The worst is over, but recovery needs support

Over the medium term, the hope is that the global economy will resume the rapid and broad-based expansion enjoyed from the early years of the decade until 2008 — without, however, the accompanying financial fragility and the trade imbalances.

This optimistic scenario depends to a large extent on a measured rebalancing of the economies of the US, with the world largest deficit, and China, with the world’s largest surplus. In view of the central place occupied by the dollar in the international reserve system, it is recognised that international monetary and financial stability depends fundamentally on spending discipline by the US —in line with its income.

Shift in focus

However, in order to maintain growth, the US should not simply cut domestic absorption but also shift to export-led growth. An orderly US adjustment would also require, inter alia, a shift by China from export-led to consumption-led growth and the realignment of the exchange rate of the renminbi against the dollar.

Even if such a rebalancing proceeds smoothly, most developing and emerging economies (DEEs) are caught in a dilemma: they are damned if the US adjusts and damned if it does not. On the one hand, ‘business as usual’ would expose them to recurrent currency and financial instability. On the other hand, retrenchment and adjustment in the US could cause problems on several fronts. It is likely to lead to tightened global financial conditions with negative effects on several DEEs that have structural external deficits and are hence dependent on capital inflows to sustain acceptable growth.

More important, there is no other country that could act as a global locomotive. China could not replace the US even if it maintained Gross Domestic Product growth of 10 per cent based on domestic consumption rather than exports. Its GDP is about one-third that of the US; the share of household consumption in GDP is much smaller.

While there has been an almost exclusive focus on US-China relations, a global restructuring of the pace and pattern of demand cannot exclude the two other major surplus countries, Japan and Germany, which have been siphoning off global demand without adding much to global growth and relying on exports to a much greater extent than China.

There is more, however, to global imbalances than macroeconomic geography. Income distribution has played an important role and should also be part of the solution. Market-driven globalisation has systematically tilted the balance of economic power against labour and in favour of capital, as indicated by the falling share of wage income almost everywhere. The outcome has been under-consumption in all major surplus countries, notably China, Germany, and Japan. However, the threat of global deflation has been avoided thanks to consumption and property surges financed by growing debt and capital gains brought about by rapid credit expansion and asset inflation, notably in the US but also a number of other advanced economies and DEEs, particularly in Europe.

The US needs to live within its means. China, Germany, and Japan all need to boost domestic consumption by reversing the downward trend in the share of wages in GDP. In the latter two countries, this is needed to accelerate growth, while in China it is needed to avoid a growth slowdown that may result from a deceleration of exports. Furthermore, China should not only accelerate domestic consumption but also increase its import content.

All these changes need to be complemented with a reform of the global financial architecture so as to ease the payments constraints of deficit and indebted developing countries.

However, there are no signs that the reorientation of policies needed for such a rebalancing is on the agenda of the major countries or the international community at large. Consequently, the world economy generally and DEEs particularly may face more serious challenges in coming years than they have seen during the recent global downturn. The outcome could be sluggish, with uneven and erratic growth, continued and even deepened instability in currency and asset markets, the rise of protectionism and economic nationalism, an escalation of conflicts in the international trading system, and a backlash against globalisation. IPS