Paradigm Shift?

I first heard the word "paradigm" about 15 years ago. It has certainly come into wide usage. One definition is "pattern", but the connotation is that of a complex pattern with many different elements closely linked. I suppose one would look at the global economic set-up and consider it a paradigm. It is also suggested, given the severity and breadth of the current economic downturn that perhaps the paradigm confronts a change.

For the past decades the world's economy seems to have been divided into rich, consuming countries of which the US is a leader, and countries that have grown their economies primarily through exporting goods to the first group. Japan was probably the first and most successful practicianer developing very large and sophisticated industries producing mostly consumer goods like automobiles and electronic entertainment products but also substantial intermediate goods like machine tools, construction equipment and mechanical components. Japan was so successful that various pundits spoke of the 21st Century as being Japan's century. The decade of the 90's did Japan in as its version of the "bubble" economy burst, a downturn that Japan has yet to recover from. Nevertheless Japan's economy remained dependant on exports and its balance of payments surpluses covered its domestic deficits and generated reserves of hundreds of billions of dollars. As export king, Japan in the last 20 years has given way to China where everything including the balance of payments surplus has been bigger. China now has about a trillion dollars of US debt instruments in reserve. China's emergence as the world's prime exporter had ramifications world wide inasmuch as the prime and intermediate components it needed to support finished goods manufacture were largely imported. So China's exports to the US and western Europe were fueled by exports from Japan, Korea, and Taiwan as well as raw materials shpped from Australia, Indonesia, Brazil, Russia, the US and others.

The very large American economy has been driven by consumption, representing some 70% of its gross national product. The country, probably unconsciously, moved into a regime where much of the consumables were imported and the large imbalance in trade in goods covered by investments of the exporters in US debt. A similar system developed in Europe in recent years as the once poor economies of the former Soviet bloc attracted investment into export industries owing to their comparative cost advantage compared to the developed European markets. While the Chinese and other Asians tended to save their trade surpluses, generating huge national reserves, the eastern Europeans went on a consumption binge aimed at producing parity in life style with the west. Western Europe has also served as a prime market for Asian exporters.

The housing and financial system bubbles in the US and western Europe have come crashing down. Housing markets are paralyzed, banks are insolvent, workers - white, blue and pink collared -are being layed off and nobody except governments are spending. There are other bubble spots affected also, places like Dubai, for example. To the extent that the US and other developed economies reduce imports, the exporters can only suffer sharp declines in their economies as well. Japan's exports have declined 18 to 20% throwing thousands of Japanese out of work, reducing domestic consumption and aggravating government finance. China's export declines have had similar effects, with thousands of newly urbanized workers being forced back into the countryside. Commodity markets that made producers giddily profitable have collapsed. The impact of the price of oil falling from $140 to $42 a barrel has shocked the economies of Russia, Iran and Venezuela not to speak of the budgets of other oil producers. A year ago there were complaints that rice was priced too high for the poor of the world: now Thaland and Vietnam are working together in an attempt to put a floor under the much diminished price. Soybeans, wheat, corn, iron and other minineral ores are all in the dumps. Depressed employment in developed economies badly affects economies in the developing world from the loss of billions of dollars in remittances and the return home of thousands of workers from employment abroad.

The question that remains to be answered is whether this economic downturn, that bodes to be the worst since the Great Depression, is temporary or will the recovery - assuming there will be one - reflect changed circumstances, a "paradigm shift" as it were. It appears likely that the emerging financial systems, world wide, will be subject to greater regulation and that the role of some of the wilder financial products will be much curtailed if not eliminated. One can foresee a move to break up megabanks into more manageable pieces as well as a basically more risk averse financial climate. What will the impact be on venture capital, mergers and acquisitions and private equity buyouts? Those that have, even in these times, are already "bottom fishing" by buying companies in distressed situations and low valuations. Does this imply a more rational system of asset valuation? Fewer retailers? Fewer restaurants? Perhaps even fewer lawyers?

Some have suggested that the US needs to reduce consumption and save more. Conversely China needs to save less and spend more. Whether this can happen and to what degree may be determined by trends that we can only glimpse at present.

A big factor has to be the value of currency and the interrelation between national currencies. Should the US generate the huge budget deficits now contemplated by President Obama there obviously will be a risk that the resultant US debt will overload the market, and diminished demand will drive up interest rates and drive down the relative value of the dollar. A significant devaluation of the dollar relative to Euros, Yen and other currencies can only serve to drive up the cost of imports, like oil, while driving down the cost of US manufactures and commodities. What happens to the world economy if the US no longer generates a balance of payments deficit? Can China, for example, really achieve the rapid economic growth it believes it needs through increased domestic consumption? And without the stimulus of foreign exchange earning exports?

A second trend that may well be in process is a general discrediting of the "free enterprise" market driven economy and its replacement by a far more intrusive public sector. This has been the model in Europe for some time and one can interpret Mr. Obama's budget proposals as moving the US in that direction. But what if the belief that government is the problem, not the solution, and that small government is to be preferred turns out to be right. If we should find ourselves in an economy heavily regulated by a government, motivated by social and political goals, and that plays a large economic role, what may we expect in terms of innovation, new investment and entrepreneurs willing to take risks. Will the new paradigm be one of a stodgy, but safe economy, in which nothing much happens. Ah to live in interesting times.