Sustained global economic recovery still elusive – UNCTAD

A report released by the UN Conference on Trade and Development (UNCTAD) in September confirms that the global economy has still not returned to the growth rates it enjoyed before the onset of the 2008 financial crisis. Kanaga Raja highlights the report's findings.

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'THE global economy is still struggling to return to a strong and sustained growth path' and world output growth is forecast to decelerate further from 2.2% in 2012 to 2.1% in 2013, the United Nations Conference on Trade and Development (UNCTAD) has said.

In its flagship Trade and Development Report 2013, released on 12 September, UNCTAD said that developed countries will continue to lag behind the world average, with a likely 1% increase in gross domestic product (GDP), due to a slight deceleration in the United States and a continuing recession in the euro area.

Developing and transition economies should grow by about 4.7% and 2.7% respectively, it added. 'Even though these growth rates are significantly higher than those of developed countries, they remain well below their pre-crisis levels. Furthermore, they confirm the pace of deceleration that started in 2012.'

At a 12 September media briefing, Mukhisa Kituyi, the new Secretary-General of UNCTAD, who replaced Supachai Panitchpakdi on 1 September, said that for about five years, as the crisis in the world economy has refused to go away, UNCTAD has been very consistent in its argument that the traditional paradigms - the traditional assumptions - about getting out of the financial crisis do not appear to be part of the solution.

New thinking and new approaches are needed urgently at the global and national levels in areas of economies to be emphasised but importantly in looking afresh at unfettered deregulation in particular in financial markets and how it impacts on national policy, planning and projection, he added.

Analysing recent trends in the global economy, the UNCTAD report said that economic activity in many developed countries and a number of emerging market economies is still suffering from the impacts of the financial and economic crisis that started in 2008 and the persistence of domestic and international imbalances that led to it. However, continuing weak growth in several countries may also be partly due to their current macroeconomic policy stance.

Among developed economies, growth in the European Union is expected to shrink for the second consecutive year, with a particularly severe economic contraction in the euro area. Private demand remains subdued, especially in the eurozone periphery countries (Greece, Ireland, Italy, Portugal and Spain), due to high unemployment, wage compression, low consumer confidence and the still-incomplete process of balance sheet consolidation.

Given the ongoing process of deleveraging, expansionary monetary policies have failed to increase the supply of credit for productive activities. In this context, continued fiscal tightening makes a return to a higher growth trajectory highly unlikely, as it adds a deflationary impulse to already-weak private demand.

The report said that while foreign trade (mainly through the reduction of imports) contributed to growth in the euro area, this was more than offset by the negative effect of contracting domestic demand, which even the surplus countries have been reluctant to stimulate. This perpetuates disequilibrium within the eurozone and reduces the scope for an export-led recovery of other countries in the zone.

'Hence, despite the fact that the tensions in the financial markets of the euro area have receded following intervention by the European Central Bank (ECB), prospects for a resumption of growth of consumption and investment in these countries remain grim.'

Japan is bucking the current austerity trend of other developed economies by providing a strong fiscal stimulus in conjunction with monetary policy expansion with the aim of reviving economic growth and curbing deflationary trends. An increase of government spending on infrastructure and social services, including healthcare and education, has been announced, to be accompanied by efforts to boost demand and structural policies oriented towards innovation and investment.

To complement these efforts, UNCTAD noted, in April 2013, the Bank of Japan announced that it will increase its purchase of government bonds and other assets by 50 trillion yen per year (equivalent to 10% of Japan's GDP) in order to achieve an inflation target of 2%. Overall, these measures could help maintain Japan's GDP growth at close to 2% in 2013.

The United States is expected to grow at 1.7%, compared with 2.2% in 2012, due to a new configuration of factors. Partly owing to significant progress made in the consolidation of its banking sector, private domestic demand has begun to recover. The pace of job creation in the private sector has enabled a gradual fall in the unemployment rate.

'On the other hand, cuts in federal government spending, enacted in March 2013, and budget constraints faced by several State and municipal governments are a strong drag on economic growth. Since the net outcome of these opposing tendencies is unclear, there is also considerable uncertainty about whether the expansionary monetary policy stance will be maintained.'

Main growth drivers

By contrast, said UNCTAD, developing countries continue to be the main drivers of growth, contributing to about two-thirds of global growth in 2013. In many of them, growth has been driven more by domestic demand than by exports, as external demand, particularly from developed economies, has remained weak.

UNCTAD forecast developing countries to grow at the rate of 4.5-5% in 2013, similar to 2012.

'This would result from two distinctive patterns. On the one hand, growth in some large developing economies, such as Argentina, Brazil, India and Turkey, which was subdued in 2012, is forecast to accelerate. On the other hand, several other developing economies seem unlikely to be able to maintain their previous year's growth rates. Their expected growth deceleration partly reflects the accumulated effect of continuing sluggishness in developed economies and lower prices for primary commodity exports, but also the decreasing policy stimuli which were relatively weak anyhow.'

The combination of these factors may also affect China's growth rate, which is expected to slow down moderately from 7.8% in 2012 to about 7.6% in 2013. Even though this would be only a mild deceleration, it is likely to disappoint many of China's trading partners.

Among the developing regions, East, South and South-East Asia are expected to experience the highest growth rates in 2013, of 6.1%, 4.3% and 4.7%, respectively. In most of these countries, growth is being driven essentially by domestic demand.

In China, the contribution of net exports to GDP growth was negligible, while fixed investment and private consumption, as a result of faster wage growth, continued to drive output expansion. Encouraged by various incomes policy measures, domestic private demand is also supporting output growth in a number of other countries in the region, such as India, Indonesia, the Philippines and Thailand.

Economic growth in West Asia slowed down dramatically, from 7.1% in 2011 to 3.2% in 2012, a level that is expected to be maintained in 2013. Weaker external demand, especially from Europe, affected the entire region, but most prominently Turkey, which saw its growth rate fall sharply from around 9% in 2010 and 2011 to 2.2% in 2012, but it is expected to accelerate towards 3.3% in 2013.

Growth in Africa is expected to slow down in 2013, owing to weaker performance in North Africa, where political instability in some countries has been mirrored in recent years by strong fluctuations in growth. In sub-Saharan Africa (excluding South Africa), GDP growth is expected to remain stable in 2013, at above 5%. The main growth drivers include high earnings from exports of primary commodities and energy as well as tourism, and relatively strong growth of public and private investment in some countries.

Growth is set to remain relatively stable in Latin America and the Caribbean, at around 3%, on average, as a slowdown in some countries, including Mexico, is likely to be offset by faster growth in Argentina and Brazil.

In 2012 and the first months of 2013, regional growth has been driven mostly by domestic demand based on moderate but consistent increases in public and private consumption and investment. Governments generally turned to more supportive fiscal and monetary policies in a context of low fiscal deficits and low inflation for the region as a whole.

According to the report, domestic demand will continue to support growth in 2013 based on rising real wages and employment, as well as an expansion of bank credit. In addition, a recovery of agriculture and investment should contribute to better economic performance in Argentina and Brazil after weak growth in 2012.

On the other hand, owing to sluggish international demand and lower export prices of oil and mining products (although they remain at historically high levels), a slowdown is expected in the Bolivarian Republic of Venezuela, Chile, Ecuador, Mexico and Peru.

There has been a downward trend in the economic performance of the transition economies since 2012. The impact of the continuing crisis in much of Western Europe caused the economies of South-Eastern Europe to fall into recession in 2012, and they will barely remain afloat in 2013. The members of the Commonwealth of Independent States (CIS) maintained a growth rate of over 3% in 2012 based on sustained domestic demand, but this is expected to slow down slightly in 2013.

The report noted that the continuing expansion of developing economies as a group (in particular the largest economy among them, China) has led to their gaining increasing weight in the world economy, which suggests the possible emergence of a new pattern of global growth. While developed countries remain the main export markets for developing countries as a group, the share of the latter's contribution to growth in the world economy has risen from 28% in the 1990s to about 40% in the period 2003-07, and close to 75% since 2008.

'However, more recently, growth in these economies has decelerated. They may continue to grow at a relatively fast pace if they are able to strengthen domestic demand and if they can rely more on each other for the expansion of aggregate demand through greater South-South trade. However, even if they achieve more rapid growth by adopting such a strategy, and increase their imports from developed countries, this will not be sufficient to lift developed countries out of their growth slump.'

UNCTAD also pointed out that international trade in goods has not returned to the rapid growth rate of the years preceding the crisis. On the contrary, it decelerated further in 2012. And while the outlook for world trade remains uncertain, the first signs in 2013 do not point to an expansion. After a sharp fall in 2008-09 and a quick recovery in 2010, the volume of trade in goods grew by only 5.3% in 2011 and by 1.7% in 2012. This slower rate of expansion occurred in developed, developing and transition economies alike. 'Sluggish economic activity in developed countries, particularly in Europe, accounted for most of this very significant slowdown.'

Overall, said UNCTAD, 'this general downward trend in international trade highlights the vulnerabilities developing countries continue to face at a time of lacklustre growth in developed countries. It is also indicative of a probably less favourable external trade environment over the next few years, which points to the need for a gradual shift from the reliance on external sources of growth towards a greater emphasis on domestic sources.'

Policy differences

According to UNCTAD, the analysis has revealed that neither the developed economies nor the developing and transition economies have been able to return to the rapid growth pace they experienced before the onset of the latest crisis.

Since the factors that underpinned the pre-crisis economic expansion were unsustainable, endogenous adjustment mechanisms or automatic stabilisers are not likely to restore them. Moreover, relying on such a strategy will not succeed in returning economies to their previous growth pattern, nor is it desirable.

Many proponents of structural reforms believe their main goals should be to improve competitiveness and restore the strength and confidence of financial markets. These goals are supposed to be achieved by short-term measures such as the compression of labour costs and fiscal austerity.

'However, so far, this approach has delivered disappointing results. Other proposals include radical measures, such as more flexible labour markets, lower social security coverage and a smaller economic role for the State. However, none of these proposed reforms are likely to solve the structural problems, and may even aggravate them, because they appear to be based on a flawed diagnosis,' asserted UNCTAD.

The discrepancies between developed and developing countries with regard to employment generation reflect their different growth performances, it said.

In developed countries, the strategy of creating jobs by reducing (or allowing a reduction of) real wages has not delivered the expected results in the presence of slow, or in some cases negative, output growth. Such wage policies have an adverse impact on aggregate demand, which makes private firms less willing to invest and to hire new workers. Reducing the price of labour does not lead to the expected outcome of equilibrating demand and supply on the labour market, because lowering the price of labour (the real wage) reduces not only the costs of producing goods and services, but also the demand for those goods and services.

'Attempts to overcome employment problems by lowering wages and introducing greater flexibility to the labour market are bound to fail because they ignore this macroeconomic interdependence of demand and supply that causes the labour market to function differently from a typical goods market,' the report stressed.

In the current policy debate, there is broad agreement about the goals but not about how best to achieve them, and sometimes the means appear to be confused with ends. Restoring growth and employment levels, reducing public debt ratios, repairing banking systems and re-establishing credit flows are generally shared objectives.

However, disagreement on priorities, on the appropriate policy tools, as well as on the timing and sequencing, leads to quite different, and sometimes opposite, policy recommendations. For instance, the dominant view in most developed countries and in several international organisations, at least since 2010, has been that fiscal consolidation is a prerequisite for sustained growth because it will bolster the confidence of financial markets and prevent sovereign defaults.

Those opposed to this shift towards fiscal austerity see fiscal consolidation as a long-term goal which would be achieved through sustained growth, and not as a precondition for growth. In this view, premature fiscal tightening will not only be very costly in economic and social terms; it will also be counterproductive, because, with slower growth, fiscal revenues will be lower, and the public-debt-to-GDP ratio is unlikely to decline or may even rise further.

'Despite growing evidence that fiscal austerity hampers GDP growth, many governments are unwilling to change this strategy as they believe they do not have enough policy space for reversing their fiscal policy stance; instead, they are relying on monetary policy for supporting growth and employment.'

However, said UNCTAD, there is little scope for monetary policy to further reduce interest rates in developed economies, as these are already extremely low. In addition, so far, unconventional monetary policies (i.e., quantitative monetary expansion) have failed to revive credit to the private sector. Banks and other financial institutions that have access to liquidity will not automatically increase their supply of credit commensurately, as they may still have to consolidate their balance sheets.

Moreover, even if they did expand their credit supply, many private firms would be unlikely to borrow more as long as they have to consolidate their own balance sheets without any prospect of expanding production when they face stagnant, or even falling, demand. This is why using monetary policy for pulling an economy out of a depression triggered by a financial crisis may be like 'pushing into a string'.

On the other hand, said UNCTAD, central bank interventions (or announcements of their intentions) have proved remarkably effective in lowering risk premiums on sovereign debt. Thus, monetary and fiscal policies may be used for different purposes for tackling the crisis. Fiscal policy, given its strong potential impact on aggregate demand, could be used to support growth and employment instead of trying to restore the confidence of financial markets through fiscal austerity. Meanwhile, central banks could enlarge their role as lenders of last resort to generate that confidence and maintain interest rates at low levels. Moreover, these central bank actions to support credit and growth are more likely to succeed if they are accompanied by an expansionary fiscal policy.

Structural vulnerabilities

According to the report, since the late 1970s and early 1980s, policies based on supply-side economics, neoliberalism and finance-led globalisation have involved a redefinition of the role of the state in the economy and its regulatory tasks; an extraordinary expansion of the role of finance at the national and international levels; an opening up of economies, including a reduction of trade tariffs; and a general increase in inequality of income distribution.

The resulting new roles of the public, private and external sectors, the expansion of finance and the increasing income concentration altered the structure and dynamics of global demand in a way that heightened vulnerabilities, eventually leading to the crisis.

'In other words, the present crisis was not the unfortunate result of some misguided financial decisions; rather, it was the culmination of a number of structural problems that have been building up over the past three decades, which created the conditions for greater economic instability.'

In order to achieve sustained global growth and development, there has to be consistent growth of household income, the largest component of which is labour income obtained from the production of goods and services. However, over the past three decades, labour income in the world economy has been growing at a slower pace than the growth of world output, with some diverging trends over the past decade.

'The observed declining trends in the share of labour income - or wage share - have often been justified as being necessary in order to reduce costs and induce investment. However, wage income constitutes a large proportion of total income (about two-thirds in developed countries), and is therefore the most important source of demand for goods and services. Thus, sizeable reductions of such income relative to productivity gains will have tangible negative effects on the rate of household consumption. And, to the extent that productive investment is driven by expectations of expanding demand, second-round effects of lower consumption on investment would seem unavoidable.'

In addition to these negative effects on long-term growth, greater income inequality also contributed to the financial crisis. The links between expanding finance and rising inequality operated in two ways. The larger size and role played by the financial sector led to a greater concentration of income in the hands of rentiers (both equity holders and interest earners) and a few high-wage earners, especially in the financial sector.

Concomitantly, greater inequality led to rising demand for credit, both from households whose current income was insufficient to cover their consumption and housing needs and from firms that distributed a disproportionate share of their profits to their shareholders. This led to a financial bubble that eventually burst, leaving many households, firms and banks in financial distress.

The UNCTAD report emphasised that another long-running trend since the early 1980s has been the diminishing economic role of the state in many countries by way of privatisation, deregulation and lower public expenditure. This served to increase economic fragility in different ways.

Another factor contributing to those crises since the 1980s has been widespread financial liberalisation, which is another major aspect of the reduced economic role of the state. Financial deregulation, coupled with the extraordinary expansion of financial assets, allowed macroeconomic policies limited room for manoeuvre, and their effects came to be increasingly swayed by reactions on financial markets.

Moreover, as the access of governments to central bank financing was limited, the financial sector gained greater influence over policymakers. This interaction between developments in the financial sector, together with the weakening of government and central bank influence on the economy, generates a particular problem when a recession does not result from cycles in the real sector of the economy, but instead from over-indebtedness of the private sector as a whole.

The value of global financial assets grew from $14 trillion in 1980 to $56 trillion in 1990 and $206 trillion in 2007; and in current GDP terms it tripled, from 120% of GDP in 1980 to 365% in 2007. This expansion was accompanied (and encouraged) by extensive deregulation of national financial markets and the progressive liberalisation of international capital movements. As a result, cross-border capital flows jumped from $500 billion in 1980 to a peak of $12 trillion in 2007.

Between 1980 and 1995, the stock of foreign-owned financial assets represented around 25% of global financial assets. This share increased to 28% in 2000, 38% in 2005 and almost 50% in 2007-10, when foreign-owned assets exceeded $100 trillion, or 150% of world output.

'This more prominent role of financial markets carries the risk of greater economic instability, because these markets are intrinsically prone to boom-and-bust processes, especially if they are loosely regulated,' cautioned UNCTAD.

The extraordinary expansion of the financial sector over the years has also been accompanied by changes in its patterns of operation, which contributed to an increase in financial fragility. These included a high level of financial leveraging, an increasing reliance on short-term borrowing for bank funding, the extension of a poorly capitalised and unregulated shadow financial system, perverse incentives that encouraged excessive risk-taking by financial traders, a reliance on flawed pricing models and the 'lend and distribute' behaviour that weakened the role of banks in discriminating between good and bad borrowers.

The pro-cyclical bias of bank credit was exacerbated by value-at-risk models and the Basel rules on bank capital, which allowed banks to expand credit during booms, when risks seemed low and the price of collaterals rose, and obliged them to cut lending during downturns. The vulnerability of the financial system also increased as a result of its growing concentration and loss of diversity. Much of its operations today are handled by 'too-big-to-fail' institutions which tend to take on far greater risks than would be taken by smaller institutions.

'It is possible that some of the characteristics of the credit boom in developed countries are being replicated in developing countries, with some variations. Asset appreciations and private spending that exceeds income are often supported by capital inflows, usually channelled through domestic financial institutions. In such cases, currency mismatches between debt and revenue tend to generate or reinforce the credit boom-and-bust cycle.'

Through these different channels, the growing size and role of the financial sector, together with its present structure and modes of functioning, have become a major source of economic instability and misallocation of resources in many countries. It has also facilitated the rise of international imbalances, another key structural problem.

Global imbalances

UNCTAD explained that increasing current account imbalances and the expansion of international finance are closely intertwined. In the immediate postwar era, there are unlikely to have been any countries that had large external deficits for extended periods of time. But such deficits have become more and more common in the era of financialisation that started in the 1980s and deepened from the 1990s onwards.

By the end of the 1990s, a tendency towards rising global imbalances re-emerged, owing largely to current account deficits in a few developed countries where credit-driven expansion became prevalent. This tendency was reinforced by the adoption of export-led strategies by developed-country exporters of manufactures, such as Japan and a few North European countries, followed by Germany.

'Export-led growth strategies, to the extent that they have frequently led to trade surpluses, are only sustainable if other countries maintain trade deficits over a long period. In short, the success of such strategies in some countries relies on external deficits in other countries, and the willingness and capacity of the deficit countries to pile up external debt.'

But since the crisis, developed countries with deficits seem to be less willing and able to play the role of global consumer of last resort due to their ever-increasing indebtedness. Despite this, policymakers in some countries are trying to respond to weaker domestic demand by gaining export market shares through improved international competitiveness. This is particularly the case with those crisis-hit countries that were running large current account deficits before the crisis and have undertaken recessionary adjustment programmes.

The most common measure adopted, at least in the short run, has been internal devaluation, particularly through wage compression. However, this simultaneous action by several trade partners contributes to a global compression of income and reinforces a race to the bottom. This not only has negative effects on global aggregate demand, since a country's lower wage bill constitutes a demand constraint that affects other countries as well, but it also undermines their efforts to gain competitiveness.

UNCTAD argued that a global mechanism to help rebalance external demand will not be effective if it places the entire or most of the burden of adjustment on deficit countries. Such an asymmetric adjustment is deflationary, since debtor countries are forced to cut spending while there is no obligation on the part of creditor countries to increase spending, which leads to a shortfall of demand at the global level.

'It would be preferable, from an economic and social point of view, if surplus countries assumed a greater role in the rebalancing process by expanding their domestic demand. Ideally, an asymmetric expansionary approach would be the most effective way to restart global output growth on a sustainable basis. In such an approach, the adjustment burden would be taken on primarily by the surplus countries by way of stronger wage increases and fiscal expansion,' it concluded.                                            

Kanaga Raja is Editor of the South-North Development Monitor (SUNS), from which this article is reproduced (No. 7654, 16 September 2013). SUNS is published by the Third World Network.

*Third World Resurgence No. 276/277, August/September 2013, pp 41-45