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Monday
Oct 15 2001
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Now, a world in recession
Rudi Dornbusch
IN LATE summer, there remained a chance that the world might still avoid recession: Japan was in a mild recession, Europe was expected to emerge from a slowdown, and the US was caught between slipping briefly on an economic banana peel and outright recession.
Not surprisingly, the dramatic loss of confidence worldwide following the attacks of September 11 has tilted the balance toward recession. Even if the IMF is not yet ready to use the word, the world is in recession.
World economic growth, which has averaged 3.8 per cent over the past 35 years and more than 4 per cent last year, is now poised to fall to only about 2 per cent.
The question now is what to expect next: is this just an ordinary recession or will another shoe drop? In fact, could this turn into something as ugly as the early 1980s?
Even worse, is there a risk of depression? When things are going down everywhere, why should we believe that they will stabilise in time? Why not fear the worst?
The central scenario is relatively benign and features a US upturn, and an upturn in Europe by the middle of next year. Monetary stimulus ever more from the Fed, and more hesitantly from the ECB provides an underpinning for demand expansion. There is no evidence that monetary stimulation, if sufficient, wont work.
Indeed, the evidence suggests that monetary loosening always takes time to show its effects, and today is no different. There is also in the US but not in Maastricht-ridden Europe substantial fiscal expansion.
There is already a tax cut worth half-a-per cent of GDP in the mail; another full per cent of GDP in fiscal spending and tax cuts is partly approved and on the fast track to full approval.
In the past, a monetary and fiscal policy of expansion has gotten economies, notably the US, out of every recession. This one will be no different.
In fact, just looking at the US, there are favourable factors this time around: no banking crisis; no real estate crisis.
The stockmarket, which had soared so high, has been sold off to a point where even long-term observers believe that the sell-off is mostly over. So much for optimism.
Of course, weak points abound all over the globe. Japan is in recession and is unlikely to emerge any time soon. No policy instruments are left to lift Japans economy from the mire.
The common plea to stimulate inflation as a means to jump-start the economy only lays bare Japans sheer absence of effective instruments to help itself, and the lack of sound thinking as well. Yes, Japan is the greatest risk in the world economy.
If it capsizes, it will take all of Asia with it. In that event, a deep world recession or worse is unavoidable. Yet, though Japan is the worlds high-risk economy, a prompt US upswing might let it hang on as is for a few years more.
A second weak point, though not near as dire as Japan, is Europe. The European Central Bank has been slow in cutting rates; it remains mesmerised by inflationary fears, though these are obviously the least of todays worries.
European public finance is locked in the Maastricht treaty and cannot help stimulate growth.
If the US recovery is not prompt and substantial, Europe will regret the Maastricht provisions that make counter-cyclical policies impossible.
Maastrichts budgetary straitjacket was invented to pacify German bondholders in the face of EMU; they may yet prove a disaster. For the time being, Europe is getting by with growth just short of recessionary levels.
But such estimates may now be too optimistic and a progressive downward recession may ensue for Europe as the US recession widens to the world economy.
Emerging markets are the third front of weakness. Latin America is in recession. Default in Argentina is expected; Brazil has an election-year recession and debt problems akin to Argentina. Mexico is entering a recession.
No help will come from the world economy. Instead, Latin Americas leading economies resemble a drought-stricken river where the water level has fallen so low all the ugly things stick out. The same holds true for Asia, where lack of exports and lack of reform have cut growth in half.
With problems everywhere, why be optimistic? Why believe in a moderate recession and an early upturn? The strongest reason is that in the US there is no major issue other than confidence, and that may return soon.
After that, the blast of monetary and fiscal policy will raise all ships. It has done so in the past 10 recessions and this one is no different except that it may be milder.
Once the US pulls out of recession and Europe turns up, we are set for a moderate recovery in world growth. There is no chance of a new boom, however, as world growth will gradually build up to 3 to 3.5 per cent, not even average growth of the past.
So the disappointment ahead is not the lack of an upturn but rather of slow growth once it comes.
All this, however, can go wrong. If confidence worldwide fails to rise, output will plummet. That was the case in 1982 when world growth fell to just 0.6 per cent.
That is far away from a world depression, but it will mean massive problems of unemployment and bankruptcy worldwide. At this point the betting must be for an upturn no later than the middle of next year. In the meantime, watch confidence and watch Japan, they are the two key risk factors that can topple the recovery scenario.
(The author is Ford Professor of economics at MIT and a former chief economic advisor to both the World Bank and IMF.)
Copyright: Project Syndicate, October 2001 -
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