Historians increasingly attribute the Depression to broad geopolitical upheavals. World War I shattered the existing global economic order that was dominated by Great Britain, fostered vibrant trade, and rested on the gold standard. The war also spawned huge international debts. It was impossible to reconstruct the prewar order. Britain was too weak, the gold standard was too constricting, and the debts were too heavy. But countries tried, because the prewar order had delivered prosperity. This futile effort brought on Depression.
There are eerie, if crude, parallels now. The welfare state is today's equivalent of the gold standard. With aging societies, advanced countries have promised more benefits than their tax bases can support. Hence, high government debt. Greece is merely the canary in the coal mine. But politicians resist cutting popular benefits except under extreme pressure. It takes a crisis. Greece, again. Another unsettling parallel is the global economy. The United States' leadership since World War II is eroding before China's ascent.
Of course, these parallels do not preordain a second Depression. But they at least clarify today's confusing economic outlook. There's a tug-of-war. The normal mechanics of the business cycle signal recovery, while deeper economic weaknesses threaten it. People and firms are opening their wallets again. The world economy will grow almost 4.3 percent in 2010 and 2011, with the United States expanding at nearly 3 percent, reckons the International Monetary Fund.
But the deep-seated problems remain: first, the weight of the welfare state and aging populations; second, the burden of huge private debts (mortgages and consumer loans in America and elsewhere); and finally, huge imbalances in global trade, with some countries - notably China - running massive surpluses and others - notably the United States - having large deficits. Each could conceivably plunge the world back into a protracted slump.
To cope with deficits, developed countries would cut spending or raise taxes. These steps would weaken recovery, but failing to do so might have the same effect by creating a financial crisis.
The dilemma posed by Greece isn't unique. In 2009, Greece's budget deficit was almost 14 percent of gross domestic product (GDP) - its economy. Its accumulated debt was 115 percent of GDP. Spain's deficit was 11 percent of GDP, and its debt 53 percent. Germany's deficit was 3 percent, and its debt 73 percent. The U.S. deficit - calculated slightly differently - was 9.9 percent of GDP; the debt, 53 percent of GDP. Most developed countries, representing about half of the world economy, are caught in the same trap.
The same is true, though to a lesser extent, of heavily indebted households in the developed world. In the United States, household debt reached 138 percent of disposable income in 2007, reports the Organization for Economic Cooperation and Development. Elsewhere, comparable figures were also high: 138 percent in Canada, 128 percent in Japan, 186 percent in Britain, 102 percent in Germany. Going forward, these debt levels suggest restraint and retrenchment by consumers, not exuberant spending.
On paper, the escape from these problems seems plain. China, India, Brazil, and other "emerging market" countries would become the world's engine of growth. Their appetite for advanced goods - airplanes, power plants, earthmoving equipment, medical instruments - would raise their living standards and sustain production and employment in advanced countries. This could be happening. The latest IMF forecasts have poorer countries growing at about 6.5 percent in 2010 and 2011, compared with 2.4 percent for all developed countries. The trouble is that this shift requires that China and other Asian countries renounce export-led growth. It's not clear that they can or will.
Everywhere, countries face changes of policies, practices and habits that are deeply woven into their social, political and economic fabrics. Can developed countries rein in their welfare states? Will Asia's export economies shift to domestic-led growth? Will Americans save more and spend less - and the Chinese do the opposite? It was the inability to see and adapt to change in the 1920s that fundamentally caused the Depression, economic historians have argued.
The case that we have dodged a second Great Depression rests on a narrower notion: that the Depression was preventable. Government central banks, like the Fed, were too passive. They didn't halt bank panics. Intervention at decisive moments could have changed history. Instead, mounting unemployment and falling prices fed on each other. Debtors couldn't repay loans, leading to more bank failures, a contraction of credit, and deposit losses. But this time the mistakes were not repeated. Banks were "bailed out." Money was pumped into credit markets.
By this reading, the world has bought itself time. As the recovery strengthens, the politics of confronting underlying problems will grow easier. People will be more optimistic; they will be more open to necessary, if not popular, adjustments. This could happen.
But there is a more sobering reading of the Depression. It is that painful changes are made only under the pressure of acute crisis. Gold was abandoned in various countries only after it seemed untenable. The post-World War I debt problem wasn't "solved" until repayment was impossible. As for Britain's place as global leader, the United States assumed that role only in World War II.
Against that backdrop, today's unresolved problems - over the welfare state, leadership in the global economy - become more ominous. They suggest that major adjustments won't be made until they're compelled by some sort of crisis. This possibility defines the present economic drama. Will the recovery encourage conscious changes? Or is recovery providing a false sense of security? The stakes are, of course, enormous, because - as everyone knows - the economic suffering of the Great Depression transformed many countries' politics for the worse and led to World War II.
This column was published by Newsweek International.
