It is now widely acknowledged that the increasing international integration and liberalization of the past decades has ushered in an era of turbulence and uncertainty in the global economy.footnote¹ The growth and fragility of financial markets, the impact of their excesses upon real economies, the disruptive effects of China’s dramatic rise, the scale of America’s foreign debt and the effects of intensifying competition on national labour markets all point to continuing instability in the decades ahead. What follows is a survey of some of the most salient trends in the world economy today and a sketch of the directions they may indicate.

To begin with the United States. It is worth recalling that, as recently as 1989, an mit Commission on Industrial Productivity set up to consider the risk posed to the us economy by rising productivity levels in Europe and Japan, could begin its report with the gloomy warning that:

To live well a nation must produce well. In recent years many observers have charged that American industry is not producing as well as it ought to produce, or as well as it used to produce, or as well as some of the industries of some other nations have learned to produce. If the charges are true and the trend cannot be reversed, then sooner or later the American standard of living must pay the penalty . . .

Products made in the United States are said to be inferior . . . American factories are accused of inefficiency; the work force is said to be indifferent and ill-trained; and managers are criticized for seeking quick profits rather than pursuing more appropriate long-term goals.footnote²

The mit Commission carried out eight case studies, including cars, computers and consumer electronics; in each industry, the seriousness of the competition posed by European or, more often, Japanese companies was stressed. Given the excitement that has since surrounded the nimble high-tech companies of the ‘new economy’ boom, the Commission’s comment on semiconductors is striking: ‘The contest was between small, single-product, inexperienced under-financed American start-ups and the heavyweights of Japanese industry. David did not defeat Goliath’.footnote³

The turnaround came after 1995, as American productivity growth accelerated and both Europe and Japan, having made considerable headway in catching up with the us in the postwar period, fell further behind again (Figure 1). Although these can only be very approximate, comparisons of productivity levels suggest that European and Japanese manufacturing industry had got within striking distance—80 to 90 per cent—of American levels by the mid-1990s, then sank back to around 65 to 75 per cent.

One effect of the relative improvement in American economic performance was to encourage massive inflows of capital into us financial assets, driving up the value of the dollar which appreciated by 29 per cent against the currencies of its main trading partners between 1995 and 2001. Figure 2 shows the shifts in both the nominal value of the dollar against other currencies and in the ‘real exchange rate’, measuring the cost competitiveness of us manufacturers by adjusting for labour-cost changes. As is clear from the chart, the overwhelming influence on the real exchange rate has been the fluctuation in the nominal exchange rate of the dollar against other currencies. The real dollar exchange rate appreciated by some 40 per cent in the first half of the 1980s, fell rather more than that in the later 1980s and early 1990s, before appreciating by around one third during the subsequent boom. The real depreciation in the early 1990s was a bit more than the nominal depreciation, as us costs also rose relatively slowly. However, for each of these big swings, including the most recent dollar depreciation, shifts in the nominal rate have dominated.