Western financial markets are in high spirits. Credit spreads and other indicators of uncertainty such as the CBOE Volatility Index, or VIX, suggest that there is no reason to worry.
Yet markets have been lulled into a false sense of security. The simmering crisis of the political-economic system in the West could throw the financial markets off their optimistic course. It is undermining the U.S. economy -- the largest economy in the world -- and many other major players.
Shrinking margins for error
The weapons governments have at their disposal to deal with misadventure are increasingly blunt. National debts have reached worryingly high levels, and there is limited fiscal room to absorb political setbacks, especially if future obligations are taken into account: Health care costs and pension expenditures will rise as populations age.
Central banks have little ammunition left to combat threats to the economy. Interest rates are already extremely low, while major central banks have exploded their balance sheets via quantitative easing. The Federal Reserve is worried enough about the combination of minimal interest rates and an economic recovery that has dragged along for eight years that it wants the short-term interest rate to rise in order to buffer against a recession that, statistically speaking, could erupt at any moment.
Overall trust in the political, economic, and financial systems has been considerably dented in recent years. Citizens wonder whether the authorities are even capable of protecting them against physical danger or economic risk.
Market optimism may prevail awhile longer, but the underlying trends are not very encouraging. The great strides in peace and prosperity that the West made in the decades following World War II were rooted in the realization that countries stood to benefit from a global community based on trust, rules, international institutions, free trade, and some level of solidarity among nations. The immense value of this political and economic construct is lost on U.S. President Donald Trump. To quote Professor of International Relations Charles Kupchan, “‘America First’ really means ‘America Only.’ On the horizon is not a world without the West, but a West without the United States.”
That leaves it up to Europe to guard the Western fort, but the Continent is not known for effectively deploying political and military power. Europe is still an economic giant, but the competition is catching up -- and the trend, again, does not look good. Economic growth after all is the product of growth in the working population and increases in labor productivity; Europe’s population is growing slowly or even shrinking, while productivity has been under pressure for quite some time.
This was not always the case. The successful decades that followed the Second World War saw not only accelerating economic growth and extensive productivity growth, but also the emergence of the welfare state. Pension and care systems were constructed; social security was introduced. Then high jobless rates, stagnating wages, and other economic headwinds gave rise to Margaret Thatcher and Ronald Reagan, who put the axe to the very foundations of the welfare state. Free-market thinking dominated and productivity was boosted at the expense of social safety nets and real pay. Actual productivity growth seldom approached the increases of the Golden Era of 1948-1973.
Giant strides were made following World War II. Education became available to many. The construction of roads, railways, and airports helped to open up countries as women gradually started to work more outside the house. Organizations and institutions such as the European Economic Community (now the European Union) and General Agreement on Tariffs and Trade (later the World Trade Organization) were set up and boosted growth to an enormous degree.
But all of the low-hanging fruit has been picked by now. More is needed to achieve progress than the improvement of free-trade agreements or motorways. And while new sectors such as artificial intelligence and nanotechnology may yet lead to massive breakthroughs, we have yet to see it.
Stagnating productivity and depressed real pay are growing problems -- our economies have been built on debt and an ever-expanding financial sector in recent decades. Growth must accelerate, or debts will become unsustainable.
Worryingly, it is increasingly obvious that market thinking has overshot its mark. The checks and balances that should prevent excrescences have been stymied, particularly in the United States and the United Kingdom, the two economies that Edward Luce says are the most “commodified.” Reagan and Thatcher made some valid points, but their corrections went too far and overreached. Later political leaders often continued on the same foot. This is no great surprise: Many of the leaders of recent decades (and their advisers) grew up with the gigantic failure of communism and the problems the West experienced during the 1970s.
One of the main issues now is that social mobility has greatly diminished. It has become harder and harder to move up the social ladder. The problem is not so much that some are rich and others are poor, but rather that the system is often experienced as unfair. Growing inequality, decreasing economic mobility, and administrators that are as detached as they are distant form a threefold problem for the West.
