The Goldilocks Economy

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Japan seems more resilient, too, under the leadership of Prime Minister Junichiro Koizumi. He has been pushing to cut the nation's red tape and deregulate the economy. One of his biggest reforms involved privatizing the heavily state-funded postal service, a highly controversial issue that prompted him to call a snap election last year. December figures released last week suggested that some of the reforms are helping to restore confidence: exports rose by 17.5%, more than expected, while imports surged by 27%, reflecting healthy domestic demand and higher oil prices. Overall, the Japanese economy grew by an estimated 2.6% in 2005, and despite a huge budget deficit and heavy debt most forecasters expect it to grow by at least 2.2% this year. Despite stock-market jitters caused by a scandal this month at Internet company Livedoor, Goldman Sachs even estimates Japan's economy could grow slightly more strongly than last year. And in Germany, business confidence is at its highest point since May 2000, according to a survey released last week, auguring well for the new coalition government led by Chancellor Angela Merkel. In a well-received speech to the Davos participants Wednesday, Merkel promised to introduce greater flexibility into the German economy and attack bureaucracy in an attempt to break out of what she called "our self-inflicted paralysis."

But China's continuing boom and its uneasy economic relationship with the U.S. was a central preoccupation of this year's Economic Forum. "This locomotive has changed the whole structure of the global economy," said Zhu. "The U.S. and Japan are no longer the global growth engine." In Washington, U.S. officials have largely sought to tackle the lopsided relationship with China by calling on the Chinese to revalue their currency as a way of making their goods more expensive and thus reducing consumer demand. China obliged last year with a small adjustment. But that failed to halt the growing trade imbalance, and the economists were in agreement that currency adjustments alone won't be enough to reduce the U.S. deficits. At the end of last year, China officially adjusted the size of its economy in an attempt to better reflect the plethora of activity taking place that wasn't counted in previous Soviet-central-planning-inspired statistics. The upshot was a 16.8% increase in gross domestic product that pushed China's economy past France's into fifth place worldwide — just behind the U.S., Japan, Germany and Britain. Zhu said that the new number is a better reflection of reality, but still doesn't take into account small private companies and service firms, including retailers, with fewer than 60 employees. As a result, "Chinese gdp is still underestimated. There's still 15-20% to go," he said.

That's good news for the rest of Asia too, as China's growth boosts the whole region. Frenkel pointed out that while China is exporting goods worth about $300 billion to the U.S. and Europe, it is at the same time importing about 100 billion dollars' worth of raw materials and goods from elsewhere. Indeed, Zhu estimated that while China accounts for only about 5% of the world economy, it is responsible for as much as 30% of the world's economic growth. Investment and exports are driving this boom, however, which is why the economists all argue that China needs to boost its own domestic demand.

The revision of the economy's size means that Chinese spending on education, health care and other social programs is even smaller as a proportion of the overall economy than previously thought. And industrialization is taking a toll: several industries, including steel and automobiles, have been growing so rapidly that they now have problems of overcapacity. Still, with 300 million rural laborers in China eager to join the industrialization push for pay that's a fraction of what Americans or West Europeans earn, the downward pressure on wages and jobs worldwide is likely to continue.

Just last week, Ford announced it will lay off up to 30,000 workers and close 14 plants in the U.S. in a huge restructuring to shore up its finances. Such drastic steps are feeding a backlash against globalization that's of growing concern to the panelists. "There's a win-win depiction of globalization that the world doesn't buy," Roach said. Added Tyson: "I worry that there are many, many voices who feel they are being harmed by globalization. In the U.S. I can find very few groups who deeply understand the economic dependency of the U.S and China and speak positively about it. They see China more as a power threat than as an effective economic ally, as a threat to American jobs rather than a source of jobs, and as a threat to U.S. financial markets rather than a source of funds that gives us all lower interest rates."

These worries are longer-term concerns, and not likely to put major obstacles in the way of another year of vibrant economic growth. But, as Goldilocks discovered, even if the porridge is just right, it can still lead to problems when the bears return.