World economy is recovering, but is it sustainable?
The state of the global economy is slowly beginning to improve with the support of massive fiscal stimuli, but the recovery is uneven across regions and conditions for sustained growth remain fragile. Uncertainties and risks still exist, as well as policy challenges, which need to be addressed.
The global economic landscape has begun to show signs of improvement. Since the second quarter of 2009, global equity markets have rebounded, risk premiums on lending have fallen and international trade and global industrial production have noticeably recovered. An increasing number of countries are starting to register positive quarterly growth of gross domestic product (GDP).
According to the World Economic Situation and Prospects (WESP) 2010, to be launched worldwide in the 3rd week of January, a mild growth of 2.4 per cent in the baseline scenario is expected for the global economy in 2010, compared with a rate of 7 per cent below where it might have been if pre-crisis growth had continued.
However, the speed of recovery is uneven among different economies: although still below their potential growth, developing countries, especially those in Asia, are expected to show the strongest growth in 2010, led by the economies of China and India, which are expected to grow at 8.8 and 6.5 per cent respectively. Meanwhile, the Russian economy, which is leading the turnaround among economies in transition, is expected to grow at 1.5 per cent in 2010 after a severe decline by 7 per cent in 2009.
Compared with developing economies, the major developed economies are not expected to provide a strong pull to global growth in the near future. The United States is expected to grow by 2.1 per cent in 2010, following an estimated downturn of 2.5 per cent in 2009, while the European Union and Japan will see a much weaker recovery, with GDP growth of no more than 0.6 and 0.9 per cent respectively.
But the circumstances for sustained growth remain fragile. Credit conditions are still tight in major developed economies, the rebound in domestic demand remains tentative at best in many economies and is far from self-sustaining, and high unemployment rates and the large output gap in most countries continue to pose challenges for policy makers worldwide. Further, the global macroeconomic imbalances could widen again to form a source of renewed financial instability.
Sustainable global rebalancing
Continued fiscal stimulus will be necessary to keep up global aggregate demand, amidst further pressures on financial institutions to cleanse their balance sheets and restore lending capacity. For policymakers, the immediate challenge 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. Although it is difficult to establish when and where the recovery has become robust, substantial improvements in employment conditions and reduction of output gaps will likely be meaningful indicators for establishing the turning point.
Three forms of rebalancing of the global economy would need to take place over time, in order 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 rebalanced 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 rebalanced, which would involve a shift towards external demand (net exports) in major deficit countries, such as the United States and a few others, and towards domestic demand in the major surplus countries, especially those in Asia.
Close policy coordination is required to achieve these three rebalancing acts, since they are strongly interdependent. Consumer demand in the United States, as one of the key drivers of pre-crisis growth, is expected to remain sluggish in the outlook, making a rebalancing across countries necessary. From the perspective of global imbalances, it would also be undesirable to have to rely again on this source of growth for the recovery. Public and private investment to address climate change can also be an integral part of the rebalancing efforts.
Strengthening policy coordination
The framework for “strong, sustainable and balanced growth” launched by the G20 leaders at the Pittsburgh Summit could prove an important step in the right direction. As part of this framework, G20 members with significant external deficits (mainly the United States) have pledged to undertake policies to support private savings and undertake fiscal consolidation while maintaining open markets and strengthening export sectors.
As elaborated in detail in the World Economic Situation and Prospects 2007, 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 strengthen global governance, further progress is needed on four fronts: extension of multilateral surveillance by the IMF well beyond the traditional emphasis on exchange rates, to address broader macro-financial surveillance and to monitor the “sustainable rebalancing” process of the global economy as outlined; more pervasive progress on governance reform of the IMF to add legitimacy to the institution’s enhanced role in this respect and also for mediating multi-annual agreements; strengthening accountability through clear and verifiable targets for desired policy outcomes, including a mechanism for penalizing non-compliance; and close coordination with other areas of global governance, including those related to development financing and the multilateral trading system, and the United Nations Framework Convention on Climate Change.
Reforming the global reserve system
The present global reserve system, which uses the United States dollar as its major reserve currency, suffers from a number of systemic flaws that have been well documented since its creation. The key deficiencies could be addressed by either evolving the present reserve system into a full multi-currency reserve system or, preferably, by moving to a reserve system based on SDRs.
Policy actions will make the difference
The effectiveness with which policy makers address these three challenges will ultimately determine whether the global economy will recover or once again slide into recession.
WESP 2010 provides in-depth analysis of policy responses from governments and financial institutions. This and further analysis and forecasts are backed up by detailed macroeconomic statistics.
More information on WESP.