Sunday, November 23, 2014

Missing Growth Multipliers

PRINCETON – In April 2010, when the global economy was beginning to recover from the shock of the 2008-2009 financial crisis, the International Monetary Fund’s World Economic Outlook predicted that global GDP growth would exceed 4% in 2010, with a steady annual growth rate of 4.5% maintained through 2015. But the forecast proved to be far too optimistic.

In fact, global growth has decelerated. In its most recent WEO, the IMF forecasts global GDP to grow by only 3.3% in 2012, and by 3.6% in 2013. Moreover, the downgrading of growth prospects is remarkably widespread.

The forecast errors have three potential sources: failure to recognize the time needed for economic recovery after a financial crisis; underestimation of the “fiscal multipliers” (the size of output loss owing to fiscal austerity); and neglect of the “world-trade multiplier” (the tendency for countries to drag each other down as their economies contract).

For the most part, the severity and implications of the financial crisis were judged well. Lessons from the October 2008 WEO, which analyzed recoveries after systemic financial stress, were incorporated into subsequent forecasts.

As a result, predictions for the United States – where household deleveraging continues to constrain economic growth – have fallen short only modestly. The April 2010 report forecast a US growth rate of roughly 2.5% annually in 2012-2013; current projections put the rate a little higher than 2%.

By contrast, the fiscal multiplier was seriously underestimated – as the WEO has now recognized. Consequently, forecasts for the United Kingdom – where financial-sector stresses largely resembled those in the US – have been significantly less accurate.

The April 2010 WEO forecast a UK annual growth rate of nearly 3% in 2012-2013; instead, GDP is likely to contract this year and increase by roughly 1% next year. Much of this costly divergence from the earlier projections can be attributed to the benign view of fiscal consolidation that UK authorities and the IMF shared.

Likewise, the eurozone’s heavily indebted economies (Greece, Ireland, Italy, Portugal, and Spain) have performed considerably worse than projected, owing to significant spending cuts and tax hikes. For example, Portugal’s GDP was expected to grow by 1% this year; in fact, it will contract by a stunning 3%. The European Commission’s claim that this slowdown reflects high sovereign-default risk, rather than fiscal consolidation, is belied by the UK, where the sovereign risk is deemed by markets to be virtually nonexistent.

The world-trade multiplier, though less widely recognized, helps to explain why the growth deceleration has been so widespread and persistent. When a country’s economic growth slows, it imports less from other countries, thereby reducing those countries’ growth rates, and causing them, too, to reduce imports.

The eurozone has been at the epicenter of this contractionary force on global growth. Since eurozone countries trade extensively with each other and the rest of the world, their slowdowns have contributed significantly to a decrease in global trade, in turn undermining global growth. In particular, as European imports from East Asia have fallen, East Asian economies’ growth is down sharply from last year and the 2010 forecast – and, predictably, growth in their imports from the rest of the world has lost momentum.

Global trade has steadily weakened, with almost no increase in the last six months. The once-popular notion, built into growth forecasts, that exports would provide an escape route from the crisis was never credible. That notion has now been turned on its head: as economic growth has stalled, falling import demand from trade partners has caused economic woes to spread and deepen.

The impact of slowing global trade is most apparent for Germany, which was not burdened with excessive household or corporate debt, and enjoyed a favorable fiscal position. To escape the crisis, Germany used rapid export growth – especially to meet voracious Chinese demand. Although growth was expected to slow subsequently, it was forecast at roughly 2% in 2012-2013. But, as Chinese growth has decelerated – owing partly to decreased exports to Europe – the German GDP forecast has been halved. And, given that this year’s growth has largely already occurred, Germany’s economy has now plateaued – and could even be contracting.

In good times, the trade generated by a country’s growth bolsters global growth. But, in times of crisis, the trade spillovers have the opposite effect. As the global economy has become increasingly interconnected, these trade multipliers have increased.

Indeed, while less ominous and dramatic than financial contagion, trade spillovers profoundly influence global growth prospects. Failure to recognize their impact implies that export – and, in turn, growth – projections will continue to miss the mark. The projected increase in global growth next year will likely not happen. On the contrary, policy errors and delays in individual countries will seriously damage economies worldwide.

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    1. CommentedNathan Coppedge

      On the other hand, this is supposed to be the heyday of the virtual economy.

      Histories are always missing histories.

    2. CommentedRoman Bleifer

      Most estimates are based on the essence on the extrapolation of the past for future periods. They work well enough in times of stability. But such predictions can not be taken into account to predict the fluctuations typical of periods of crisis. Much more accurate forecasts are built on an understanding of the qualitative character of the processes ( ). Attempts to counteract the crisis as the financial crisis has failed. Systemic problems of the world economy can not be solved alone financial instruments. In the global economy began to form a system of global production. It was as a system, not as a sum of national economies.

    3. CommentedProcyon Mukherjee

      Multipliers are different in every country.

      Ashoka Mody’s article is dedicated to the developed economies, while the developing like India’s story is more severe; a country with a predominantly young people coming into the labor force each year in numbers that the rest of the world would struggle to achieve, we have a growth conundrum that is muddled in lack of political will.

      To recast the multiplier in India, one would have to simply start with institution building, elimination of corruption and building governance structures to make any difference.

      But if one sector has to be singled out it is the core sector, which must be put back on track. A country which still has hundreds of thousands of villages lacking electrification, the power in the bulk of the electricity producing states is surplus! A country where thousands of miles must be connected by roads, the infrastructure companies cannot progress without land acquisition. And to top it all we have a coal sector, which continues to produce less and less as there is a policy lock-jam.

      Procyon Mukherjee

    4. CommentedZsolt Hermann

      The greatest reason for the prediction errors is that we simply refuse to see reality.
      Almost everybody as if by the wave of a magic wand entered a mass hypnosis, refusing to wake up, continuously repeating the by now "religious mantra" of "continuing growth", "return to growth", "recovery, stimulus", and so on...
      You cannot kick a dead horse and hope that it will carry you, the unnatural and unsustainable constant quantitative growth economic model is dead.
      People are still playing with the numbers, a little makeup here a little cosmetic surgery there, if nothing else works let us print more money like in a gigantic, virtual Monopoly Game.
      Humanity matured through evolution into a global, interconnected and interdependent system.
      Just like any species living in colonies, or herds, or any other living ecosystem, humanity is also a single, intertwined organism in a mature state, and this human organism is part of a closed and finite natural system.
      In such systems after the initial stages of development constant, expansive growth is not possible any longer, different interactions, qualitative changes are necessary and all elements have to interact in a very precisely mutual fashion to secure the life and sustainability of the whole system.
      If in such a system a cell or an organ refuses to settle into the overall balance and pushes on with expansive and quantitative growth, that is a cancer, or a virus that is totally harmful from the respect of the global system and also from its own viewpoint as even its own life depends on the well being and longevity of the whole system.
      What stands here is all scientifically proven, but humans are incapable of digesting it as it would require a fundamental change in lifestyle and attitude.
      But since we are only part of the system we have no free choice about it, the only question is if we make the necessary adjustments willingly, being conscious partners in the process, or we are beaten to change by suffering, and the threat of extinction.

    5. CommentedFrank O'Callaghan

      The biggest multiplier (apart from confidence) is equality. Increasing the incomes and wealth of the great majotity while decreasing their indebtedness will spur the growth.

      The concentration of wealth in few hands is a drag on the world economy.