Global Trends by Martin Khor

Monday 3 October 2011

Prepare now for a new global downturn

The IMF-World Bank meetings last week confirmed the global economy has entered the “danger zone” of a new downturn and possibly recession.  This time it could be more serious and prolonged than the last 2008-09 recession.


The last two weeks have seen a clear downward shift in expectations on the global economy.  The dominant view now is that the world has slipped into stagnation that may well become a recession.

Warnings that the economy had entered a “danger zone” generated the gloomy mood at the annual Washington gathering of the International Monetary Fund and World Bank, as well as the G20 finance ministers’ meeting.

Prominent economists are predicting the new crisis will be more serious and prolonged than the 2008-9 Great Recession.

If the United States and its sub-prime mortgage mess was the immediate cause of the last recession, the epicentre this time is the European debt crisis.  The eurozone’s GNP grew by only 0.2% in the second quarter, and the European Commission predicts the rates will be 0.2% and 0.1% in the third and fourth quarters.

As the domino effect of contagion hit one European country after another (rather like how Asian countries were affected in 1998-99), European leaders have scrambled for a solution. 

But none has worked so far.  In the Greek debt tragedy, the government has had to announce one painful austerity measure after another, but its economic condition continues to worsen and the social protests and strikes indicate the approach of the political breaking point.  The costs of austerity are already being seen (by the public at least) to outweigh the benefits.

Several British newspapers last week reported a set of big measures to tackle the European crisis was reportedly being worked on by unnamed European officials.

The centrepiece is a Greek debt default with creditors repaid only 50%, and two measures to cushion that shock – an injection of fresh capital into European banks that would suffer big losses from the default, and the boosting of the European bail-out fund from 400-plus billion euros to almost two trillion euros to enable hundreds of billions of euros in new credit to countries like Italy and Spain to prevent them from becoming new debt-crisis economies.

However, this leaked news of a big Plan B was not confirmed by any policy maker, so its status or even existence is unknown. Instead, the news out of Washington last week was of continued paralysis in European policy.

Greece this week is facing a new crunch time – waiting to see if the European institutions and IMF will approve the next bail-out instalment of US$8 billion to service loans that are coming due, and what would happen if they do not. Would it be time then to declare a default?

Meanwhile the United States has its own budget deficit tug-of-war between the President and Congress and between Republicans and Democrats.

What this means is that Europe and the US are not able to make use of the policies (massive increases in government spending, interest rate cuts and pumping of money into the economy) that pulled them quickly out from the last recession.

Moreover, the coordination of policy actions among developed countries (and several developing countries as well, that also undertook fiscal stimulus policies) that fought the last recession no longer seems to exist, at least for now.

Thus the new global slowdown or recession is likely to last longer than the short 2008-9 recession.

The developing countries should thus prepare to face serious problems that will soon land on them.

We can expect a sharp fall in their exports as demand declines in the major economies.  Commodity prices are expected to climb down; they have already started to do so.

There may be a reversal of capital flows, as foreign funds return to their countries of origin. The currencies of several developing countries are already declining and it may be the start of sharper falls.

It’s beginning to look like 2008 all over again. But this time the developing countries are starting this downturn in a weaker state than in 2008, since they have not yet fully recovered from the last shock.

And as the downturn proceeds, there will be fewer cushions to blunt the effects or to enable a rapid recovery.

It is also clear that there is an absence of a global economic governance system, in which the developing countries can also participate in.

All countries are affected when the global economy goes into a tail spin. Once again, the developing countries are not responsible for the new downturn, but they will have to absorb the ill effects.  Yet there is no forum in which they can put forward their views on how to lessen the effects of the crisis on them and what the developed countries should do.

As the new crisis unfolds, there will be renewed calls for reforms to the international financial and economic system.  This time there should be a more serious reform process, otherwise more crises can only be expected in the future.