April 23, 2008
A turning point in managing the world’s economy
By Martin Wolf
As the latest World Economic Outlook from the International Monetary Fund remarks, “the world economy has entered new and precarious territory”. What are perhaps most remarkable are the contrasts between booming commodity prices and credit-market collapses and between buoyant growth in emerging economies and incipient recession in the US. So where are we? How did we get here? And what should we be doing?
The WEO’s answer to the first question is that the US economy may shrink by 0.7 per cent between the fourth quarter of last year and the fourth quarter of 2008. This is a big shift from the 0.9 per cent increase over that period forecast in the January WEO Update. Moreover, growth is expected to be only 1.6 per cent over the following four quarters. Meanwhile, the eurozone’s growth is expected to fall to just 0.9 per cent between the fourth quarter of 2007 and the fourth quarter of 2008.
The remainder of this column can be read here. Debate from our panel of economists appears below.
Per Kurowski: Our first turning point has to be in the how we manage the world’s economy.
When I was an Executive Director at the World Bank 2002-2004 I am on the record complaining that there were no significant mention of energy plans in the country assistance strategies presented to us, when in light of the tremendous energy intensive growth occurring in places like China and India, we could very well be facing 100 dollar per barrel of oil in a short time. And I do not yet understand how the International Energy Agency was not capable of mustering sufficient strength to warn the world of the upcoming imbalances with the supply and demand of oil.
For more than a decade I have been also been voicing, sometimes quite noisily, that in fact we do not have a workable regulatory framework for our financial systems, since it should be clear to anyone that our real objectives for it must reach much further than the current limited and almost silly objective that Basel has in mind, that of just avoiding defaults.
Also, from the very first moment I heard about officially empowering the credit rating agencies to do the risk measurements that determined the capital requirements of banks, I have repeatedly stated that this would just lead some participants to let down their guard and end with many investors following, sooner or later, the credit rating agencies over a precipice.
I mention these three aspects, though there are many more, like the “scandalously wasteful biofuels programmes”, in response to Martin Wolf’s “A turning point in managing the world’s economy”, April 23, in order to emphasize that the first turning point we really need to make has to do with the how we manage the world’s economy. Obviously we must break lose from the habit of blindfolding and ossifying our institutions. Perhaps we need to impose term limits on the bureaucrats too, especially since their first rule for survival seems to be…do not ask questions and do not answer what you have not been questioned.
Posted by: Per Kurowski | April 25th, 2008 at 1:00 pm | Report this commentDomenico Lombardi (guest): Martin’s reading of the latest IMF WEO is very interesting, but let me add the following.
The WEO is certainly upbeat as far as economic activity in emerging markets and low-income countries (LICs) goes and quite rightly, since it has held up fairly well so far. But the fact that emerging markets and LICs have not been largely touched yet by direct spillovers from financial turmoil in no way means that we can rule out stronger spillovers in the future.
Take for example the WEO’s suggestion that capital flows to these economies could increase as investors become more worried about asset quality in advanced economies. A far more likely response might lead to just the opposite: a general increase in risk aversion could translate into a decline in flows to emerging markets, especially those with macroeconomic vulnerabilities.
The WEO also says, interestingly, that the increase in intra regional trade means that emerging Asia is now less sensitive to a downturn in the advanced economies. But hasn’t much of the increase in intra regional trade been in intermediate products, used ultimately for production in Europe and the United States? Let’s not forget that, even if domestic demand has been robust in many Asian economies, the reason for it is partly the result of investment in export oriented industries, and this investment could weaken in the face of a waning demand for exports. Unless domestic consumption rises to offset the decline in external demand, I think we can count on noticeably slower growth in the emerging Asian economies.
Another thing the WEO stresses is Japan’s insulation from financial market turmoil. From the direct consequences of the turmoil, yes, perhaps it has enjoyed a reasonable degree of isolation. But not from the indirect consequences of recent events, like the decline in equity prices, which could weaken consumer spending and the business investment even there. What’s more, while almost half of Japanese exports are now produced for Asia, it may well be that a significant portion of these is comprised of intermediate goods, re-exported at least in part to advanced economies.
Lastly, it seems to me that the WEO exaggerates the progress made so far (starting from the time of the IMF’s special round of multilateral consultations) in achieving an orderly unwinding of global imbalances. What we have in fact seen is an increase in global imbalances in 2007, notwithstanding the decline in the US current account deficit. Of all the large surplus countries that the consultation concerned, China and Japan recorded an increase in their current account surpluses, while Saudi Arabia’s current account surplus fell moderately.
Domenico Lombardi is president of The Oxford Institute for Economic Policy
Posted by: Domenico Lombardi, President of The Oxford Institute for Economic Policy (OXONIA) | April 25th, 2008 at 5:34 pm | Report this commentDavid Heigham (guest): As Domenico Lombardi suggests, the WEO may well be over-optimistic about resolution of problems in the medium term. It certainly does not draw out the key questions as clearly as Martin Wolf does. However, what shines out to me from Martin Wolf’s policy questions is that they are all about global economic policy. Who is in a position to respond to these questions?
Planning for a smooth readjustmnet of global payments patterns is in the IMF’s original remit,
but it seems outwith their current responsibilities.
Considering global monetary policy issues is in no-one’s remit. It is aguable that the necessary offset to rising commodity prices is being provided through the markets by the fall in real property values; but no body has responsibility for assessing such questions for the whole system.
We have a body in Basel that has made a de facto start on issues of global financial market regulation; how do we widen and broaden that remit and capacity for organising action?
Finally, where and how do responsible political leaders in the rich countries find a political forum which will offer them mutual support and legitimation for the case for managing the world economy as whole, in the common interest?
David Heigham formerly worked in the UK Government economic service.
Posted by: David Heigham | April 26th, 2008 at 8:36 pm | Report this commentMartin Wolf: I take Domenico’s points. It is quite likely that the global consequences of the US slowdown will be more serious than the IMF’s central estimates suggest. But the IMF is well aware of the downside risks, which are many, as I indicated.
On the global imbalances, I agree. They are being reallocated, rather than diminished and, with oil at $120 a barrel, will, no doubt, soon be increasing again. Furthermore, the improvement in the US deficit must, in large part, be the result of the slowdown and so temporary (one hopes), not permanent.
In short, there are plenty of things to worry about if one wishes to do so.
Posted by: Martin Wolf | April 29th, 2008 at 9:23 am | Report this commentMartin Wolf: One economy, many states. This is, in a nutshell, the problem David Heigham defines. It is effectively insoluble, but a stronger and more representative IMF would help. Probably the best body to co-ordinate discussion about the world economy is the G20, which includes all the important developing countries, but is not too large to be manageable.
Posted by: Martin Wolf | May 2nd, 2008 at 10:48 am | Report this comment