Global economy not as healthy as it looks
By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The global economy is not as healthy as it looks. The International Monetary Fund now predicts 4.4 percent growth for 2011. But inflation has reared its ugly head across the globe, suggesting that many economies are growing faster than can be sustained without structural changes. Spurring on reform should be the main focus of the annual World Economic Forum shindig this week in Davos.
If one wants to look at the glass half full, there are things to feel positive about. The U.S. economy is growing smartly again — the IMF predicts 3 percent this year. China and India should each grow at around 9 percent this year. Even the euro zone may be pulling itself out of crisis.
But the glass is still very much half empty, too. America is only growing so rapidly because it has engaged in loose monetary and fiscal policies. The monetary splurge has resulted in hot money spilling out across the world — which, in turn, is driving asset and consumer price inflation and that is causing difficulties in emerging economies. The fiscal profligacy, meanwhile, will have to be reined in — or America will suffer its own sovereign debt crisis in a few years time. The same goes for Japan, which is living on borrowed time and borrowed money.
China and India, meanwhile, are trying to curb inflation. But each is moving gingerly. Beijing is unwilling to allow the yuan to appreciate significantly — something which would also help rebalance global trade flows. And India is maintaining negative real interest rates, despite nudging up policy rates by another 25 basis points this week.
In the euro zone, the big question is Spain. If the authorities can regain credibility with investors, the crisis will end with Portugal. Creating a firewall in the Iberian peninsular will, however, require Madrid to recapitalise its weak savings banks. The plan announced this week may work but there’s a risk that investors will conclude it is too little, too late. What’s more, even if the hot phase of the crisis ends, the periphery of Europe is still saddled uncompetitive economies and heavy debt burdens.
There are, though, many things that can be done to create a healthier global economy in the long term. Unfinished business from the last financial crisis is tackling the “too big to fail” problem among banks. More coordinated effort across frontiers is required to ensure that a future Lehman Brothers could be packed off to the knackers’ yard without running the risk that doing so would bring the rest of the financial system down with it.
Clearer thinking is also required on how to tame destabilising capital flows. Part of the answer is to distinguish between what is healthy (foreign direct investment) and what is not (short-term foreign currency borrowing). The emerging “macroprudential” toolkit can be used to tackle the latter. South Korea is, for example, considering imposing a levy on banks’ foreign currency liabilities. A code of conduct on capital flows, as advocated by Nicolas Sarkozy, who is chairing the G20 this year, may also be part of the solution — so long as France’s president doesn’t try to stuff the code with pet anti-market ideas.
Improved governance should also be high on the list of priorities. Large swathes of the world — whether it is corruption-riddled India, Greece with its rampant tax evasion or most of the Arab world with its democratic deficit — are held back by poor governance.
Finally, there is liberalisation. It has become fashionable to blame the global financial crisis on free markets. But the problem rather was that markets were distorted by bailouts and skewed incentives. Freeing up markets — whether it is liberalising hiring and firing, or sweeping away restricted practices in professions — still has the capacity to deliver a big long-term boost to productivity in much of the world. The Davos delegates should grasp this agenda.