Job #1 for the IMF: Stay the course and avoid lurches to austerity
If the global economy was in trouble before the annual World Bank and IMF meetings in Tokyo this past weekend, it is hard to believe that it is now smooth sailing. Indeed, apart from the modest stimulus provided to the Japanese economy by all the official visitors to Tokyo, it’s not easy to see what of immediate value was accomplished.
The U.S. still peers over a fiscal cliff, Europe staggers forward preventing crises King Canute-style with fingers in the dyke but no compelling growth strategy, and Japan remains stagnant and content if it can grow at all. Meanwhile, each BRIC is an unhappy story in its own way, with financial imbalances impeding growth in the short run and deep problems of corruption and demography casting doubt on long-run prospects.
In much of the industrial world, what started as a financial problem is becoming a deep structural problem. If growth in the United States and Europe had been maintained at its average rate from 1990 to 2007, GDP would be between 10 and 15 percent higher today and more than 15 percent higher by 2015 on realistic projections. Of course this calculation may be misleading because global GDP in 2007 was inflated by the same factors that created financial bubbles. Yet even if GDP was artificially inflated by 5 percentage points in 2007, output is still about $1 trillion short of what could have been expected in the U.S. and EU. This works out to more than $12,000 for the average family.
With these results, it will be argued that the process of international economic cooperation is failing. It will be suggested that there have been failures of leadership on the part of the major actors. There will be calls for changes in the international economic architecture.
There is some validity in all of this. Political constraints interfere with necessary actions in much of the world because international processes do not trump domestic imperatives. U.S. politics have been dysfunctional in the run-up to the 2012 election. The European Union sometimes makes the U.S. Congress look like a model of crisp efficiency in coming to conclusions. In Russia and China, authoritarian leaders lacking legitimacy have difficulty driving economic reform. So also do those with democratic mandates in India and Brazil.
Concern about dysfunctional politics and the processes of international cooperation is certainly warranted. But the best one can hope for from politics in any country is that it will drive rational responses to serious problems. If there is no consensus on the causes of or solutions to serious problems, it is unreasonable to ask a political system to implement forceful actions in a sustained way. Unfortunately, this is to an important extent the case with respect to current economic difficulties, especially in the industrial world.
While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can best be accomplished.
What might be labeled the “orthodox view” attributes much of our current difficulty to excess borrowing by the public and private sectors; emphasizes the need for credibly containing debt accumulation over the long term; puts a premium on austere fiscal and monetary policies; and stresses the need for long-term structural measures rather than short-term, demand-oriented steps to promote growth.
The alternative “demand support view,” while recognizing the need to contain debt accumulation and avoid high inflation, emphasizes the need for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing.
International economic dialogue has been defined by vacillation between these two viewpoints over the last few years. At moments of particularly acute concern about growth like spring 2009 and the present moment, the IMF and many but not all monetary and fiscal authorities tend to emphasize demand-support views. But as soon as clouds start to lift, orthodoxy reasserts itself and attention shifts to fiscal contraction and long run financial hygiene.
This is a dangerous cycle whatever your economic beliefs. Doctors who prescribe antibiotics warn their patients that they must complete the full course even if they feel much better quickly. Otherwise they risk a recurrence of illness and worse yet the development of more antibiotic resistance. So too with economic policy. Advocates of orthodoxy prize consistency. Those like me whose economic thinking emphasizes promoting demand, worry that expansionary policies carried out for too short a time prove insufficient to kick-start growth while at the same time discrediting their own efficacy and reducing confidence.
The Tokyo meetings may not have had an immediate impact. But the IMF’s recognition of the need to sustain demand and avoid lurches to austerity can be very important for the medium term if and only if it is sustained through the next round of economic fluctuations.
PHOTO: International Monetary Fund (IMF) Managing Director Christine Lagarde speaks at the Development Committee at the IMF and World Bank Annual Meetings in Tokyo October 13, 2012. REUTERS/Stephen Jaffe/IMF/Handout