The pain of rebalancing global growth

By Martin Wolf

The world economy is like a see-saw. What was down comes up and what was up comes down. This creates new difficulties and new opportunities. But, overall, the story the 

International Monetary Fund tells in its latest World Economic Outlook is no disaster. Provided nothing bad happens – such as a US default – the world economy should now achieve somewhat more balanced growth.

In the fund’s own words: “Activity in the major advanced economies has started to accelerate from subdued levels. By contrast, growth in China and many other emerging economies in Asia and Latin America, and to a lesser extent in the Commonwealth of Independent States, has cooled, after a surge in output beyond potential following the recovery from the Great Recession.”

The overall picture presented, then, is one of a tricky rebalancing of the pattern of global growth: modestly improved dynamism in high-income economies, mainly the US, and reduced dynamism in a puzzlingly large number of emerging economies.

Where are the risks? There are a few obvious ones. What if progress in the eurozone turns out to be temporary? A backlash against austerity and high unemployment in vulnerable members is still quite possible. Meanwhile, progress towards a true banking union in the eurozone seems to have stalled.

A more immediate danger is a breakdown in US politics, leading to a huge disorderly tightening of fiscal policy or even a default on debt obligations. Yet another risk is that the unwinding of unconventional monetary policy and subsequent raising of interest rates prove chaotic. Some fear that inflation will suddenly explode in the high-income economies. This seems very unlikely.

In the high-income countries, a big danger arises from an excessively rapid pace of fiscal austerity, as has already been seen in the eurozone, the UK and, more recently, the US. One result has been inordinate reliance on monetary policy, often highly unconventional monetary policy, whose effects on the economy are at least as uncertain as those of fiscal stimulus. Future economists may wonder about our extraordinary belief in the efficacy of monetary policy during what is, quite clearly, a private sector savings glut.

In the US, the recovery of the property sector, higher household wealth and easier credit are helping to keep the recovery going. This year’s fiscal tightening is estimated to be 2.5 per cent of gross domestic product, driven by sequestration. 

But this should ease to 0.75 per cent in 2014. 

Japan is determined to tighten fiscal policy next year, possibly prematurely. In the eurozone, fiscal tightening is expected to fall from about 1 per cent of GDP in 2013 to less than 0.5 per cent next year. Unfortunately, demand is too weak in the core euro countries and credit too constrained in the periphery, despite help from the European Central Bank. The apparent hope that the eurozone might achieve fast export-led economic growth will prove deluded.

For the longer term, the pace of potential growth in the richer world and the path of fiscal stabilisation are the big questions. The former is, contrary to conventional wisdom, the most important issue. Governments need a coherent strategy for 

growth, which will be the principal determinant of their ability to manage the fiscal position. This is why decisions not to use the exceptional opportunity afforded by ultra-low interest rates for a large expansion of investment are unforgivable errors.

For emerging market economies, growth is forecast at just 4.5 per cent this year and 5.1 per cent in 2014. China’s growth forecast is 7.6 per cent this year and 7.3 per cent in 2014; India’s at a mere 3.8 per cent this fiscal year and 5.1 per cent in 2014. But note: with growth of 6.3 per cent this year and 6.5 per cent in the next, developing Asia – half of humanity – is still expected to grow faster than anywhere else. sub-Saharan Africa is in second place.

Emerging market economies face two different challenges. First, they are now likely to find themselves in a global environment of higher interest rates, lower commodity prices, stronger growth in high-income economies and weaker growth in China. 

The time of easy global credit is ending as monetary tightening returns slowly to the high-income countries. The world is being provided with yet another cautionary tale of the perils of flows of “hot money” into emerging economies. Yet these countries possess other sources of fragility: one is excessive past credit growth, notably in China; another is reliance of too many on high commodity prices.

Second, beyond these shorter-term challenges, there are long-term challenges for certain emerging market economies. A structural slowdown is occurring, not least in China and India. Stellar growth does not last forever. Both countries also suffer from important imbalances. Yet a modest rebalancing of global growth will not halt the “great convergence” – the economic story 

of our age. It will simply mean that it is happening at a slightly slower pace.

Both the short-term and long-term global shifts should be manageable, provided nothing goes very wrong. But what is manageable must still be managed, all the same. Emerging countries must overcome the immediate challenges and prepare themselves for medium-term growth.

They must let exchange rate flexibility take some of the economic strain. They should also use foreign currency reserves, where these have been accumulated on a large scale.

Emerging economies are, in general, more robust than in the past. But, to keep growth going, many must also urgently consider a new round of structural reforms – particularly India. 

China may face a difficult choice between a sharp slowdown and politically difficult reforms on the one hand, and embarking on another credit surge on the other. Given the already very high credit levels in the economy and the huge structural imbalances, the leadership should choose the former option. Will it? We do not know.

The world is now on a path to something rather more normal than the strange state that has persisted since 2007. It is going to be bumpy.

Copyright The Financial Times Limited 2013