Faster Growth Will Come If Governments Raise Their Game
Growth in the world economy subsided in 2012. The expansion since 2009 has been a bitter disappointment because much of the slack created by the great recession remains. With so much idle capacity, an opportunity exists for robust growth in 2013, but only if governments raise their game.
This recovery was always going to be slow and troubled. A crash brought on by public and private overborrowing pushes prices down and deters business investment as distressed debtors, struggling to repair their balance sheets, quit spending. Yet wherever you look, political failure is holding economies back. Things don’t have to be this bad.
When the figures are in, global growth will probably be less than 3.5 percent in 2012 -- down from 3.8 percent in 2011, itself a disappointing year. The advanced economies will probably increase their output by less than 1.5 percent. Europe is back in recession. With unemployment still high in every major economy and extraordinarily high in some, the sluggishness is unacceptable.
Every economy has its unique problems, yet political failure is a recurring theme. In some of the biggest economies, this takes a similar form: Governments have failed to get fiscal policy working as it should, meaning adequate short-term stimulus combined with credible medium-term control.
Premature fiscal contraction (or inadequate fiscal support in the first place) is plainly holding back growth in the U.S., the European Union and Japan. Governments are trapped in undue austerity because they can’t or won’t commit themselves to tighten later, when their economies could better stand it. To maintain financial-market confidence, governments have gone overboard with fiscal tightening.
Hamstrung by lack of credibility, governments have also delegated stimulus to central banks. The U.S. Federal Reserve has responded with remarkable innovations, including quantitative easing on a huge scale. As of this month, the Fed says it will apply aggressive monetary stimulus until unemployment falls to 6.5 percent or inflation rises to 2.5 percent.
The European Central Bank, still an infant, has less political room to maneuver. Still, it has promised to do “whatever it takes” to preserve the euro system and has begun a QE program of its own. The more rigidly conservative Bank of Japan has so far dragged its feet -- and Japan’s prolonged stagnation is the result. To force the Bank of Japan’s hand, the newly elected prime minister, Shinzo Abe, has issued barely veiled threats to its independence.
Trouble is, monetary stimulus isn’t the first-choice policy under current conditions. Nominal interest rates can’t be cut to less than zero -- hence the resort to QE. But unorthodox stimulus only works if it raises expectations of higher inflation, which central banks are loath to admit, much less advertise. This reluctance makes the policy partly self- canceling.
With fiscal policy broken, we don’t doubt that aggressive central-bank easing is the right course. Still, it would be much better to mend fiscal policy, the tool of first resort, once nominal rates have been cut to nothing.
Japan, with public debt that is more than double the size of the economy, has little if any remaining fiscal capacity. The U.S. and Europe, however, have room to maintain or increase short-term fiscal support, so long as clear, binding plans for longer-term restraint are in place. Instead, on both sides of the Atlantic, there is total disarray over budgetary policy.
In the U.S., breaking the impasse over the so-called fiscal cliff is only a first, albeit vital, step. The White House and both parties on Capitol Hill must also agree to a binding plan, similar to what President Barack Obama’s fiscal commission has proposed, to bring the ratio of public debt to gross domestic product back below 50 percent.
That is a more ambitious goal than either side has suggested so far. With this in place, fiscal stimulus in the short term would be feasible. Greater certainty plus relief from the short-term squeeze would give growth in 2013 a double lift.
There is no excuse for Washington’s perpetual fiscal paralysis. Getting policy right in Europe, in contrast, is genuinely difficult. There, fiscal reform involves constitutional reform. Lifting the threat of insolvency from Spain and Italy -- it’s too late for Greece -- requires further pooling of sovereignty, to allay the justified fears of Germany and other countries that they will be on the hook permanently for southern profligacy.
Yet hardly anyone in the union wants to take a big stride toward a United States of Europe right now, least of all in Germany. New fiscal arrangements shouldn’t wait on grandiose ambitions. Europe should do the minimum necessary to keep borrowing rates sustainable -- perhaps with fiscal transfers or conditional, collectively guaranteed bonds, as we have recommended. It is a debate Germany may want to postpone until after its elections in 2013. Every month’s further delay is dangerous.
It is a good sign that the EU has just advanced a plan for a single bank supervisor, a measure needed since the beginning of the euro system. Still missing, though, are an EU-wide deposit-guarantee system and a method for shutting down insolvent banks. A currency union needs all three.
In the developing economies, fiscal issues are less pressing, though 2013 could bring nasty surprises. China, bouncing back from its own pause earlier this year, remains a concern. Many economists fear the consequences of too much bank- financed, locally directed public investment. China’s new leadership, preoccupied with fighting corruption, needs to get a grip on local government spending and to marshal its resources in case those debts go bad and end up on the central government’s books. Efforts to make consumption, not investment, drive growth need to be redoubled.
India should be the other great engine of global prosperity, but has the opposite problem: It is investing too little in infrastructure. This year’s power failures couldn’t have made the point more forcefully. Even more than China’s, its government has aroused fears that the earlier zeal for pro- market reform has faded. In recent weeks, a new policy team has promised to revive those efforts. A lot is riding on their success.
China and India underline a point often forgotten in the rich economies: Important as demand may be, supply-side reforms are the keys to longer-term growth. A great danger everywhere -- especially in the U.S., where it has come as a shock -- is the rise of long-term unemployment. Skills atrophy and the will to work fades with prolonged joblessness. It is still possible to arrest this decay with better demand management and measures aimed directly at the labor market, such as more support for job search, retraining and midcareer education. Soon, it might be too late.
Wherever you look, better domestic policy is the path to faster global growth. International coordination has a big supporting role, though, and it has also been neglected. Progress toward an effective system of global bank regulation has been halting: Governments have delayed putting into force the new Basel rules for capital adequacy, and the intended new requirements aren’t nearly stringent enough. Long-stalled global trade talks aren’t formally deceased, though it is hard to tell the difference. Negotiations on a successor to the failed Kyoto Protocol have yet to move things forward on climate change.
These domestic and international policy failures all prompt the question: Is anybody in charge? Effective policy action early in the recession prevented an outright economic catastrophe, and governments deserve much credit for that. But their performance more recently has ranged from flawed to lamentable. They will have to do better if 2013 is to deliver the advances in incomes and employment the world needs.
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