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Prospects for global growth
By Robert Fauver, former G7/G8 sherpa, United States
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The rate and pace of economic recovery have varied across the globe, with the US leading the way in the industrial world and China showing strong growth in the emerging economies
As leaders gather for the G8 Muskoka Summit on 25-26 June, 2010, the short-term prospects for growth are stronger than earlier anticipated. The latest forecast by the International Monetary Fund (IMF) suggests that for 2010 “world output is expected to rise by about 4.25 per cent, following a 0.5 per cent contraction in 2009”. As such the risks appear to be on the downside.
Monetary policy has been expansionary and has included unprecedented injections of liquidity in many countries. In addition, fiscal policy – especially in industrial countries – has provided strong stimulus to the recovery process. Budget deficits are running at unsustainable rates in many countries.
In the industrial world, growth recovery has once again centred on the US economy, with Europe and Japan lagging behind the rebound. In the emerging economies, China leads the pack with a surprisingly strong 10 per cent real growth projection for 2010. India is close behind, expecting 9 per cent real growth.
While the short-term growth outlook is encouraging, other parts of the situation are not. For the first time in history, the recovery in the industrial world is lagging significantly behind that of many of the developing countries. Historically, the developing world has depended on the industrial world’s demand for its exports in order to provide growth stimulus. Now the recovery is led by the developing world. One real question is whether the developing world can be an engine of growth for the global economy. Are developing countries’ propensities to import – based on domestic demand growth and not export growth – significant? And are their import volumes large enough to promote global growth?
On the external side, the sharp recession did produce a much-needed reduction in external imbalances in the industrial world – particularly in the United States. The US current account deficit, which was running at an unsustainable rate of 6 per cent of gross domestic product (GDP) prior to the global recession, dropped to 3 per cent in 2009. Most of this improvement is likely temporary since it reflects a slowdown in imports due to the recession in the United States. Forecasts indicate that the deficit will start growing again this year. Germany’s current account surplus narrowed a bit in 2009 to a little less than 5 per cent of GDP, but it is projected to rise again this year and will approach 5.5 per cent next year. China’s surplus rose to a staggering 11 per cent of GDP in 2007, but narrowed to a little less than 6 per cent in 2009. It is projected to rise steadily in coming years. Clearly the recession has reversed some of those imbalances. The question is whether this is a temporary reversal or a structural one.
The recession has led to very large fiscal and monetary efforts to stimulate domestic demand – especially, but not exclusively, in the industrial countries. Rebalancing the world economy must also include a return to sustainable fiscal positions in many countries. And it must include the eventual withdrawal of the extraordinary monetary easing that has taken place in the past year or so.
It is almost axiomatic to suggest that one way or another, global imbalances will adjust over time. Rebalancing of external accounts will, in the end, occur whether or not governments undertake separate or coordinated policy actions. Eventually, market forces will react to unsustainable deficits or surpluses and bring about rebalancing through foreign exchange market reactions to the situation. A rebalancing not generated by government tends to result in an overshooting of exchange rate movements and a relatively dramatic rebalancing process caused by relative price changes.
Without appropriate policies coming from China, the adjustment of imbalances in the industrial world will be very slow – or will move toward greater imbalances. China needs to foster greater appreciation of its exchange rate. It has witnessed a relative devaluation of the yuan during the recession as the dollar – to which the yuan has been linked – has moved downward against the yen and the euro. In addition, China could help the global adjustment process if it shifted away from export-focused growth and substituted domestic demand growth. At first blush, this seems to be the aim of authorities with their recent stimulus policies. However, China’s marginal propensity to import due to domestic demand is quite low. Most of its import demand is related to production for export. Hence the role of China as an engine for global growth or external rebalancing based on domestic growth is not very significant.
Collectively, governments can decide – perhaps through the G8 or G20 process – that coordinated demand management could foster smoother adjustment than either going it alone or letting markets bring about the adjustment. Deficit countries need to foster policies that encourage domestic saving over domestic spending. This holds for private and public sector decisions about savings and spending.
It is important that in most economies government stimulus needs to be withdrawn very carefully. None of the deficit countries should move precipitously to rebalance their savings and consumption. The unwinding of government monetary and fiscal stimulus in the industrial world too early would risk damaging the emerging yet still fragile economic recovery.
Surplus countries, on the other hand, need to foster policies that encourage consumption over savings. This policy switch will be tricky to implement, especially as the output gaps in several major developing countries is closing rather rapidly. This situation argues for a modest tightening of monetary policy in some key developing countries. A rise in interest rates, if coupled with an easing of capital controls, would also foster exchange rate appreciation, which would help facilitate the adjustment of imbalances.
For the industrial countries – most of which are still in the fragile recovery stage – the withdrawal of monetary support is less urgent and more precautionary than a move needed to cool off domestic pressures. While the unwinding of recent extraordinary monetary ease may be warranted, some important degree of ease is still necessary. Additionally, continued monetary ease will likely prevent unwanted exchange rate appreciations. A gradual removal of fiscal stimulus is perhaps more important for many industrial countries, in order to rebalance savings/spending propensities. In particular, a public announcement of a medium-term strategy for reducing fiscal deficits could stabilise expectations in many of the industrial countries.
If the weak recovering European countries move too quickly in implementing an exit strategy, their fragile recovery will quickly weaken further. Their contribution to global rebalancing should be to run trade and current account deficits as opposed to relying on export surpluses to help domestic growth as they have for the last decade.
For the United States, a serious plan for the medium-term reduction of the fiscal deficit is critical to a sustainable recovery. The Obama administration’s medium-term budget submissions indicate that government spending will average something on the order of 26 per cent of GDP for the next ten years. Historically, federal revenues have averaged 19 per cent of GDP. This 8 per cent of GDP deficit is unsustainable and will need attention.
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