Friday, November 28, 2014

Misreading the Global Economy

PRINCETON – In April 2010, the International Monetary Fund’s World Economic Outlook offered an optimistic assessment of the global economy, describing a multi-speed recovery strong enough to support roughly 4.5% annual GDP growth for the foreseeable future – a higher pace than during the bubble years of 2000-2007. But, since then, the IMF has steadily pared its economic projections. Indeed, this year’s expected GDP growth rate of 3.3% – which was revised downward in the most recent WEO – will probably not be met.

Persistent optimism reflects a serious misdiagnosis of the global economy’s troubles. Most notably, economic projections have vastly underestimated the severity of the eurozone crisis, as well as its impact on the rest of the world. And recovery prospects continue to depend on the emerging economies, even as they experience a sharp slowdown. The WEO’s prediction of a strengthening recovery this year continues the misdiagnosis.

European Central Bank President Mario Draghi’s announcement last summer that the ECB would do “whatever it takes” to preserve the euro reassured financial markets. But, as pressure from financial markets has eased, so has European leaders’ incentive to address problems with the eurozone’s underlying economic and political dynamics. Easy ECB liquidity is now sustaining a vast swath of Europe’s banking system.

The eurozone is operating under the pretense that public and private debts will, at some point, be repaid, although, in many countries, the distress now is greater than it was at the start of the crisis almost five years ago. As a result, banks, borrowers, and governments are dragging each other into a vicious downward spiral. Politicians have exacerbated the situation by doubling down on fiscal austerity, which has undermined GDP growth while failing to shrink government debt/GDP ratios. And no decisive policy action aimed at healing private balance sheets appears imminent.

Moreover, Europe’s problems are no longer its own. Europe’s extensive regional and global trade networks mean that its internal problems are impeding world trade and, in turn, global economic growth. In 2012, world trade expanded by only 2.5%, while global GDP grew at a disappointing 3.2% rate.

Periods in which trade grows at a slower pace than output are rare, and reflect severe strain on the global economy’s health. While the trauma is no longer acute, as it was in 2009, wounds remain – and they are breeding new pathologies. Unfortunately, the damage is occurring quietly, enabling political interests to overshadow any sense of urgency about the need to redress the global economy’s intensifying problems.

Against this bleak background, it is easy to celebrate the success of emerging markets. After all, emerging and developing economies are growing much faster than the advanced countries. But even the world’s most dynamic emerging markets – including China, Brazil, and India – are experiencing a sharp deceleration that cannot be ignored.

Consider India, where growth is now running at an annualized rate of 4.5%, down from 7.7% annual growth in 2011. To be sure, the IMF projects that India’s economy will rebound later in 2013, but the basis for this optimism is unclear, given that all indicators so far suggest another dismal year.

The emerging economies’ supposed resilience, which has buoyed economic forecasts in recent years, needs to be reassessed. Like the advanced economies, emerging economies experienced a boom in 2000-2007. But, unlike the advanced economies, they maintained high GDP growth rates and relative stability even at the height of the crisis. This was viewed as powerful evidence of their new economic might. In fact, it was largely a result of massive fiscal stimulus and credit expansion.

Indeed, as the effects of stimulus programs wear off, new weaknesses are emerging, such as persistent inflation in India and credit misallocation in China. Given this, the notion that emerging economies will recapture the growth levels of the bubble years seems farfetched.

Economic forecasts rest on the assumption that economies ultimately heal themselves. But economies’ powerful self-healing capabilities work slowly. More problematic, a misdiagnosis can lead to treatments that impair the healing process. Overly optimistic economic projections based on mistaken assessments of the global economy’s ailments thus threaten recovery prospects – with potentially far-reaching consequences.

In Europe, the banks’ wounds must be closed – weak banks must be shut down or merged with stronger banks – before recovery can begin. This will require an extensive swap of private debts for equity. For the global economy, the malaise reflected in anemic trade growth calls for coordinated fiscal stimulus by the world’s major economies. Otherwise, the risk of another global recession will continue to rise.

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    1. CommentedLennart fredrikson

      And who should pay for all Zombie BANKS Bailouts?
      In several countries we have seen Nationalistic movements
      a sign of lost confidence and correcting policies .
      For example in Eurozone with ongoing recession what happen "IF the FAT LADY=Germany stops singing=Approve bailouts and the MUSIC=Bailouts stops?
      Ein EUROKNALL??

    2. CommentedJoshua Ioji Konov

      IMF's mistaken projection are roduct of pro-industrial trickle down economics, which seemingly is not performing as this article has fluently presented, whereas is gone the alternative expanding role of the governments, but mostly what is at most gone is the rliance of large business (i.e. transnationals) and large investors to solve the issues and bring long term economic growth...., well ask yourselves if any alternatives are possible at all? - I dare to say yes:?

    3. CommentedProcyon Mukherjee

      Either way, if we go by the Anna Karenina principle: "Happy families are all alike; every unhappy family is unhappy in its own way" or the Aristotle principle: "it is possible to fail in many ways (for evil belongs to the class of the unlimited, as the Pythagoreans conjectured, and good to that of the limited), while to succeed is possible only in one way", we have the BRICs as the best example.

      But let me take the Indian case. The bulging service sector with unsustainable growth rates and with a manufacturing sector that has stopped to grow, we have an agricultural one where productivity has grown only in pockets. The manufacturing sector holds the key, where for growth to happen the polity must decide whether land acquisition for industry and infrastructure should be left to the vagaries of petty political mileage gathering or the most important topic where convergence of political will must happen for the good of democracy.

    4. CommentedZsolt Hermann

      I would not call it misdiagnosis, we are simply in denial.
      It is the same as the recent upheavals about the fundamental "austerity article" from Harvard, discussing the relevance of mistaken calculations, wrong data input, when the problem is the wrong paradigm, wrong frequency, coordinate system.
      We have been living in an artificial bubble, we stubbornly want to remain in the bubble, while the artificial, unnatural laws and principles we created within the bubble fall apart as the vast natural system our bubble exists in "encroaches on us" (more precisely we expanded in it so we cannot escape its influence any more), forcing the fundamental, natural laws and principles on us, which laws and principles we simply cannot escape, ignore any longer.
      This is simply an evolutionary process, humanity has matured, grown up, it became global and integral, we cannot play like children any more thinking we can do whatever we want.
      Now we have to take on the full responsibility to understand the system where we exist, our own nature and characteristics, and we have to adapt to the system.
      We cannot change the natural system around us since it is infinitely larger, stronger than us.
      Only we ourselves can change and adapt, as any other living organism that wants to develop and survive.
      And humans, more than any other living organism have the capability to do this, since we are the only ones with the capability of critical self-assessment, conscious self-change.
      We do not have to climb back on the trees, or into caves, we can adapt to the natural system in full awareness, creating a comfortable, modern lifestyle that is optimal for us, but is also within the framework and resources of the system.
      The option opening up before us is not defeat, or backtracking, it is the opposite, a chance to rise to a new, much higher quality of human existence, an "omnipotent", interconnected humanity fully, mutually complementing itself, and fully integrating into the natural system it exists in.