Watching America’s leaders scramble in the closing days of2012 to avoid a “fiscal cliff” that would plungethe economy into recession was yet another illustration of an inconvenienttruth: messy politics remains a major driver of economic developments.
In some cases during 2012, politics was a force for good:consider Prime Minister Mario Monti’s ability to pull Italy back from the brinkof financial turmoil. But, in other cases, like Greece, political dysfunctionaggravated economic problems.
Close and defining linkages between politics and economicsare likely to persist in 2013. Having said this, we should also expect muchgreater segmentation in terms of impact – and that the consequences will affectboth individual countries and the global system as a whole.
In some countries – for example, Italy, Japan, and theUnited States – politics will remain the primary driver of economic-policyapproaches. But elsewhere – China, Egypt, Germany, and Greece come to mind – the reverse will be true, witheconomics becoming a key determinant of political outcomes.
This duality in causationspeaks to a world that will become more heterogeneous in 2013 – and in at leasttwo ways: it will lack unifying political themes, and it will be subject tomulti-speed growth and financial dynamics that imply a range of possiblescenarios for multilateral policy interactions.
With an election looming in Italy, the country’s technocratic interim administration will return thereins of power to a democratically elected government. The question, both forItaly and Europe as a whole, is whether the new government will maintain thecurrent economic policy stance or shift to one that is less acceptable to thecountry’s external partners (particularly Germany and the European CentralBank).
Monti may or may not be involved in the new government. Thefurther removed from it he is, the greater the temptation will be to alter thepolicy approach in response to popular pressures. This would involve lessemphasis on fiscal and structural reforms, raising concerns in Berlin,Brussels, and Frankfurt.
Japan’s incoming government has already signaled aneconomic-policy pivot, relying on what itdirectly controls (fiscal policy), together with pressure on the Bank of Japan,to relax the monetary-policy stance, in an effort to generate faster growth andhigher inflation. In the process, officials are weakening the yen. They willalso try to lower Japan’s dependence on exports and rethink sending productionfacilities to lower-wage countries.
The economic impact of politics in the US, while important,will be less dynamic: absent a more cooperative Congress, politics will mute policy responses rather than fuel greateractivism. Continued congressional polarization would maintain policyuncertainty, confound debt and deficitnegotiations, and impede economic growth. From stymieingmedium-term fiscal reforms to delaying needed overhauls of the labor andhousing markets, congressional dysfunction would keep US economic performancebelow its capacity; over time, it would also eat away atpotential output.
In other countries, the causal direction will run primarilyfrom economics to politics. In Egypt and Greece, for example, rising poverty,high unemployment, and financial turmoil could place governments underpressure. Popular frustration may not wait for the ballot box. Instead, hardtimes could fuel civil unrest, threatening their governments’ legitimacy,credibility, and effectiveness – and with no obvious alternatives that couldensure rapid economic recovery and rising living standards.
In China, the credibility of the incoming leadership willdepend in large part on whether the economy can consolidate its soft landing.Specifically, any prolonged period of sub-7% growth could encourage oppositionand dissent – not only in the countryside, but also in urban centers.
Then there is Germany, which holds the key to the integrityand unity of the eurozone. So far, Chancellor Angela Merkel has been largelysuccessful in insulating the German economy from the turmoil elsewhere inEurope. Unemployment has remained remarkably low and confidence relativelyhigh. And, while growth has moderated recently, Germany remains one of Europe’sbest-performing economies – and not just its paymaster.
While some would have favored greater policy activism,Merkel’s Germany has provided a steady anchor for a eurozone struggling to end bouts of financial instability and put an end toquestions about its survival as a well-functioning monetary union (one thataspires to becoming much more). A change in German leadership would, therefore,raise questions about Europe’s policy underpinning.
How politics and economics interact nationally and globallyis one of the important questions for 2013 and beyond. There are threescenarios: good economics and effective politics provide the basis for agrowing and more cooperative global economy; bad economics interact withdysfunctional politics to ruin the day; or the worldmuddles through, increasingly unstable, as a tugof war between economics and politics plays out, with no clear result ordirection.
Part of the answer depends on what happens in threecountries in particular – China, Germany, and the US. Their economic andpolitical stability is essential to the well-being of a world economy that hasyet to recover fully from the 2008 global financial crisis.
Current indications, albeit incomplete, suggest that thethree will continue to anchor the global economyin 2013. That is the good news. The bad news is that their anchor may remainboth tentative and insufficient to restore thelevel of growth and financial stability to which billions of people aspire.