In the wake of releasing the IMF’s latest assessment of the global economy, Chief Economist Maurice Obstfeld noted in his blog, “Global growth continues, but at an increasingly disappointing pace that leaves the world economy more exposed to negative risks. Growth has been too slow for too long.”
The IMF anticipates 3.2% global economic growth this year, down from 3.4% predicted in January, 3.6% last October and 3.8% last April. Nonetheless, this continuously downward revised forecast is still higher than the United Nations global growth forecast of 2.9% and 3.2% in 2016 and 2017 respectively early this year.
‘Solution’ is the problem
The United Nations has been warning against early fiscal consolidation and austerity since 2009 before G20 leaders retreated, in mid-2010, from their earlier commitment, at their April 2009 London Summit, to coordinate their responses involving large fiscal stimulus packages to prevent the global financial crisis from becoming a depression. In effect, Gordon Brown, the host, considerably strengthened the IMF, ostensibly to better support affected countries, to ensure a coordinated and balanced global recovery.
But the first ‘green shoots of recovery’ provided the pretext for a policy U-turn once powerful financial interests had been saved. Rapid ‘fiscal consolidation’ through budgetary austerity measures, it was claimed, would restore investor confidence, thus ensuring higher investment and growth. Even though much cited research justifying ‘fiscal austerity’ was discredited as flawed, and the IMF admitted that such advice was based on erroneous ‘back of the envelope’ estimates, leaders in Europe have stuck to their contractionary fiscal policy stance.
The entire burden of economic recovery has been put on monetary policy and structural reforms, which are clearly not working. Structural reform measures are understandably slow. Low and now negative interest rate policies, euphemistically termed quantitative easing, have kept economies barely afloat, while causing financial instability and exchange rate volatility in emerging economies, one reason cited by the IMF for its downward growth forecast revision.
While reforms aspire to offer win-win solutions, most involve winners and losers. Political resistance tends to be greater in a stagnating economy, especially one characterized by rising inequality due to stagnant or falling real wages. Cutting social services when unemployment is high not only depresses aggregate demand, but also exacerbates inequality and social unrest.
Thus, instead of raising productivity, boosting growth and expanding employment, attempts at structural reforms often result in deteriorating productivity, slow growth, stagnating employment and declining aggregate demand. After six years of fiscal consolidation, debt levels, including in the euro zone, are still rising with no signs of labour market improvements.
Europe holding us all back
The unemployment rate in the euro area has only declined marginally from the 2013 peak of 12%. It is still unacceptably high and remains well above pre-crisis levels. Eurostat estimates that 21.7 million men and women in the EU-28, of whom 16.67 million were in the euro area (EA-19), were unemployed in February 2016 while the seasonally-adjusted unemployment rate in the euro area was 10.3%.
The youth unemployment rate — which had declined sharply between 2005 and 2007 in the EU-28, reached its low of 15.2% in the first quarter of 2008, and peaked 23.8 % in the first quarter 2013 — stood at 21.4% at the end of 2015. In February 2016, 4.4 million youth were unemployed in the EU-28, of whom 3.0 million were in the euro area.
Despite drastic fiscal consolidation and severe cuts in public services, the debt-GDP ratio increased, not only in Greece, but also in other countries such as Italy, Portugal, Belgium, Spain, France and the UK. Continued low growth is making the current debt-reduction strategy and fiscal consolidation self-defeating. Government debt in the Euro zone reached nearly 92% of GDP at the end of 2014, the highest level since the single currency was introduced in 1999, compared to 66% in 2007. The new debt to GDP ratio is more than 50% higher than the maximum allowed level of 60% set by the Stability and Growth Pact rules designed to make sure EU members “pursue sound public finances and coordinate their fiscal policies”.
With domestic demand declining, growth is supposed to come from export demand, but obviously, all countries cannot simultaneously find external markets for their output – as implied by so much contemporary trade rhetoric. Hence, addressing high unemployment and public debt has to involve reinvigorating domestic demand. This would entail both immediate policy actions to expand domestic demand as well as medium-term policies to address structural issues and longer-term challenges such as climate change.
Governments should expand public services including active labour market programs, subsidized childcare, universal healthcare and education. Such public provisioning enhances ‘social wages’, taking pressure off wage demands as businesses strive to recover. These measures help ensure social and political stability at modest fiscal cost.
New Deal again?
Over eight decades ago, President Franklin Delano Roosevelt introduced the New Deal for a strong and sustained economic recovery. It not only ushered in a new era of economic growth and prosperity, especially in some poorer US regions, but also addressed widespread environmental, economic and social distress. The current crisis needs such a response. But after decades of globalization and environmental deterioration, a feasible and viable response must necessarily involve international cooperation and commitment to sustainable development.
Such a Global New Deal (GND) would be in line with the United Nations Agenda 2030 for sustainable development goals that all countries adopted last September. It would have employment elements in line with the Global Jobs Pact, but also support private investments and welfare provisioning for the Global Social Protection Floor. It should therefore be central to international recovery efforts complemented by national stimulus packages aimed at reviving and greening national economies.
The GND will inevitably increase public debt in the near term, but the fiscal costs of public borrowing should be modest when long-term interest rates are at a historic low. In the longer-term, it will engender sustained economic growth, employment recovery and fiscal consolidation, as the New Deal did.
Many countries had huge public debts when WW II ended. Despite calls then for drastic expenditure cuts, governments spent a great deal on economic reconstruction and social welfare. Had they caved in to the fiscal hawks of their time, post-war European recovery would have been delayed and the Cold War could have been lost. As governments continued with massive expenditure to rebuild their countries, economies grew all over the world, and debt diminished quickly with rapid economic growth and fast growing tax revenues during the post-war Golden Age.