World Faces Serious New Economic Challenges

By Olivier J. Blanchard 

Let me begin with some good news. The global recovery has evolved better than expected.  We at the IMF now forecast global growth to reach 4.2% in 2010, an upward revision of 0.3% from our  January forecast, and 4.3% in 2011. Alongside growth, global trade has also shown a strong rebound, and so have capital flows.  And, as discussed in the newly released Global Financial Stability Report, financial market conditions and stability have improved.

These good global numbers hide however a more complex reality, namely a tepid recovery in many advanced economies, and a much stronger one in most emerging and developing economies.

Let me discuss each group in turn.   

We forecast growth in advanced economies to be 2.3% for 2010 and 2.4% in 2011.   This is just not enough to make up for the ground lost during the recession.  Output for these countries is now 7% below its pre-crisis trend, and this “output gap” is expected to remain large for many years to come.  Associated with this prolonged output gap is persistent high unemployment.  We forecast the unemployment rate in advanced economies to reach 8.4% in 2010, and to only decline to 8.0% in 2011.  

The main factor behind this weak performance and this prolonged output gap is weak private demand.  In the United States, consumers, who were the drivers of the economy before the crisis, are being more prudent.   In Europe, where banks play a central role in financial intermediation, the weak banking sector limits credit supply.   In Japan, deflation has reappeared, leading to higher real interest rates, and putting in danger an already weak recovery.

By contrast, we forecast growth in emerging and developing economies to be much stronger, 6.3% in 2010, and 6.4% in 2011.   Developing Asia is in the lead, with forecasts of 8.7% for 2010, and 8.6% in 2011.   Growth appears not only strong but sustainable.   While fiscal policy often played a central role in supporting activity in 2009, private demand is strengthening, and can sustain growth in the future. 

Serious new challenges

 The asymmetric nature of the recovery creates serious challenges, both for advanced and for developing and emerging market economies. 

In advanced countries, the main challenge is fiscal consolidation.  A year ago, the risk was that private demand would collapse, leading to another Great Depression scenario.  The priority was thus to implement fiscal stimulus programs, and avoid this catastrophic scenario. This we did.  

Thanks in part to the stimulus programs, demand did not collapse, and has indeed started to grow again, if only weakly.  One year later however, the risk has shifted location.   The loss in fiscal revenues associated with the loss in output is threatening to lead, if not contained, to a debt explosion.   In most countries, fiscal consolidation must increasingly be the priority.  

Emerging and developing countries face a different set of challenges.   One of them is large capital inflows.   Higher growth prospects and higher interest rates are attracting large capital inflows.   Such inflows, especially when driven by growth prospects, are fundamentally good news, but we have learned from experience that they can also lead to booms and busts.  Thus, the main policy issue facing recipient countries is how to best accommodate these flows, how much to let the currency appreciate, how to use macroeconomic policy, how to use macro-prudential tools, reserves, and capital controls, to best avoid excesses and maintain stable growth. 

Solutions closely linked

Interestingly, and importantly, the solutions to the challenges facing advanced and emerging countries are closely linked:  

In advanced economies, fiscal consolidation is needed, but is likely to have an adverse effect on demand and thus on growth.   To offset these adverse effects and maintain growth, advanced countries, as a whole, may need to depreciate their currency so as to increase their net exports.  

 This, in turn, implies that emerging and developing countries, again as a whole, do the reverse, namely let their currency appreciate, and reduce net exports.  It is in their global interest to do so, as this adjustment may be needed to sustain growth in advanced countries, and, by implication, strong growth in the rest of the world.   In many countries, it is also clearly in their own, direct, interest to do so. 

In China for example, a shift away from exports towards domestic consumption—a shift that requires both structural measures to decrease saving, and an appreciation of the currency—appears highly desirable. 

New stage of the crisis

To conclude, we find ourselves at an important new stage of the crisis. A global depression has been averted. The world economy is recovering, and recovering better than we had previously thought likely. This is certainly welcome news. 

But new—and no less formidable—challenges have presented themselves. Achieving strong, sustained and balanced growth will not be easy.  It will require more work—namely fiscal consolidation in advanced countries, exchange rate adjustments, a rebalancing of demand across the world.

These are the tasks facing policymakers over the next few years.

4 Responses

  1. Having participated in two exciting days with The World Bank Annual Bank Conference in Development Economics (ABCDE) 2010 has received a number of perspectives and new business cards. This year’s theme was the hot topic “Development Challenges in a Post-Crises World” and organized jointly with the Government of Sweden. Hosts for Monday evening’s dinner at the Vasa Museum was finance minister Anders Borg and Development Cooperation Gunilla Carlsson.

    The conference included some of the most pressing global challenges such as environmental and climate issues, development issues in the light of the financial and economic crisis, failing states, and human and social development – topics of high priority for world leaders, policy makers, researchers and debaters.

    Among the speakers was recovered Nobel Laureates Elinor Ostrom, Joseph Stiglitz, James Mirrlees, Robert Solow.

    I had fruitful talks with Nobel prize winner Eric Maskin, Justin Yifu Lin Chief Economist / Senior Vice President of World Bank and Erik Berglöf Chief Economist for the European Bank for Reconstruction and Development (EBRD).

    From state of the world, emerging economies, the old economies, the euro crisis, municipal finance and how to create new growth after the crisis was handled. We were all broadly that it probably takes a long time before the world economy recovers the situation before the crisis.

    The picture you get days after calling for self-understanding of the Swedish economic situation and our position in the global economy. Basically, we must bear in mind that Europe’s monetary union is shaken by a serious internal instability and that several countries, despite measures will be a long time, have to struggle with growing public debt.

    The financial crisis has also led to increasing imbalances in the world. Today, around 1.2 billion of the world population in poverty, at the end of the year is estimated to have increased the sum tilll approximately 1.8 billion.

    What we can say is that Sweden welcomed the forefront of Europe’s economic recovery and the voices that echo the danger is over. But then it is important to note that Friday’s high GDP figures in Sweden only for the first quarter and that we are one of the world’s most export-dependent countries. I believe that a recovery should be on more solid basis than that for us to beat our chests and say that we are best in class.

    We note that the recent crisis, policy has worked; stability has largely returned to the economic and financial systems. Kris policy is still needed but now also handled the aftermath of heavy ten years skuldexcesser and a deep recession and severe financial crisis.

    But even if it is shaky in many countries so different in the economic situation in Sweden from a few European countries. Sweden, Estonia and Bulgaria are the only member countries in the years keep their budget deficits under 3 percent of GDP. That means we do not have to build a new debt mountain as a consequence of the financial crisis.

    The background can be found in the public finances in Sweden was strong when the crisis broke out in full force. Current Government completed the previous government and maintained a surplus in the state budget.

    Another reason is that parliament has so far escaped having to go into expensive support for the financial sector. The takeover of Kaupthing and Carnegie was no economic bang for the taxpayer. And the new stabilization fund are paid by the banks themselves.

    The new figures presented to the state budget also shows surprisingly large surplus in the state budget by as much as 98 billion for the period. The surplus for the period January to April amounted to 98 billion, which is 26 billion more than previously estimated.

    Sweden’s prosperity was based on exports mainly directed to Europe and the United States. In Greece, if extended crisis in world economies, it becomes a weaker growth than previously forecast pointed to.

    Many countries will pursue a tighter fiscal policy to put their public finances, which could dampen growth in the slightly longer term. Euro crisis can also give substantial financial turbulence with increased systemic and refinancing risk.

    Although the short-term turmoil is gone, so are the long-term left. It is about many countries must reduce their budget deficits and to overcome growing public debt.

    EU countries will mainly focus on spending cuts but also tax increases. This means tighter, which means reduced demand for goods and services from Swedish export companies.

    But there is, as you know two sides of the coin.

    The recent weakening of the krona and the euro may also create good growth benefits for both Sweden and Europe and strengthening the export position of businesses in the international arena, particularly in China.

    In the long run it may well mean that Sweden is not affected by the fall in GDP, but can handle the effects of the crisis relatively well-Greece. Of course, provided that it does not spread to very large dimensions or affecting the financial sector with a second setback and a new financial crisis.

    If I were to sum up the conference with what we have learned from the financial crisis, I would like to say:

    “We have learnt a lot about what we do not know and understand. And how hard it is to learn …”

    On Thursday I go down to Bulgaria to discuss the euro crisis and the international economies, together with Europe’s leading economists and EU Commission.

    Now we need to monitor developments.

    Lena Bäcker

    Chief Economist
    The Swedish Local Government Debt Office
    and member of
    The European Chief Economist Network

  2. For a long time, we have searched high and low trying to find persuasive indicators that the economy has really turned. Now we can see that the indicators also getting the facts.

    The financial crisis has once again opened our eyes that our economies are completely integrated with other countries. What started with a mortgage crisis in the U.S., spread like a cold blanket over world economies.

    From the international perspective, we can see interesting economic shifts as a result of the crisis. I note that China is now overtaking the U.S. as the world’s largest car market. In fact, today BRIC countries (China, Brazil, Russia and India) account for 18% of world market capitalization. Of the world’s 20 largest companies, five are Chinese and one is Brazilian. Of the world’s largest 5,000 companies, close to 1,000 are in the BRIC countries.

    It is China who is the strongest coming out of the global crisis and the country is now catching up with Japan in growth. This development can affect the entire global economy through consumption, tariffs, etc.. My assessment is that we underestimated the power and potential of China but also in the other BRIC countries. Especially clear was that in Copenhagen, which clearly showed what is now happening in the world, the U.S. and China, are the major economic countries.

    For Sweden, things looks pretty bright and we can become one of the countries seeing the fastest recovery in the economy, with redundancy notices falling off.

    More and more companies in the country are starting to recruit–mainly the services sector. Instead of a peak in the unemployment rate of 12%, we are talking today about some 9% – 10% of unemployment. My assessment is that Sweden was in crisis with a fundamentally sound economy and is now also well positioned for a recovery.

    But we must not forget that we are a small open economy that is dependent on our environment where domestic consumption alone cannot account for a strong and stable growth. We also have before us a major employee bargaining period,with approximately 3.3 million employment contracts to be renegotiated. In conclusion I would say that the Swedish economy is still weak but growing stronger.

    Lena Bäcker

    Chief Economist
    The Swedish Local Government Debt Office
    and
    member of The European Association of Public Banks (EAPB) Chief Economist Network

  3. As I have predicted, the IMF had to revise upward its economic growth forecasts, esp. for the USA. I am sure that it will have to revise them again for the third time in October. Maybe the IMF should revise its macroeconomic models, putting monetary policy at the epicenter of macroeconomic fluctuations (see a paper by Adrian and Estrella linking monetary, financial and business cycles).

    • You’ve over looked price inflation and exchange rate manipulation among IMF trading member nations to account for an “illusion” of economic growth.

      Instead, the number of tons of natural resources extracted and processed, number of units of products ordered and shipped, and number of units sold at retail outlets absent prices needed for an accurate measure of (+/-/0) in economic activity.

      Since some of these are service economies, the number of hours worked per
      person per week and number of persons employed measure “real
      economic” change. Especially note, financial assets must identified and set aside when measuring GDP of each IMF member nation. As creation of “financial products” remains a private sector clouded by unknown processes yet extracts prior “real savings”. Moreover, “carbon credits/set off” creation, offerings, sales, and proofs of “results” must be subjected to IMF supervision.

      As there are yet to be defined economic results to be subject to numerical analysis before including each in a nation’s GDP? “Loans” are contractual obligations with set interest rates and pay back schedules. “Investments” are other than “loans”. “Carbon credits/set offs” created and sold are neither loans
      nor investments. A looming economic problem wouls be set aside.
      Granted, more analysis will be needed.

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