank losses and other corrective measures.

Loans for industry remain in short supply, but then borrowing and investing are unattractive because Japan is suffering deflation--prices declining 0.4% a year. It’s not encouraging to invest in properties and industrial assets that are losing value every day.

Japan, still the world’s second-largest economy, is farming out production to China, which is becoming the low-cost provider of every kind of product because of its vast work force.

But China’s extraordinary price competitiveness threatens other Asian economies, which have earned their keep in recent years by selling into the booming U.S. economy.

Now with the boom over, Asian countries face the need to educate their workers and to build up their internal economies.

In Europe, too, traditional economies need to change. One reason Germany’s big economy is flagging is that its companies and political forces balk at the kind of restructuring involving mergers and acquisitions that U.S. companies have gone through repeatedly.

“Other countries, notably France, are adapting better than Germany,” observes Stephan Richter of Transatlantic Futures, a Washington economic consulting firm.

What can the U.S. do? Keep the dollar stable and strong and strive to boost economic growth, experts say. For the foreseeable future, the dollar will be the world monetary standard and the U.S. economy the engine of the world, says veteran economist Albert Wojnilower.

But a crisis of globalization does not signal retreat. A world that was interconnected first by communications and now by economics is not an abstract thing. People are on the move: immigrants from Eastern and southern Europe and Africa filling labor needs of Western European countries; Latin Americans developing new economic ties between North and South; Asian populations avid and striving for higher living standards.

If global recession can be avoided, the potential of the interconnected world economy can be one of rising living standards and unleashed human potential. And the crises of the present may one day be seen as mere growing pains.

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Slower-Growing World

The world’s economies, large and small, are afflicted with slower growth this year. Slower growth means fewer jobs and lower living standards. For example, a 1% difference in U.S. gross domestic product equals $100 billion in economic activity, or roughly 3 million jobs paying $30,000 a year.

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Real GDP growth Economy 2000 2001 est. Argentina -0.5% -2.1% Brazil 4.2 3.0 China 8.0 7.0 Germany 3.0 1.0 Japan 1.7 -0.9 Mexico 6.9 1.3 South Africa 3.2 2.7 United States 5.0 1.5

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Sources: International Monetary Fund; Ecanal, Mexico City; Economist magazine survey of 15 banks and securities firms

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James Flanigan can be reached at jim.flanigan@latimes.com.