Info Service on WTO and Trade Issues (Jan10/04)
: Global economy on the mend, but recovery fragile
Geneva, 21 Jan (Kanaga Raja) -- Following a sharp, broad and synchronized global downturn in late 2008 and early 2009, the global economy is expected to bounce back with a mild growth of 2.4% this year, the rebound being due to the massive and to some extent concerted policy actions undertaken by the major economies, the United Nations said on Wednesday.
In its annual report "World Economic Situation and Prospects 2010", the UN said that an increasing number of countries have registered positive quarterly growth of gross domestic product (GDP), along with a notable recovery in international trade and global industrial production. World equity markets have also rebounded and risk premiums on borrowing have fallen.
The UN report however says that the recovery is uneven and conditions for sustained growth remain fragile.
"The economic revival is driven in no small part by the effects of the massive policy stimuli injected worldwide since late 2008. This is an important turnaround after the free fall in world trade, industrial production, asset prices, and global credit availability which threatened to push the global recovery into the abyss of a new Great Depression in early 2009. The recovery is uneven and conditions for sustained growth remain fragile," the report cautions.
It further warns of
the failure to address two risks in particular which could cause the
global economy to enter into a double-dip recession. First, is the risk
of a premature "exit" from the stimulus measures to prevent
further financial sector fallout. Second, is the risk of a renewed significant
widening of the global macroeconomic imbalances, especially the
(In its "Global Economic Prospects 2010" report released Thursday, the World Bank said that the global economic recovery, now underway, will slow later this year as the impact of the fiscal stimulus wanes. Financial markets remain troubled and private sector demand lags amid high unemployment. The Bank cautioned that while the worst of the financial crisis may be over, the global recovery is fragile. It predicts that the fallout from the crisis will change the landscape for finance and growth over the next 10 years.
(The Bank said that global GDP, which declined by 2.2% in 2009, is expected to grow 2.7% this year and 3.2% in 2011. Prospects for the developing countries are for a relatively robust recovery, growing 5.2% this year and 5.8% in 2011. The GDP for rich countries, which declined by 3.3% in 2009, is expected to increase much less quickly - by 1.8% and 2.3% in 2010 and 2011, respectively. World trade volumes, which fell by a staggering 14.4% in 2009, are projected to expand by 4.3% and 6.2% this year and in 2011, said the Bank.
(While this is the most likely scenario, considerable uncertainty continues to cloud this outlook, said the Bank, adding that depending on consumer and business confidence in the next few quarters and the timing of fiscal and monetary stimulus withdrawal, growth in 2011 could be as low as 2.5% and as high as 3.4%.)
At a media briefing on the UN report Wednesday afternoon, Heiner Flassbeck, Director of UNCTAD's Division on Globalization and Development Strategies, said that one risk that has been mentioned in the report is that of an early withdrawal of monetary and fiscal stimulus. He highlighted two factors on the private sector side that can revive the economy once the government withdraws, namely, consumption and investment. Many people also believe that trade as such can be a factor that can bring about a recovery in the world economy.
He however noted a lot of fragility in both consumption and investment. On the investment side, the capacity utilization is very low. On consumption, he asked where are the big stimuli that would increase consumption. He said that employment is falling and unemployment is rising and that incomes of private households are flat.
It is very hard to see from the private sector that there will be a strong stimulus coming in the course of next year. That leads to the conclusion that "what we have seen is to a very large extent the effect of governments' stabilizing action, and if that is withdrawn, there is a real big danger of a second-dip recession occurring," he said.
He also pointed to
a lack of re-balancing of growth almost anywhere. For the surplus countries,
there has hardly been any re-balancing of growth, with one exception
The UNCTAD official further pointed to a clear disconnect between the financial markets and the real economy, in that the financial markets "recovered" much earlier than the real economy. This has a number of dangers, he added, citing amongst others several new bubbles in the world economy that have inflated in the last year.
He noted that the gamblers in these financial markets have been subsidized by very cheap government money through the central banks and that they are using it not for what it was intended - to make life for investors in real capital easier, and to play their role as intermediaries in the market, as well as to allow for easier credit - but they have used the money to inflate new bubbles. This is clearly a mis-allocation of money that was (intended) to help overcome the real recession, he stressed.
According to the UN report, global equity markets have rebounded and risk premiums on lending have fallen. International trade and global industrial production have also been recovering noticeably, with an increasing number of countries registering positive quarterly growth of gross domestic product (GDP).
"The economic revival has been driven in no small part by the effects of the massive policy stimuli injected worldwide since late 2008. It also reflects strong cyclical inventory adjustment," says the report, adding that this is an important turnaround after the free fall in world trade, industrial production, asset prices and global credit availability which threatened to push the global economy into the abyss of a new great depression in early 2009.
However, credit conditions are still tight in major developed economies, where many major financial institutions need to continue the process of de-leveraging and cleansing their balance sheets. The rebound in domestic demand remains tentative at best in many economies and is far from self-sustaining. High unemployment rates and the large output gap in most countries, along with a number of other factors, such as the possibility of a further spread of pandemic influenza A (H1N1) that could hurt economic activity, continue to pose challenges for policy-makers worldwide.
In addition, says the report, the global macroeconomic imbalances, which were part of the problem in the first instance, could widen again to form a source of renewed financial instability.
The UN forecasts that
global economic recovery is expected to remain sluggish, unemployment
rates will stay high and inflation will remain low. Developing countries,
especially those in
While necessary, the fiscal and monetary stimulus policies undertaken to counteract the crisis have at the same time become a source of concern, says the report. Some Governments fear that the rapid build-up of public debt could affect economic growth in the longer run and are calling for an exit of the policy stimuli.
However, as global demand is still weak, a premature withdrawal of those measures could abort the incipient recovery, the report cautions. Going forward, the most pressing policy challenges over the near term include maintaining the momentum of economic recovery through economic stimulus measures and re-balancing global growth towards a more sustainable path so as to avoid a re-emergence of the global imbalances, while, at the same time, facilitating high growth, especially for developing countries, and addressing the climate change challenge.
"After a sharp and synchronized global downturn - indeed the only contraction since the Second World War - the world economy is improving. An increasing number of economies showed positive growth in the second quarter of 2009, and momentum towards recovery continued to build in the third quarter. Nonetheless, because of the steep downturn at the beginning of the year, world gross product (WGP) is estimated to fall by 2.2% for 2009. Premised on the assumption of a continued supportive policy stance worldwide, a mild growth of 2.4% is forecast in the baseline scenario for 2010. According to this scenario, the level of world economic activity will be 7% below where it might have been had pre-crisis growth continued."
According to the UN report, in developed economies, consumer and investment demand remain subdued as a result of the continued rise in unemployment rates, the wealth losses incurred during the crisis and the desire of households and firms to rebuild balance sheets. Domestic demand is further constrained by continued tightness in credit supplies, despite more stable conditions in financial markets. Another important factor is that the impetus from the stimulus measures and the turn in the inventory cycle are expected to diminish over time.
The continued weakness of the world economy is manifest in the continued increase in unemployment. Through the end of 2009, the recovery will have been "jobless". Unemployment rates are expected to continue to rise well into 2010. Labour market conditions in developing countries are expected to remain difficult, says the report, citing as an example the fact that most of the 47 million new workers who enter labour markets worldwide each year will be searching for jobs in developing countries.
rates have fallen. The majority of countries have experienced significantly
lower inflation rates (disinflation) in 2009, while a growing number
of economies, mainly developed countries and a few emerging economies
Deflation, rather than inflation, should be a policy priority for many countries in the near term. Inflationary pressures as a consequence of ballooning government deficits and the ample liquidity injected during the crisis, if they emerge, will be more of an issue in the medium run, after the recovery has become more solid, and should not be of immediate concern, says the report.
Following a sharp deterioration in late 2008 and early 2009, the international economic environment for developing countries and the economies in transition has been stabilizing and improving, but it remains daunting. Certain categories of private capital flows are returning to some emerging economies, and external financing costs are normalizing, but the general external financing conditions for developing countries are expected to remain tight in 2010. Both global trade flows and world market prices of primary commodities rebounded during 2009, but the contribution of international trade to growth in developing countries is not expected to recover its full strength in the near term.
Net private capital inflows to emerging economies, which comprise some 30 large developing countries and the economies in transition, declined precipitously in late 2008 and early 2009, but have rebounded somewhat since. After peaking at about $1.2 trillion in 2007 before the crisis, the inflows halved in 2008, plunged further in 2009 to an estimated $350 billion, and are expected to recover to about $650 billion in 2010.
The financial crisis has also significantly affected world trade, says the report. Triggered by a retrenchment in import demand in major developed countries and more restricted access to trade financing, trade flows fell at an annualized rate of between 30% and 50% in most economies in late 2008 and early 2009. Trade flows have recovered since the second quarter of 2009. The rebound has been largely driven by the turn in the global inventory cycle, while import demand from consumption and business investment has remained weak.
Even given the recent rebound, trade flows for 2009 as a whole are still estimated to decline by more than 12%. A mild growth of 5% is forecast for the volume of world trade in 2010 along with the projected moderate recovery of global aggregate demand.
The report points out that governments worldwide have responded with massive fiscal stimulus measures to the tune of $2.6 trillion over 2009 and 2010, or more than 4% of WGP, while - especially in developed countries - another $20 trillion of taxpayer money has been set aside for financial sector rescue operations.
These policies have been effective to the extent that they have helped to stabilize global financial markets, support global effective demand and alleviate the economic and social impact of the crisis. Yet, these unprecedented responses have not been sufficient to induce a self-sustained process of recovery. At the same time, however necessary they might be in the crisis, these policies have also redistributed risks from the financial sector to other sectors in the broad economy and reallocated debts from the private sector to the public sector, as well as led to a substantial expansion of the balance sheet of central banks and considerable deterioration in government budget positions worldwide.
Despite positive signs, says the report, concerns also remain regarding the health of the financial sectors in major economies. The risk of new speculative bubbles remains as long as regulatory reforms to rein in high risk-taking and operations in markets for financial derivatives and other speculative instruments are not put in place. At present, an important number of banks still show signs of distress.
The report notes that a large number of countries have implemented fiscal policy measures to support aggregate demand (it highlights some fiscal stimulus packages adopted by 59 economies since late 2008, totaling $2.6 trillion). These packages consist of a wide range of measures, including increases in spending on public consumption and infrastructure investment and measures to boost disposable household income, through cutting taxes and increasing benefits and subsidies, as well as through tax cuts for businesses.
Although the impact of discretionary fiscal policies would typically show effect later than automatic stabilizers and monetary policy, new evidence suggests that fiscal policy in the form of government spending is most effective in the presence of market rigidities and liquidity constraints, as it can raise real wages and, hence, consumption. It is also a stylized fact that fiscal policy has the greatest effect when monetary policy is accommodative, as is the case in the current crisis.
The crisis and the
policy responses have led to a substantial widening of fiscal deficits
in most countries, resulting in most cases from a combination of declining
tax revenue and rising spending. The general government budget deficit
in the euro area is forecast to reach 6.5% of GDP in 2010, compared
to a pre-crisis level of
Rapidly widening budget deficits are causing public debt ratios to soar, which in turn have raised concerns about fiscal sustainability. As a consequence, there is mounting political pressure in many countries to end the fiscal stimulus and start consolidating government finances. The average public debt-to-GDP ratio in developed economies is expected to exceed 100% in 2010 and to move even higher thereafter.
"A premature withdrawal of fiscal stimuli, however, could well pull the plug on the nascent recovery, as much of the rebound has been a direct result of the policy responses. A fall back into recession caused by early withdrawal could well lead to another widening of budget deficits resulting from a further drop in tax revenue and could trigger a downward spiral of pro-cyclical fiscal adjustment."
A premature withdrawal of policy support poses a significant risk, as both the financial sector and the real economy continue on a fragile path. While mounting public debt could become a drag on growth in the future, immediate concerns should be focused on the continued weakness in financial sectors, persistent large output gaps and continued rising unemployment rates, which signal that the recovery is far from robust. An early phasing-out of stimulus measures could therefore exacerbate these weaknesses in the global economy and abort the nascent recovery, the report cautions.
Simulations using the UN Global Policy Model (GPM) suggest that an early withdrawal of the fiscal and monetary stimulus packages in the major economies could cause the world economy to dip into a double dip recession and sustain increases in public indebtedness. The double-dip recession resulting from this scenario would be most marked for the developed economies and the economies in transition. The subsequent recovery would be sub-par and slow.
The recession caused
by a premature withdrawal of stimuli would affect European countries
the most, followed by
The report analyzes
what would happen in a scenario of premature exit from fiscal stimulus
measures and concludes that it would cause an early aborting of the
recovery. Instead of solving the problem of high public indebtedness,
it in fact would worsen the situation as economic activity would continue
to slow. Policy-makers face a dilemma because sustaining the stimulus
measures as presently undertaken would lead to a renewed widening of
the global imbalances, with the
"Such a return to 'business as usual' would support a strong recovery of the world economy in 2010, but one that would not have a lasting effect," says the report, adding that this will lead to an inevitable further weakening of the dollar, but this by itself would not be enough to re-balance the global economy. Rather, loss is confidence in the value of the dollar could set off renewed turmoil in financial and commodity markets.
The report underscores that continued fiscal stimulus will be necessary to keep up global aggregate demand, and further pressure on financial institutions will be needed to cleanse their balance sheets, resume normal lending and avoid a return to pre-crisis excess. The immediate challenge for policy-makers will be to determine how much longer the fiscal stimulus should continue. Given the risk of a double-dip recession resulting from premature withdrawal, the stimulus should continue at least until there are clearer signals of a more robust recovery.
The report calls for three "re-balancing acts" to avoid a return to the unsustainable pattern of growth that led to the global crisis in the first place.
First, the pressure
on Governments to buoy global demand would need to diminish gradually
through renewed impulses from private demand. Second, the composition
of aggregate demand would need to be re-balanced to lend greater weight
to investment in support of future productivity growth, and especially
to initiate the transformative investments needed to meet the challenge
of climate change. Third, demand across countries will need to be re-balanced,
involving a shift towards external demand (net exports) in major deficit
countries, such as the
These three re-balancing
acts will require close policy coordination as they are strongly interdependent,
said the UN, indicating that the framework for "strong, sustainable
and balanced growth" launched by the G20 leaders at the
A successful framework for international macroeconomic policy coordination should consist of at least four components: developing a consensus on common goals through international consultations with outside mediation; addressing commitment problems by issuing multi-year schedules for policy adjustments; enhancing the context for mediation and the perceived legitimacy of the mediator; and initiating systemic reforms in the field of international monetary and financial affairs.
To support the enhanced framework for policy coordination, further progress on global economic governance reforms will need to be made on four related fronts, says the report. First, multilateral surveillance by the IMF will need to be extended well beyond the traditional emphasis on exchange rates, to address broader macro-financial surveillance and also to monitor the "sustainable re-balancing" process of the global economy. Second, more pervasive progress on governance reform of the IMF will be needed to add legitimacy to the institution's enhanced role in this respect and also for mediating multi-annual agreements.
Third, while the ongoing crisis has given strong impetus to macroeconomic policy coordination, there is no guarantee that all parties will remain committed to agreed joint responses. Having clear and verifiable targets for desired policy outcomes will help make parties accountable, and the possible loss of reputation through non-compliance should be an incentive to live up to policy agreements. Fourth, sustainable re-balancing of the global economy will require close coordination with other areas of global governance, including those related to development financing and the multilateral trading system, as well as with the UN Framework Convention on Climate Change.
The report says that the global financial crisis has further exposed major deficiencies in the international financial architecture, as well as failures of regulation and supervision at national levels. As the global economy recovers, more, rather than less, urgent efforts will be needed to spearhead reforms of international and national financial systems so as to prevent a similar crisis from recurring.
The risk of exchange-rate instability and a hard landing of the dollar could be reduced by having a global payments and reserve system which is less dependent on one single national currency, the report suggests. One way in which the system could naturally evolve would be by becoming a fully multi-currency reserve system.
However, it would not solve the problems of the tendency towards the emergence of important global imbalances and the related deflationary bias in the macroeconomic adjustment between deficit and surplus countries. Such deficiencies could be more readily overcome by pursuing the transition to a reserve system based on a true form of international liquidity, such as by expanding the role of special drawing rights (SDRs).
The G20 decided in April 2009 on a general SDR allocation equivalent to $250 billion in recognition of the need to boost international liquidity using an international reserve unit. Further steps forward could be to make SDR issuance automatic and regular and to link it to the demand for foreign-exchange reserves and the growth of the world economy. A key criterion for SDR issuance, withdrawal and allocation would be to provide counter-cyclical finance.
An SDR-based reserve system would also provide a basis for a better pooling of international reserves, as international liquidity would be made available on a counter-cyclical basis, reducing the need for individual countries to hold costly amounts of reserves on their own. A sustainable re-balancing of the world economy will not be possible without addressing the systemic flaws in the international financial architecture, the report concludes. +