Europe’s slide widens the cracks in the liberal order

Montreal, 13 April 2012

We have quite taken for granted the liberal order since WW2, built on the foundations of open trade, freedom of seas, the rule of contract and protection of intellectual property and investments.  This post-war international order was tacitly shaped by the three main trading powers of USA, Europe and Japan.  Albeit with limits, the liberal order has provided for the industrialized nations a fair amount of stability and a good deal of prosperity.   Yet two pillars of that system, Japan and Europe, are now shaking, at a time when China appears to be more assertive in its own ways.

Consider Japan, a country that is stagnating under a cloudy outlook:  a slowish economy, a rapidly ageing population, and a string of unstable governments.  In 2002, the country was coming out of a long lost decade, only to fall into a decade of mounting rivalry from China and other grown up tigers like South Korea.  The former tech champions of Japan are not running the roost anymore.  It is not Sony but Samsung that is biting at the heels of Apple.   Alarmingly, GDP per capita has in recent years fallen off a peak.  The trends are ominous and the country is undergoing a bout of reflection on its position and policies in Asia, including allies.

It is Europe that is seriously wobbling under the current financial crisis.   Europe’s ailments are a worrisome bunch:  A volatile Euro, weak banking systems, high sovereign debts, austerity programs biting deeply and declining growth prospects.  The good news is that the Euro has at last stabilized, at least for a while.  In fact, the Euro has shown a remarkable degree of resilience in the face of tremendous pressures.  Other currencies would have collapsed under similar circumstances.  The bail-out funds and the sea of liquidity provided by the ECB have succeeded in building enough firewall around the Euro.  Just enough firewall to witness whether austerity programs will actually or not dig a bigger hole in the growth prospects of some nations.  Too much short term austerity might just slow down growth and compound deficits, a troublesome scenario.  Getting the right dose of austerity remains a tricky call for many European nations.

The country on top of the watching list is Spain, where general unemployment is close to 25%, and youth unemployment nears 50%.  This is reminiscent of past economic crises in Latin America.  Experience tells us that the social cost will be high.  The pack of austerity programs in Europe will test political and social tolerance.   We are in for several years of debates and experiments in Europe and little insight about how it will actually play out.  An excess of austerity will also cut into the people’s willingness to swallow pills of economic reforms.   Yet, reforms to boost productivity and competitiveness in order to pull up growth is just what the doctor is ordering, just as protectionist forces might find enough fertile ground in Europe to blossom.  This trap of austerity and low growth could come to test again the Euro.  In the meantime there is no question that Europe is losing clout and influence in Africa and Asia, while China sees Europe as a land of opportunity for cheap technology deals.

Luckily the natural resilience of America is again at play, notably in the stock exchanges, the showcase of the best companies.  But the overall recovery remains patchy across several economic sectors.  There is little doubt that the financial crisis has created lasting damage in municipal and state services such as education, transport and health.   Deleveraging will take its toll.  The damage is not really visible to observers outside America, but it will sap some of the traditional strengths of America and push the country into a period of mild ‘relative’ decline.   We should expect and desire a rebound in America before the end of this decade for the simple reason that America has been the sturdiest guardian of that liberal system.

The odd factor is now China.  Ever since Nixon went to China in 1972, the Americans have tried to influence China to transit from economic freedom to political freedom.  On the other hand, Deng Xiaoping, the kick-starter of economic reforms in 1978, advocated to conceal capabilities and bide time to end US  dominance in Asia.  No wonder mutual suspicions linger.  The WTO membership was meant to nod China towards the liberal system.  It has not really worked that way.  International trade has filled the coffers of China.  But the record on currency policies, intellectual property theft, and positions in international affairs point to a mixed record at best, towards the liberal system.  The political transition scheduled in China this fall will surely be scrutinized for any sign of a stronger hand by the nationalists, or any sign of a louder voice from reformists.  The stakes are not benign:  Either we move towards a period of relative stability and equilibrium, or else tensions will build up towards some clash of values.   Cracks in the liberal system will either be patched, or widen.

Andre Du Sault.