Time to turn to the Four R’s
We are certainly living through times of great economic anxiety. Four years after the collapse of Lehman Brothers, the economic skies look troubled and turbulent as global activity slows and downside risks increase.
We have entered a dangerous new phase of the crisis. Without collective resolve, the confidence that the world so badly needs will not return.
Woodrow Wilson once cautioned that “the thing to do is to supply light and not heat”. There is a path to sustained recovery, much narrower than before, and getting narrower. To navigate it, we need strong political will across the world – leadership over brinksmanship, cooperation over competition, action over reaction.
Overall, global growth is continuing, but slowing down. The advanced countries in particular are facing an anaemic and bumpy recovery, with unacceptably high unemployment. The euro area debt crisis has worsened. Financial strains are rising. And again – without collective, bold, action, there is a real risk that the major economies slip back instead of moving forward.
And while many advanced economies face these cold headwinds, many emerging markets are facing too much heat – inflation pressures, strong credit growth, rising current account deficits.
Low-income countries have been experiencing reasonable growth, but remain highly vulnerable to economic dislocation from elsewhere in the world – including from commodity price volatility, which comes with heavy social costs. We should also keep in mind the Middle East and North Africa – embarking on a historic transformation, with people yearning for a better life and decent jobs.
But before talking about solutions, we need to be clear about the problems. I would isolate three distinct, albeit related, issues – balance sheet pressures sapping growth, instability in the core of the global economic system, and social tensions.
A key short-run issue in advanced countries is that balance sheet pressures are knocking the wind out of the recovery. There is still too much debt in the system. Uncertainty hovers over sovereigns across the advanced economies, banks in Europe, and households in the United States. Weak growth and weak balance sheets – of governments, financial institutions, and households – are feeding negatively on each other, fueling a crisis of confidence and holding back demand, investment, and job creation. This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction.
This relates to the second, more long-term issue – the risk of core instability. In our inter-connected world, economic tremors in one country can reverberate swiftly and powerfully across the globe, especially if they originate in systemic economies. IMF research has shown that financial linkages transmit such tremors rapidly and broadly. And because of lingering debt problems, financial stability risks have risen significantly.
The third issue relates to social tensions bubbling below the surface. There are a number of interweaving strands here – entrenched high unemployment, especially among the younger generation; fiscal austerity that chips away at social protections; perceptions of unfairness in “Wall Street” being given priority over “Main Street”; and legacies of growth in many countries that predominantly benefited the top echelons of society. These issues add more fuel to the confidence crisis.
So, what can be done? I want to propose four key policy dimensions needed to secure recovery and economic stability – repair, rebalance, reform, and rebuild – the “4 R’s”.
First, repair. Before anything else, we must relieve some of the balance sheet pressures that risk smothering the recovery – on sovereigns, on households, on banks. On sovereigns, advanced countries need credible medium-term plans to stabilise and lower public debt ratios. This must come first. But consolidating too quickly can hurt the recovery and worsen job prospects. So the challenge is to navigate between the twin perils of losing credibility and undermining growth. There is a way to do this. Credible measures that deliver and anchor savings in the medium term will help create space for accommodating growth today – by allowing a slower pace of consolidation.
Of course, the precise path is different for each country. Some have no choice but to cut deficits today, especially if they are under market pressure. Others should stick to their adjustment plans, but be ready to change course if growth falters further. Others still are probably pushing too hard today, and could slow down a bit.
One more point – it’s not just the what of the adjustment, it’s the how. In the short run, policymakers must focus on measures with the biggest bang-for-the-buck, that create jobs and kick-start growth, and that take distributional considerations into account. The how of adjustment is also important in the medium term, where fiscal plans should seek to support growth. I’m thinking of issues like tax reform, including by broadening bases. Equally, entitlement reforms will be essential in establishing long-term debt sustainability in virtually all advanced economies.
The second “R” is reform. If repair was about getting the economy moving today, reform is about laying the foundations for a more stable economic future tomorrow. A priority here is financial sector reform. On the plus side, we have broad agreement on higher quality capital and liquidity standards with appropriate phase-in arrangements. But substantial gaps remain in areas like supervision, cross-border resolution, too-important-to-fail, and shadow banking systems. We need international cooperation across all dimensions to avoid regulatory arbitrage. The fact that so many of these issues are still unresolved four years after Lehman should be of concern to us all.
The third “R” is rebalance. This has two meanings. First, it means shifting back demand from the public to the private sector, when the private sector is strong enough to carry the load. This hasn’t happened yet.
The second rebalancing involves a global demand switch from external deficit to external surplus counties. The idea here is straightforward – with lower spending and higher savings in the advanced economies, key emerging markets must take up the slack and start providing the demand needed to power the global recovery. But any rebalancing so far is largely due to lower growth. In some countries, rebalancing is being held back by policies that keep domestic demand growth too slow and currency appreciation too modest. Some other emerging markets are dealing with dangers from capital inflows that are too rapid.
This lack of sufficient rebalancing hurts everyone. In our inter-connected world, any thought of decoupling is a mirage. If the advanced economies succumb to recession, the emerging markets will not escape. Nobody will. Rebalancing is in the global interest, but it is also in the national interest.
The fourth – and final -“R” is rebuild. Here are mainly the low-income countries that need to rebuild their economic policy buffers – including fiscal positions – that served them so well during the crisis, to protect themselves against future storms. This will also help provide the space for growth-enhancing public investment and social safety nets – for example, allowing countries to deploy well-targeted subsidies to protect the poor from commodity price swings with minimal damage to fiscal sustainability.
Policymakers must also act together. They must reclaim the spirit of 2008, or the spirit of 1944. The Wilsonian spirit – the belief that the whole is greater than the sum of its parts. If we seize the moment, we can navigate our way out of this crisis and restore strong, sustainable, and balanced, global growth.