Thursday, October 8, 2009

Global Trade Decline Worse Than Great Depression

According to Princeton economist Paul Krugman, global trade has fallen greater than during the Great Depression suggesting that the world economies are more intertwined than ever before. With consumer spending down, exports down, and government spending unsustainable, it may fall on business investment to grow the economy (using the Mundell-Fleming model Y = C + I + G + NX ). See the following post from Economist's View for more on this.

Paul Krugman notes the collapse
in world trade:

Paul Krugman: In Trade, ‘It’s Not the Great Depression — It’s Worse’, Real Time Economics: ...Paul Krugman .... offered a few comments about ... world trade. And the picture he painted was not a pretty one.

“When it comes to international trade, actually it’s not the Great Depression, it’s worse,” he said, presenting charts showing the decline in global trade activity falling much more steeply in the current downturn than during the Depression.

“The scale of the collapse of world trade has been so large that it has produced a degree of international linkage that surpasses what even the pessimists imagined,” he said. “World trade acted as a transmission mechanism,” spreading economic distress “even to those countries that had relatively healthy financial systems,” such as Germany.

“We really are one world economy in a way that has never been true before,” he said.
Despite the collapse in trade, Krugman downplayed concerns about protectionism. ...

Felix Salmon adds that:

[Krugman] also had a good line about economic forecasters, who have us returning to full employment in about five years just because all forecasts tend to bake in a return to “normal” in five years. Krugman’s more pessimistic than that, however: “We almost certainly have a long, long haul before we’re fully recovered,” he said. A good part of the reason for that is what has happened to international trade — it “has fallen through the floor in a way that it literally never has before, including in the Great Depression”. And building it back up is going to be very hard indeed.

This goes back to something I should have emphasized in Robert Solow's comments yesterday. Using Y = C + I + G + NX as a reference point, if growth in C falls, as we expect, if G cannot grow much more and if NX cannot take up the slack, also as we expect, then can I grow fast enough to make up the difference? Solow believes:
We have to expect consumer spending to be weak..., not just for six months, but for the next few years. It will not be as strong a driving force as it has been the past several years. Something has to take its place. Government spending can't, since government will have a hard time financing the inevitable deficits and is not in a position to aggressively increase its deficit spending.

We need business investment to support the economy. We have every reason to want to divert our resources toward secure and renewable sources of energy, new materials and environmental improvement. ... I also think it's the job of the federal government to shift incentives, from incentives to consume more to incentives to invest more. Obama ran on this kind of platform, and if he can put some money behind that fundamentally correct view, he might generate something. It's going to take more than that to replace 5 percent of GDP, but that would be a neat place to start.

There must be a way to bring the Republicans on board with plans to increase business investment? Will a focus on "secure and renewable sources of energy, new materials and environmental improvement" spoil whatever cooperation might have existed among Republicans for measures to enhance business investment? In any case, we need to do our best to maintain G, and another round of stimulus measures would help, while we give I the time (and the incentives) it needs to grow robustly.

This post has been republished from Mark Thoma's blog, Economist's View.

1 comment:

Anonymous said...

The collapse of the dollar — the world reserve currency — will throw the world into a global depression. Those nations with a heavy foreign debt will not be able to trade in order to earn sufficient income to service their debts, and slip into bankruptcy.