The global recovery is firmly under way, but taking place at different speeds across countries and regions, according to the OECD’s latest Economic Outlook.
Historically high unemployment remains among the most pressing legacies of the crisis. It should prompt countries to improve labour market policies that boost job creation and prevent today’s high joblessness from becoming permanent.
World gross domestic product (GDP) is projected to increase by 4.2% this year and by 4.6% in 2012. Across OECD countries GDP is projected to rise by 2.3% this year and by 2.8% in 2012, in line with the previous forecasts of November 2010.
In the US, activity is projected to rise by 2.6% this year and by a further 3.1% in 2012. Euro area growth is forecast at 2% this year and next, while in Japan, GDP is expected to contract by 0.9% in 2011 and expand by 2.2% in 2012.
The recovery is becoming self-sustained, with trade and investment gradually replacing fiscal and monetary stimulus as the principal drivers of economic growth. Confidence is increasing, which could add further buoyancy to private sector activity.
But there are downside risks, including the possibility of further increases in oil and commodity prices, which could feed into core inflation; a stronger-than-projected slowdown in China; the unsettled fiscal situation in the United States and Japan; and renewed weakness in housing markets in many OECD countries. Financial vulnerabilities remain in the euro area, in spite of strong adjustment efforts underway in some countries.
“This is a delicate moment for the global economy, and the crisis is not over until our economies are creating enough jobs again,” said OECD Secretary-General Angel Gurría. “There is also some concern that if downside risks reinforce each other, their cumulative impact could weaken the recovery significantly, possibly triggering stagflation in some advanced economies.”
The top challenge facing countries continues to be dealing with widespread unemployment, which affects more than 50 million people in the OECD area. Governments must ensure that employment services and training programmes actually match the unemployed to jobs. They should also rebalance employment protection towards temporary workers; consider reducing taxes on labour via targeted subsidies for low paid jobs; and promote work-sharing arrangements that can minimise employment losses during downturns.
Stronger competition in retail trade and professional service sectors could also lead to greater job creation, and should be considered as part of wider structural reform programmes in advanced and emerging economies alike.
In advanced economies structural reforms can play a greater in role in boosting growth as governments are forced to withdraw fiscal and monetary stimulus launched in reaction to the crisis.
In emerging-market economies, structural reforms have the potential for making growth more sustainable and inclusive, while contributing to global rebalancing and enhancing long-term capital flows.
Emerging economies must also pay particular attention to the danger of overheating, which is increasing inflationary pressures, and in some cases, widening current account imbalances.
Countries must also make progress toward their fiscal consolidation goals, which are increasingly urgent. Government debt is set to rise to close to 96% of GDP average in the euro area this year and to just above 100% of GDP in the OECD as a whole. This is about 30 percentage points above the pre-crisis level. “High public debt levels, which have been shown to have a negative impact on growth, must be stabilised and then reduced as soon as possible, especially if one considers the likely impact of ageing in the next few decades,” Mr Gurría said.
Recovery from the Great Recession is proving to be stronger than expected and is finally becoming self-sustained, meaning it’s less and less reliant on government support, according to the OECD.
“The outlook for growth today looks significantly better than a few months back,” says Pier Carlo Padoan, the OECD’s chief economist. He attributes that to a number of factors, including increasing business confidence and a global pick up in trade.
According to forecasts in the latest OECD interim economic assessment, released this morning in Paris, the G7 countries could see annualised growth of around 3% in the first half of this year. But, unusually, these G7 figures do not include Japan. The dreadful human cost of the earthquake and tsunami has been all too apparent, but there will also be an economic price. However, says Mr. Padoan, it’s “still too early to assess the impact both on the Japanese economy and the global economy”.
There are other uncertainties too: The impact of unrest in North Africa and the Middle East on oil prices, for example, and inflation, which, although still low, is tending to creep up. And, of course, there’s unemployment: On the bright side, it’s been falling in both the United States and Europe (more so in the former than in the latter), but it still remains relatively high and looks set to stay that way for some time to come.
Last week, we reported on the latest OECD Economic Outlook. Writing in the New York Times, Paul Krugman was highly critical of the Organisation’s analyses and policy recommendations. Here we summarise Krugman’s argument and the reply by OECD Deputy Secretary-General and Chief Economist Pier-Carlo Padoan.
Krugman argues that the most ominous threat to the still-fragile economic recovery is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.
He contrasts this with actions taken when the financial crisis first struck, and most of the world’s policy makers responded by cutting interest rates and allowing deficits to rise.
He goes on to say that “The extent to which inflicting economic pain has become the accepted thing was driven home to me by the latest report on the economic outlook from the Organization for Economic Cooperation and Development… what [the OECD] says at any given time virtually defines that moment’s conventional wisdom. And what the OECD is saying right now is that policy makers should stop promoting economic recovery and instead begin raising interest rates and slashing spending.
What’s particularly remarkable about this recommendation is that it seems disconnected not only from the real needs of the world economy, but from the organization’s own economic projections.”
His demonstration is as follows. The OECD declares that interest rates should rise sharply over the next year and a half to head off inflation, but inflation is low and declining, and OECD forecasts show no hint of an inflationary threat.
The reason the OECD wants to raise rates is in case markets start expecting inflation, even though they shouldn’t and currently don’t.
Likewise, although the OECD predicts that high unemployment will persist for years, it asks that governments cancel any further plans for economic stimulus and that they begin fiscal consolidation next year.
Krugman insists that both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because a weaker economy depresses tax receipts, wiping out any gains from governments spending less.
Moreover, the reasons for doing this don’t hold. Investors aren’t worried about the solvency of the US government and interest rates on federal bonds are near historic lows. And “even if markets were worried about U.S. fiscal prospects, spending cuts in the face of a depressed economy would do little to improve those prospects”.
This contrasts with the OECD’s calls for cuts because inadequate consolidation efforts “would risk adverse reactions in financial markets.”
Krugman is worried that this view is spreading, citing the case of “conservative members of the House, invoking the new deficit fears, [who] scaled back a bill extending aid to the long-term unemployed… many American families are about to lose unemployment benefits, health insurance, or both — and as these families are forced to slash spending, they will endanger the jobs of many more.
He concludes by stating that “more and more, conventional wisdom says that the responsible thing is to make the unemployed suffer. And while the benefits from inflicting pain are an illusion, the pain itself will be all too real.”
In reply, Padoan starts by saying that they differ on the strength of the recovery, with the OECD more optimistic than critics of the Outlook. Unemployment will take time to fall to acceptable levels, but this will be underway by 2011. A double-dip recession cannot be ruled out, but is not very likely. The risks of running big fiscal deficits and a zero interest rate monetary policy are rising.
Recent events in Europe are a warning sign and even though the US has the world’s biggest capital market, the risks are shifting. In this unsettled financial environment, governments need to get out ahead of markets, because otherwise they will be hostage to them.
On inflation, he argues that it is not a risk today, but could be in two-years’ time. Monetary policy needs to be forward looking and this means easing up on monetary stimulus in anticipation.
“To be clear, we are not arguing for contractionary policy, but for progressively less stimulus. In fact, stimulus should not be withdrawn completely until the economy returns to full employment. But the process should be started fairly soon, to take into account the well known long and variable monetary policy lags.”
How quickly interest rates should rise depends on many things, especially inflation, inflation expectations and the pace of growth. It also depends on fiscal policy, which influences growth.
“All else equal, if fiscal policy turns out to be tighter than in our projection, then monetary policy should be looser to compensate.”