Global Trends by Martin Khor

Monday 15 October 2012

Worries emerge on state of world economy

Serious concerns emerged at last week’s IMF-World Bank meetings in Tokyo  on  the deteriorating state of the global economy and the policy problems and paralysis in the US and Europe.


There were sobering messages on global economic prospects emerging from the annual meetings of the World Bank and International Monetary Fund held in Tokyo last week.

The IMF cut its growth projections for most major countries and said the “risks of a serious global slowdown are alarmingly high” in its World Economic Outlook released last week.

Global growth slowed from 5.1% in 2010 to 3.8% in 2011.  For this year, the latest IMF estimate is 3.3% global growth, with developed countries barely growing by 1.3% while developing countries expand by 5.3%.

This 2012 forecast is optimistic as it assumes the US and Europe will resolve their problems in economic policy making.

The IMF posed as a key issue whether the global economy is only facing just another temporary bout of turbulence or whether the slowdown will be long lasting. It said the answer depends on whether the US and Europe can deal with their short-term challenges.

That is putting the issue blandly.  The truth is that it is more difficult today to get recovery going, than it was in 2009 in the aftermath of the financial meltdown.

At that time, there was a consensus among the major countries that their collapsing economies had to be boosted through fiscal stimulus, low interest rates and massive supply of credit.  The coordinated actions led to the swift and sharp recovery of 2010.

The policy winds have changed in the past two years.  Most developed countries are now more concerned about cutting their budget deficits, and thus reversed their fiscal policy from stimulus to austerity. 

Countries in the Eurozone that are heavily dependent on foreign loans and do not have the options of printing money or currency depreciation because they have the common currency have little choice but to cut their public spending. 

But even the United Kingdom which enjoys much more policy space, chose drastic budget cuts that have now resulted in a recession.

During the IMF meeting last week, the raging debate on the wisdom of demanding extreme austerity targets for Greece and potentially other countries like Portugal and Spain in exchange for loans, broke out in an open clash.

The IMF chief Christine Lagarde said Greece should be given two additional years to meet the drastic budget reduction targets that had been imposed by its creditors (the European Union, European Central Bank and the IMF itself).  But the German Finance Minister strongly rebuked her, indicating Germany’s insistence on Greece fulfilling the targets on time as a condition for further loans.

Meanwhile, Greece is reeling from the spending cuts already made, with GNP falling by 6% and unemployment shooting up above 25%.   The public mood has reached boiling point, as evident from angry protests during the German leader Angela Merkel’s visit to Athens last week.

Europe will remain the epicentre of the global slowdown, with its economy in recession this year and possibly next, even though its crisis situation has eased with the European Central Bank intention to buy government bonds of cash-strapped countries.  Since the countries have to adhere to strict austerity and other targets as a condition, Europe’s economy will face contraction.

The US by contrast has done better with growth of 1.8% in 2011 and a projected 2.2% this year, but unemployment remains.

However, it faces the “fiscal cliff” problem at the end of the year.  If the Republicans and Democrats are unable to overcome their differences and hostility and arrive at a new budget deal, the package of tax cuts and spending cuts mandated by law will kick in by January 2013, and these measures are equivalent to reducing national income by 4%.  The implications for the global economy are enormous.

The major developing countries are also slowing down significantly.  The latest IMF forecast is of GNP growth in 2012 for China of 7.8% (from 10.4% in 2010), India 4.9% (10.1% in 2010) and Brazil 1.5% (7.5% in 2010).  

The developing countries have especially been affected by the sharp decline of exports from Europe.

Thus the three main concerns about the current global economic situation are the continuing financial crisis and severe austerity response in Europe, the confrontational politics and probable greater austerity measures in the US, and the cooling of the major developing countries’ economies.

At the IMF’s International Monetary and Financial Committee on 13 October, developing countries’ Ministers expressed their fears and frustrations over the situation and policies in the developed countries.

According to a report by Associated Press, China’s Central Bank deputy governor said at the meeting that “a durable solution to the Euro area crisis would provide a much-needed boost to global recovery” and that uncertainty over government debts in the U.S. and Japan was slowing recovery and causing "costly spillover effects to the rest of the world."

South Africa’s finance minister Pravin J. Gordhan said: "We should all be committed in our resolve to avoid a worst case scenario where strains in the euro area deepen, fiscal cliff and debt ceiling problems in the U.S. are not resolved, and growth in emerging market economies continues to decline."

Guido Mantega, Brazil's finance minister, told the committee:  "Advanced countries should rethink their macroeconomic strategies and avoid simultaneous fiscal contractions and the consequent overburdening of monetary policies….In many advanced countries, fiscal and structural policies are hampered by political paralysis.”

He also expressed concern over monetary easing in the U.S. and other countries that is meant to encourage more bank lending but that some worry could destabilize markets while failing to stave off recession, according to the AP report.