Glum gets glummer. While one part of Washington was playing chicken with a U.S. sovereign debt default, in another part of town the International Monetary Fund was delivering a downbeat outlook on the world economy. Not the backdrop either side of town would have wanted, but a dark reminder of how linked the two are.
But for all the fiscal follies of Washington it is emerging economies that immediately concern the IMF. Their slowdown is at the root of the Fund’s latest downgrades to its forecasts for global growth. Growing belief that the largest emerging economies — Brazil, China, India and South Africa — won’t be able to regain their immediate post-crisis momentum for some time has led the Fund to forecast that the world economy will grow by just 2.9% this year, and only 3.6% next year. If that turns out to be the case, this year’s growth would be the lowest since the 2008 global financial crisis. Next year’s projected growth would still be uncomfortably below the 4%-plus pre-crisis growth rates.
The IMF points its finger for this state of affairs at a weakening political will to make structural economic reforms — “adjustment fatigue” in the more tempered language of the IMF’s chief economist, Olivier Blanchard, though he was blunter about the U.S. political impasse over its budget and debt. If not sorted out, he said, “it could well be that what is now a recovery would turn into a recession or even worse.”
The global economy is doing its own bit towards pointing itself in that direction. A starkly revealing chart in the Fund’s outlook shows how its forecasts for global output have for most regions of the world got steadily more pessimistic since 2009. The steam is coming out of the global recovery, which initially had done better than expected. Developing Asian economies have slowed down the most unexpectedly. Reforms in the two largest, China and India, to clear bottlenecks in infrastructure, labor markets and investment, have not been carried forward far or fast enough to the detriment of growth.
But both developed and emerging economies get a wag of the Fund’s finger for failing to implement reform. It is possible, the IMF says, that if this situation worsens that 20 million more jobs could be lost, unemployment in the euro-zone periphery stay at record levels for many years, debt sustainability be threatened in many countries, and slow growth could lead to social unrest.
To avoid such dire circumstances, the Fund lays out its familiar prescription:
- The euro area needs to repair its financial systems and adopt a credible banking union supported by a common backstop.
- The United States should resolve its political standoff relating to fiscal policy, and promptly raise the debt ceiling. In addition, the Federal Reserve should carefully manage the process of monetary policy normalization, taking into consideration prospects for growth, inflation, and financial conditions.
- Both Japan and the United States need to accomplish medium-term fiscal adjustment and reform of their social safety net programs.
- Japan and the euro area should adopt structural reforms to boost potential output.
For emerging economies, the Fund also has a familiar round of prescriptions to adjust for lower potential growth and the cyclical part of the slowdown: let exchange rates act as shock absorbers against tighter global financial conditions, get fiscal deficits reduced where they are large, and tighten financial regulation to guard against financial instability. It also urges a new round of structural reforms as essential for many emerging market economies, including investment in infrastructure, to reignite potential growth. In the case of China, in particular, it means rebalancing growth away from investment towards consumption.
For all its glumness, the IMF’s latest outlook does recognize that the world economy has entered a new phase of its recovery. This is one in which growth is being driven more by advanced economies as emerging markets slow more than expected, even though the net effect of that is for the world economy to be stuck, to use the Funds own phrase, in low gear. Meanwhile, on the other side of town, the same old same old seems more depressing than ever.