The global economy is being hampered by a failure of co-ordination. At last week’s meetings of the International Monetary Fund, disunity was mostly evident in political wrangling over reform in the Euro zone and United States. But it was also evident in slowing growth in emerging markets. Though the developed world needs to work off its excess debt, it’s hard to see other countries picking up the slack.
The biggest short-term risks to growth lie in the West, particularly in the Euro zone. The launch of the European Stability Mechanism bailout fund — and the European Central Bank’s promise to buy the bonds of any country that seeks help — have eased immediate fears for the single currency’s future survival. However, until Spain actually seeks a bailout — and other Euro zone countries make clear what reforms they will demand in return for support — it’s far from certain that Europe’s latest “firewall” will be more effective than its predecessors.
The United States faces the opposite challenge. Unless Washington can strike a deal in the next few months, the country will plunge off a “fiscal cliff” of automatic spending cuts and tax hikes. As Tim Geithner, the US Treasury Secretary, argued in Tokyo, it should be easier for politicians to negotiate a package that avoids deep cuts than for them to agree on imposing more austerity. Even so, there is a risk that the United States will shoot itself in the foot.
The fear of shocks is a drag on markets, and on growth. As Larry Fink, chief executive of Blackrock, the giant asset manager, argued in an interview with Reuters, investors can only guess at the financial damage from a euro zone break-up. As long as it is a possibility, they will remain cautious.
However, even if big mistakes are avoided, the world is still growing less quickly than previously expected. The IMF’s central forecast for the global economy is based on the assumption of no renewed Euro zone turmoil or self-imposed austerity in the United States. Nevertheless, the fund last week scaled back its growth prediction for the world to 3.3 per cent this year and 3.6 per cent in 2013.
In the developed world, public and private sector debt burdens taken on during the boom and subsequent bust are dragging on growth. As the IMF acknowledged last week, government spending cuts have had a bigger-than-expected effect on the private sector. Moreover, most of the world’s largest economies are simultaneously grappling with overhanging debt. While each country might be following a rational path, the cumulative result is a recipe for global stagnation.
Until recently, the hope was that emerging markets would take up the slack. However expectations have been scaled back: GDP growth in Asia averaged 5.5 per cent in the first half of the year, according to the IMF. While that’s still much healthier than the West, it’s the lowest rate since the 2008 financial crisis. The main reason is that activity in many of these countries is still heavily dependent on the health of Europe and the United States. Over time, emerging markets – and particularly China, the world’s second-largest economy – are expected to shift their focus towards domestic consumption. That, in turn, should help the West adjust. But such a shift requires huge reforms that, even if implemented, will take years to have an impact. The 9.9 per cent jump in China’s exports in September is hardly evidence of a rebalancing economy.
Likewise, India’s new finance minister has recently cut fuel subsidies and decided to open up the country’s retail, airline and insurance sectors to more external investment. But the benefits to growth remain distant, while political opposition is immediate.
That leaves central banks. In the United States, the euro zone and Japan, monetary authorities are all making a renewed push to avoid deflation. However, each new bout of asset-buying seems to have a smaller impact than before. Meanwhile, ultra-low interest rates distort investment and lift asset prices.
There are some bright spots: the US economy is making positive noises amid signs that the housing market has finally bottomed out. If it can avoid self-inflicted pain, that’s a welcome sign. But hopes that, in the aftermath of the financial crisis, the global economy would simultaneously rebalance and recover are still disappointingly distant.