Is the Global Recovery For Real?

Originally published by the Carnegie Endowment for International Peace
Participants: Hans Timmer, Philip Suttle, Uri Dadush, Jörg Decressin

The global economic recovery is real, but it continues to rely on critical government support. With Asia and emerging markets leading the way, the world economy is beginning to grow again, but the recovery could be thwarted if leaders prematurely abandon measures that currently support the economy.

The World Bank’s Hans Timmer, International Monetary Fund’s (IMF) Jorg Decressin, Institute of International Finance’s (IIF) Philip Suttle, and Carnegie’s Uri Dadush discussed the emerging global recovery in an event moderated by Pieter Bottelier, visiting scholar at Carnegie.

Hans Timmer, lead economist and manager of the Global Trends Team in the World Bank’s Development Prospects Group, emphasized the importance of emerging markets in the economic rebound and noted their conditions are clearly improving.

• Following the eruption of the financial crisis in the United States, the decline in world trade was led by declines in developing countries, but recent improvements have come mainly from emerging economies. For instance, Asian, and particularly Chinese, demand is largely responsible for Asia’s recently improved export growth.
• Bond spreads are falling and commodity prices are bottoming out, providing encouraging news that the recovery in emerging markets can be sustained. Concerns about oil price volatility, which could hold back growth in developing countries, are exaggerated—much of the volatility has come from shifts in the value of the dollar, with real oil prices remaining relatively stable.
• Nevertheless, the recovery may not be as dynamic as the data appears to indicate, and may instead reflect a simple bottoming out of investment after sharp falls in recent quarters.

Jörg Decressin, chief of the IMF’s World Economic Studies Division, highlighted the recovery’s dependence on government policy and public demand, and outlined the IMF’s projections for economic developments in the coming months, predicting a tepid world recovery.

• Despite dramatic world trade and manufacturing improvements, consumer confidence in advanced economies, though rising, still remains very low. Governments must fill this “demand gap” until consumer spending rebounds. Until this occurs, policy makers should not mistake the current supported recovery for a sustainable one or risk revoking stimulus funds too early.
• Current accounts need to be brought into better balance, particularly in countries with large deficits. However, for that to occur, demand must rise elsewhere. Stimulus in China boosted import demand and helped to rebalance trade, but the Chinese effort alone is neither large nor sustainable enough to reach the necessary level of change.
• Historical evidence suggests that recoveries after banking crises tend to result in sustained output losses in current account surplus countries, while current account deficit countries experience both output losses and prolonged slowdowns in growth. The IMF is projecting a similar outcome for the coming years.

Philip Suttle, director of Global Macroeconomic Analysis at the IIF, highlighted factors supporting synchronized world growth and explained that recent favorable growth trends are likely to persist for at least the next six months.

• The need to rebuild inventories, the easing global financial conditions, the return of capital spending, and the bottoming of housing markets are all likely to contribute to growth. Suttle also suggested that labor market conditions may improve sooner than expected.
• However, Suttle noted three risks for a potential “double-dip”:
• Emerging markets could fail to deliver on growth, which is unlikely.
• More financial turmoil could occur, so troubled markets, such as commercial real estate, should be closely monitored.
• Policy makers may be forced by market developments to tighten policy too soon. Though inflation is not predicted, inflation forecasts are historically very poor; if inflation flares up, policy makers may act too early.
• In addition, Suttle noted that, having learned from past experience, emerging economies put macroeconomic policies in place in the years before the crisis. Those policies were essential to their success in the current recovery.

Carnegie’s Uri Dadush similarly urged leaders to maintain current policies until the economic recovery is clearly established.

He also noted that, given the extremely depressed level of economic activity and the strain implied for consumer and firm balance sheets, the global recovery cannot be a slow one. Otherwise, it would likely become aborted. For example, a slow recovery would imply continued increases in unemployment and in the incidence of defaults and foreclosure.

• Historical experience of previous banking crises suggests that the recovery will be slow and protracted, but “forecasting straightjackets” can be misleading . Every crisis is different. An important determinant of the return to growth is the speed at which households and firms restructure their balance sheets.
• U.S. firms appear to be making this adjustment very quickly relative to those in other countries. Big declines in inventories, employment, and investment have enabled labor productivity to increase and corporate profits to rise in the last two quarters. Once demand recovers convincingly, U.S. firms will be in a position to expand employment again quickly.
• Provided that exports are not a drag to growth in Asia, the region will continue to grow, driven by domestic demand, with the private sector in the lead. However, Asia alone cannot pull the world out of the recession. The United States, Europe, and Asia must rely on their own restructuring and domestic demand for recovery.
• The importance of global rebalancing for world recovery is over-emphasized. Rebalancing does not increase global demand; it only redistributes it. Furthermore, it is already happening—the U.S. deficit is declining, China’s surplus is falling, and the surpluses of oil-exporters have come down dramatically.
• Developing countries are on a much higher long-term growth path than advanced economies, but the two remain closely coupled, in the short run, through demand effects and international capital markets. For example, while the Chinese stock market recently set the tone for world stock markets, big trade complementarities persist between advanced and developing countries rather than among South-South economies.
• Policies must persist until the recovery gains additional traction. Revenue and tax declines have had a much more pronounced effect on mounting government debt than has stimulus spending; withdrawing stimulus too early may ultimately cost tax payers much more through lost revenues than they would gain through the implied stimulus savings.
• While the process of eliminating excess liquidity after a solid recovery may be quite straight-forward in technical terms, the timing of raising interest rates may be far less clear. Inflation expectations or lagging unemployment may create political pressures to act too soon or too late. A large fiscal deficit will make the job of tightening monetary policy politically difficult.

Finally, panelists called on participants in the coming G20 meeting to steadfastly maintain stimulating policies, as well as to commit to better financial regulation that would forestall the next crisis.