Global action required on fiscal front
A united effort is needed to shake the world out of its torpor, writes Ashoka Mody.
As the year comes to an end, it looks like the world economy will remain stuck in low gear. For those reading the tea leaves of global recovery, the third-quarter gross domestic product numbers offered no solace.
While the US is ahead of the pack, some of its gains could soon be lost, as accumulating inventories begin eroding profits. Despite glimmers of hope, the eurozone and Japan are struggling to cross the 1 per cent threshold for annual economic growth. And the emerging economies are all slowing, with Russia practically at a standstill.
Not surprisingly, a catchphrase in economic policy debates nowadays is "secular stagnation", the idea that excess savings chronically dampens demand. Economist Robert Gordon has also argued that the world is low on economically productive ideas. But before we despair, there is work to be done.
The co-ordinated fiscal stimulus that saved the world from economic collapse in 2009 disappeared too quickly, with governments shifting their focus to domestic politics and priorities. As domestic policy options have been exhausted, economic prospects have dimmed. A renewed emphasis on stimulus must be augmented by global
co-ordination on the timing and content of stimulus measures.
The crisis was and remains global. Trade data tell the story: after increasing by about 7 per cent annually in the decade before 2008, world trade fell faster than global GDP in 2009 (and more sharply than during the Great Depression). Once the brief stimulus-fuelled recovery faded, growth in world trade again slowed quickly, falling to 2 per cent year on year over the past 18 months. Disappointing export performance is largely responsible for the recent weakening of economic growth prospects.
At the end of 2008, when the scale of the impending economic destruction was not yet apparent, Olivier Blanchard, the International Monetary Fund's chief economist, boldly called for a global fiscal stimulus, stating that, in these "not normal times", the IMF's usual advice - fiscal retrenchment and public-debt reduction - did not apply. He warned that if the international community did not come together, "vicious cycles" of deflation, liquidity traps, and increasingly pessimistic expectations could take hold.
Fortunately, world leaders listened, agreeing in April 2009 at the G20 summit to provide $US5 trillion in fiscal stimulus. The US and Germany added stimulus amounting to about 2 per cent of GDP. And China's banks pumped massive amounts of credit into their economy, enabling it to sustain import demand, which was critical to the global recovery. But hubris set in and parochial interests took over. Before the wounds had fully healed, the treatment was terminated.
The worst offenders were the US and Germany, which shirked the responsibility to protect the global common good that accompanies their status as economic hegemons. Britain, with its contrived rationale for fiscal austerity, was not much better. Fiscal stimulus by these three - with smaller contributions from France and China - could have continued the necessary healing. Countries seem to think that monetary policy measures are their only option. But, whereas fiscal stimulus boosts growth at home and abroad, enabling mutual reinforcement through world trade, monetary policy is guided primarily by domestic goals, and, in the short term, one country's gain can be another's loss.
The US leads the world in monetary policy ambition. Researchers Cynthia Wu and Fan Dora Xia estimate that the US Federal Reserve's open-ended asset purchases (quantitative easing) have led to an effective US policy rate of minus 1.6 per cent. QE helped US exports by weakening the US dollar relative to other currencies. Once the Japanese engineered their own QE, the yen depreciated. That has kept the euro strong.
The weakest of the "big three" developed economies - the eurozone - has thus been left with the strongest currency. In the third quarter of this year Germany's export growth slowed and French exports fell. After a spike earlier in the year, Japan's exports have also contracted. Only US exports have maintained some traction, thanks to the weaker US dollar.
In the 1930s, after the gold standard broke down, world leaders could not agree on co-ordinated reflation of the global economy. In his book Golden Fetters, economist Barry Eichengreen said the lack of co-ordinated action dragged out the global recovery. Such delays are costly, and risk allowing pathologies to fester, prolonging the healing process further.
Now, Blanchard should make an even bolder call. These are still not "normal" times, and the "vicious cycles" persist. Another global fiscal stimulus - focused on public investment in infrastructure and education - would deliver the adrenaline shot needed for a robust recovery.
More public investment is twice blessed. It can shake the world out of its stupor; and it can safeguard against "secular stagnation". The US, Germany, Britain, France, and China should act together to provide that boost. Otherwise, a sustainable global recovery may remain elusive.
Copyright: Project Syndicate, 2013