Friday, October 22, 2010


THE optimism that overcame global governments when growth figures for the last quarter of 2009 were released is fast receding. Growth has slowed sharply in the subsequent two quarters and unemployment rates are in danger of rising further. In the United States for example, growth in the last quarter of 2009 which was placed at 5 per cent relative to the corresponding quarter of 2008, is estimated to have fallen to 3.7 and 1.6 per cent in the subsequent two quarters. Unfortunately, this occurs at a time when the resolve to address the crisis has considerably weakened.

Not surprisingly, on September 9, the OECD which had, like many other organisations, been upbeat about the recovery of the world economy from the Great Recession, issued an interim assessment that reflected a new scepticism. “The world economic recovery may be slowing faster than previously anticipated”, it argued, with growth in the Group of Seven countries in the second half of 2010 projected at around 1½ per cent on an annualised basis compared with its earlier estimate of around 2½ per cent in the Economic Outlook released in May.

This was of significance because 2009, which was otherwise a depressing year, ended on an optimistic note. Considering the year as a whole, growth was negative in the leading economies and highly so in Japan, Germany and the UK. The recession that had set in at the end of 2007 had revealed itself in 2008 and intensified in 2009. What was most disconcerting was the sharp increase in unemployment rates in the US (from 5.8 per cent in 2008 to 9.3 per cent in 2009) and the high levels at which they stood in Germany (7.5 per cent), France (9.4 per cent) and the UK (7.5 per cent).
However, as noted above, by the time full year’s figures for 2009 were available there was cause for optimism. The quarter-on-quarter annual growth rates seemed to suggest that the recession was already bottoming out in the third quarter of 2009 and had touched respectable levels in the last quarter, especially in the United States, Japan and France. The world it appeared was well on the way to recovery even though the high unemployment levels were still a cause for concern.


Unfortunately, that optimism has been dashed by performance during the next two quarters, when growth has decelerated quite sharply in the US and Japan, though it has gathered momentum in Germany and improved elsewhere in Europe. The difficulty is that Germany’s success as an exporter is often at the expense of other countries in the eurozone. Therefore, it is this turn over the first two quarters of 2010 that has affected the OECD’s projections and precipitated a sense of gloom.

It must be noted that the IMF has been more optimistic in its World Economic Outlook released in time for the annual meetings of the World Bank and the IMF held in October. It projects world output to grow at 4.8 per cent during 2010, as compared with a contraction of 0.6 per cent in 2009. This, of course, is largely because of the optimism generated by the sharp recovery in the emerging markets of Asia and Latin America. In fact, the IMF has been forced to recognise the considerable unevenness in growth performance. It notes that: “The United States and Japan experienced a noticeable slowdown during the second quarter of 2010, while growth accelerated in Europe and stayed strong in emerging and developing economies.” And again that: “Household spending is doing well in emerging market economies, but in advanced economies, low consumer confidence, high unemployment, stagnant incomes, and reduced household wealth are holding consumption down.”

The recognition of these differences is partly visible in the optimistic growth projections. The emerging and developing economies are expected to grow by 7.1 per cent in 2010, as compared with 2.5 per cent in 2009. On the other hand, the advanced economies are expected to grow by 2.7 per cent in 2010, as opposed to the contraction of 3.2 per cent they experienced in 2009. This modest recovery too is to an extent due to the significant turnaround in the newly industrialised Asian economies (included by the IMF among the advanced) from -0.9 per cent in 2009 to 7.8 per cent in 2010. In sum, the core of capitalism as we know it today is even in the optimistic projections of the IMF expected to grow rather slowly this year.

The fundamental problems remain the same. Household balance sheets are under strain because of the legacy of debt accumulated during the boom. Unemployment is curtailing current incomes. And credit is either unavailable to or being avoided by those who need to expand consumption because of a collapse of net worth. In the event, private consumption expenditure in much of the developed world, which stagnated in real terms in 2008 and declined significantly in 2009, is unlikely to recover substantially in 2010. On the other hand, governments across the developed world, overcome by conservative fears of excess public debt, are holding back on public expenditure or resorting to severe austerity measures that are sparking public dissent as in parts of Europe. Aggregate spending therefore is low. Not surprisingly, output growth remains sluggish.

In sum, the fear that an early retreat from the stimulus would deliver a second dip is still with us, at least in the developed world. Even in the US, where talk of a stimulus is repeatedly heard, the requisite action to spur the economy is not forthcoming. The situation in the US is most appropriate for recovery led by fiscal expansion. The unemployment problem persists and may be worsening as indicated by the fact that overall jobs fell by 95,000 in September. This was despite the fact that the private sector created 64,000 jobs that month and indicates that government spending cuts are substantially to blame. Unutilised capacity is rampant. And inflation is at a low that worries even Federal Reserve chairman Ben Bernanke. Consumer prices in the US rose by just 1.1 per cent over the year ending September 2010 and by just 0.1 per cent between August and September. Bernanke has declared that “inflation is running at rates that are too low” and called for an inflation target of “two per cent or a bit below”.


This would imply that a major stimulus is in order. But when talk of the stimulus arises it takes the form only of a monetary stimulus or “quantitative easing”. This involves large doses or several billions of dollars of asset purchases by the Federal Reserve aimed at injecting liquidity into the economy and driving down interest rates. The problem with this approach is the belief that the desire or inducement to spend or invest exists and the problem is the lack of credit to fuel such spending. That is a belief that has been proved wrong many times over in recent history. Yet there are myriad ways in which liquidity is sought to be injected into the system. For example, the Treasury department has announced a $1.5billion programme aimed at small businesses and designed to trigger $15billion in additional private lending.

What the quantitative easing does is that it lowers UN interest rates, widens the differential between interest rates in that country and elsewhere in the world and encourages, therefore, the carry trade. When additional liquidity is injected, financial investors (rather than industrial firms) borrow dollars at low interest rates, convert those dollars to currencies of countries where interest rates or financial returns are high or just higher and make an investment to benefit from the differential in returns.

The consequence of encouraging movements of this kind is that there is a surge of capital flows into emerging markets in Asia and Latin America that is strengthening their currencies and inviting intervention on their part to prevent currency appreciation that worsens their competitiveness. The fall outs are the much talked about “currency wars” that are mistakenly presented as the cause of rather than, partly, the result of uneven development. It is not that the faster growth of these emerging economies is the result of undervalued currencies. To the extent that in some cases that faster growth is the result of export success, the success is due to cost competitiveness which in substantial measure stems from the availability of cheap surplus labour in a context where capital and technology are mobile but labour is not. Best-practice technologies are combined with cheap labour in these locations for production for world markets. Overall, it is better performance resulting from cost competitiveness which delivers a trade surplus and encourages the capital inflow surge that tends to appreciate the currencies of these countries and undermine their competitiveness.

It is in this light that we must view the IMF’s optimism that comes from the fact that the emerging markets are doing well enough to lift “global growth”. That unevenness is not the basis for combined growth but for conflict that demands responses that could undermine the competitiveness of the emerging market economies. Moreover, the capital inflow surge into some of these emerging markets results in real estate and stock market bubbles that are likely to burst and therefore render such growth fragile. What is needed is a return to an effort at having a globally synchronised fiscal push with measures to distribute the benefits of that push across continents and countries. It is that option that the IMF foregoes when it emphasises the need to “stabilise and subsequently reduce high public debt” and calls for “a strengthening of private demand in advanced economies” without explaining how that is to be ensured.

Vol. XXXIV, No. 43, October 24, 2010

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