that
would plunge the economy into recession was yet another illustration of
an
inconvenient
truth: 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 brink of financial turmoil.
But, in other cases, like Greece, political dysfunction aggravated economic
problems.
Close
and defining linkages between politics and economics are likely to persist in
2013. Having said this, we should also expect much greater segmentation in
terms of impact – and that the consequences will affect both individual
countries and the global system as a whole.
In
some countries – for example, Italy, Japan, and the United States – politics
will remain the primary driver of economic-policy approaches. But elsewhere –
China, Egypt, Germany, and Greece come to mind – the reverse will be true, with
economics becoming a key determinant of political outcomes.
This
duality in causation speaks to a world that will become more heterogeneous in
2013 – and in at least two ways: it will lack unifying political themes, and it
will be subject to multi-speed growth and financial dynamics that imply a range
of possible scenarios for multilateral policy interactions.
With
an election looming in Italy, the country’s technocratic interim administration
will return the reins of power to a democratically elected government. The
question, both for Italy and Europe as a whole, is whether the new government
will maintain the current economic policy stance or shift to one that is less acceptable
to the country’s external partners (particularly Germany and the European
Central Bank).
Monti
may or may not be involved in the new government. The further removed from it
he is, the greater the temptation will be to alter the policy approach in
response to popular pressures. This would involve less emphasis on fiscal and
structural reforms, raising concerns in Berlin, Brussels, and Frankfurt.
Japan’s
incoming government has already signaled an economic-policy pivot, relying on
what it directly controls (fiscal policy), together with pressure on the Bank
of Japan, to relax the monetary-policy stance, in an effort to generate faster
growth and higher inflation. In the process, officials are weakening the yen.
They will also try to lower Japan’s dependence on exports and rethink sending
production facilities 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 greater activism. Continued congressional polarization would maintain
policy uncertainty, confound debt and deficit negotiations, and impede economic
growth. From stymieing medium-term fiscal reforms to delaying needed overhauls
of the labor and housing markets, congressional dysfunction would keep US
economic performance below its capacity; over time, it would also eat away at
potential output.
In
other countries, the causal direction will run primarily from economics to
politics. In Egypt and Greece, for example, rising poverty, high unemployment,
and financial turmoil could place governments under pressure. Popular
frustration may not wait for the ballot box. Instead, hard times could fuel
civil unrest, threatening their governments’ legitimacy, credibility, and
effectiveness – and with no obvious alternatives that could ensure rapid
economic recovery and rising living standards.
In
China, the credibility of the incoming leadership will depend in large part on
whether the economy can consolidate its soft landing. Specifically, any
prolonged period of sub-7% growth could encourage opposition and dissent – not
only in the countryside, but also in urban centers.
Then
there is Germany, which holds the key to the integrity and unity of the
eurozone. So far, Chancellor Angela Merkel has been largely successful in
insulating the German economy from the turmoil elsewhere in Europe.
Unemployment has remained remarkably low and confidence relatively high. And,
while growth has moderated recently, Germany remains one of Europe’s
best-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 to questions about its survival as a well-functioning monetary
union (one that aspires 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 globally is one of the important
questions for 2013 and beyond. There are three scenarios: good economics and
effective politics provide the basis for a growing and more cooperative global
economy; bad economics interact with dysfunctional politics to ruin the day; or
the world muddles through, increasingly unstable, as a tug of war between economics
and politics plays out, with no clear result or direction.
Part
of the answer depends on what happens in three countries in particular – China,
Germany, and the US. Their economic and political stability is essential to the
well-being of a world economy that has yet to recover fully from the 2008
global financial crisis.
Current
indications, albeit incomplete, suggest that the three will continue to anchor
the global economy in 2013. That is the good news. The bad news is that their
anchor may remain both tentative and insufficient to restore the level of
growth and financial stability to which billions of people aspire.