Global Economy Influencing Our Growth, Inflation

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Global Economy Influencing Our Growth, Inflation

Alan Greenspan had a pretty good run of success as the Chairman of the Federal Reserve System. During most of his tenure (1987-2006), the U.S experienced low unemployment rates, good economic growth and low inflation. Mr. Greenspan can’t take all of the credit, however. In addition to his effective monetary policy, factors contributing to these favorable conditions include a pro-competitive economic policy that was promoted by Democratic and Republican administrations for three decades, a growing educated labor force and steady investment in tools, machines and other productivity-enhancing processes.

Globalization also has played a major role. The fall of the Berlin Wall in 1989 and subsequent demise of communism’s monopolistic control in Eastern Europe paved the way for expanded trade. That, taken together with the liberalization of economies in China and India, stimulated trade and provided an expanded source of low-priced labor and products. While opinions about globalization and its impact on our economy differ widely, most economists agree that one of the effects of globalization is that it has allowed the U.S. to enjoy strong economic growth with a reduced threat of high inflation. The International Monetary Fund estimates that these cheap imports over the past 15 years have subtracted about one percentage point a year from inflation. By dampening inflation, cheap imports have also contributed to lower interest rates which stimulate investment and economic growth.

However, the tremendous economic growth in these exporting countries (notably Eastern Europe, China and India) has caused shortages of certain types of labor. As a result, workers there are winning higher wages. For example, prices of Chinese exports rose and minimum wages increased by more than 20 percent last year. More and more, U.S. businesses are complaining about the increased cost of doing business in these countries, from the cost of commodities and labor to the cost of shipping.

U.S. import prices, excluding oil, rose 2.9 percent in the year through April, the fastest clip in 18 months, while China’s export prices rose by 5.3 percent. It appears that the global economy’s role in keeping prices lower may be diminishing.

The effect of rising import prices goes beyond the amount we pay for products. As the threat of increasing prices becomes more evident, central banks are likely to increase interest rates to stave off inflation. Markets respond to the expectation of higher inflation by driving up long term interest rates. Because these higher rates make investments more costly, less is invested in our economy’s productive capacity. This, in turn, reduces economic and job growth. In general, this reduction in investment activity will have a more profound effect on our personal welfare than higher prices.

The response of a dynamic global marketplace to sources of low-priced labor is predicable. Cheap and abundant labor helped these economies grow. Now the growth in these economies (and the accompanying increased demand for their labor) is reducing some of the advantage they once enjoyed. While labor and product costs in these exporting countries increase, the U.S. must deal with expectations of heightened inflation and interest rates.