Themes > Current Issues
25.08.2001
Jayati Ghosh
It is almost like a slow motion replay of a
scene from one of those farcical black and white films starring Laurel and
Hardy, that some may remember from their childhood. The two men, in a
tunnel, observe the train, whistling and chugging as it comes at them from
the other side. They tug at each other's sleeves, gesticulate, accuse each
other of inaction, and generally do nothing useful, until the train
actually is upon them and splatters them both along the sides of the
tunnel.
Observing the world's leaders – and especially those governing the core capitalist nations and the major multilateral economic institutions – confront the ever closer possibility of international economic recession, provides a rather similar scenario. It is now clear beyond dispute that the slowdown in world economic growth is not just likely to be more prolonged than previously projected, but also wider, deeper and with every chance of turning into recession.
Thus, forecasts and projection of future growth have been revised downwards almost continuously over the past two years, and the IMF's latest projection follow a similar pattern. It is now predicting 3.2 per cent global growth in this year, a full percentage point lower than earlier forecasts. The United States economy, which was earlier expected to grow at more than 3 per cent over the calendar year, is now expected to increase by only 1.5 per cent or even less. Growth in the European Union is projected by the IMF to be only 2.5 per cent in 2001, while the Japanese economy is expected to expand marginally by 0.6 per cent.
The trouble is that even these projections appear to be optimistic in relation to most recent trends, and may well be revised downwards even further as the year progresses. Thus, the US economy grew at an annual rate of only 0.7 per cent over the last quarter, and the Japanese economy actually shrank by 0.8 per cent. Most recent figures from Germany suggest that industrial output started falling in the last quarter, leaving the level of industrial output only 1.1 per cent higher than it was a year earlier. In Britain, manufacturing has slipped into recession by falling for two consecutive quarters and total industrial production fell by 2.2 per cent over the year. Even France, which was performing better hitherto, has shown a drop in retail sales over the past one year.
The proximate cause of all this is of course the continuing slowdown in the only major economy which had served as an engine of growth in the recent past – the United States. Over the 1990s, the US was the only major economy that continued to expand at an impressive, even alarming rate. It therefore provided a major market for exports from both other developed and developing countries. The Latin American and East Asian developing countries in particular have been heavily dependent upon exports to the US in the recent past especially.
The UN's Project Link, which involves economics researchers from over 60 countries, has forecast global economic growth at 2.4 per cent this year, down from 4 per cent in 2000. It has blamed this deceleration on retrenchment in major developed economies, noting that "the economy of the United States has been at the heart of the current weakness in the global economy."
The recently released report of Project Link describes the spreading downturn as "an intended one, at least in its early stage, engineered by policy makers, in the first instance in the United States." The Federal Reserve's aim last year was to "put on the brakes" on the rapidly growing US economy in order to head off inflation. It is suggested that this went on for too long and was too severe, creating a downturn that has now taken on a life of its own. This is why it the downturn, which has lasted more than desired, now appears to be relatively impervious to the series of five interest rate cuts that the US Federal Reserve has already over this year.
Obviously this US downturn – which has not yet turned into recession but may still do so – is bad news in a world economy in which the other major developed countries are already shrinking or spluttering and where a whole range of developing countries depend upon such growth because their own domestic demand cannot sustain the required expansion. It can push other regions into not just recession but full-blown economic crisis, of the kind that is currently engulfing Argentina.
Given the severity of the situation, what is really surprising is the absence of activity among those who are supposedly in charge of maintaining a viable international capitalism. A decade or two decades ago, such a context would have provoked a flurry of meetings among the G-7, the major central bankers, and other centres of economic power. There would have been calls for concerted action, for co-ordinated intervention by the governments of the core capitalist countries, and there would have been much more decisive action by the dominant player, the United States.
Instead, consider what we have seen so far : only a series of interest rate cuts in the United States followed by George Bush's tax cutting measure which will provide, in the first instance, an estimated $300 more to be retained by each taxpayer. These have so far not prevented the continuing slowdown, and are not likely to do much more without other more substantial measures. Now attention is focussed on the European Central Bank which is also expected to announce an interest rate cut, as if that alone would be able to pull major economies out of recession.
It is interesting to find that Keynes's insights have been forgotten to such an extent that policy makers still believe that measures such as these can suffice. The possibility of a “liquidity trap” setting a floor for real interest rates is real, especially in the face of depressed expectations across the world, and this is amply shown by recent Japanese experience. That experience should also make it clear that when people anticipate bad times and more unemployment ahead, tax cuts can lead to more saving rather than more consumption, and thereby contribute to a further weakening of demand.
But the basic problem with the world economy is not simply the bad macroeconomic judgement of those at the helm. It is a deeper, more significant point. Charles Kindleberger had pointed out many decades ago, in his analysis of the Great Depression, that stable international capitalism requires a world leader, or at the very least a multilateral institution capable of functioning as such a leader.
Such a leader needs to fill three important economic functions. First, discounting in crisis, that is, serving as an emergency lender of last resort to economies with international liquidity problems so as to avoid a more general financial collapse. Second, providing countercyclical lending to economies facing cyclical balance of payments difficulties, including especially industrialising countries with more structural foreign exchange shortage. Third, providing markets for the exports of other countries especially in periods of economic downswing.
It is worth remembering that both the historical “golden ages of capitalism” were periods when one country fulfilled this role very clearly. During the period of the Gold Standard, broadly between 1870 and 1910, Britain functioned as such a leader, and through its capital flows enabled the rapid industrialisation of countries such as the United States. During the Bretton Woods regime of the 1950s and 1960s, such a role was played by the United States, which had by then become the acknowledged world leader.
In a sense, the International Monetary Fund was set up to achieve at least two of these aims, although its impact has been singularly limited in both. And over the 1980s and 1990s, the US economy did indeed serve as the engine of growth in terms of providing a huge market for exports of other countries.
Increasingly, however, it appears that the US is no longer willing to fill these functions, and certainly the IMF is not able to do so, nor does it have either the financial power or the breadth of vision required. In other words, we now have a phase of international capitalism without a clear leader (in the economic sense) which is able and willing to fulfil these important functions. Phases such as these have historically been characterised by great instability and quite frequently world recession as well.
So the current recessionary phase can be seen as an outcome of policy sclerosis, but this in turn reflects deeper changes in international political economy and power structures. While this may well mean a more intensified recession at the international level, this is not necessarily a bad thing for many developing countries. Another thing that history tells us is that periods of instability and confusion in the world economy are precisely those periods which also allow for some autonomous industrialisation in what has been called the Third World.
So, while world economic recession is both likely and potentially painful, it may also represent an opportunity for governments in developing countries to activate strategies of autonomous industrialisation. The extent to which this occurs will of course depend in turn on the various political economy forces which determine policy in our own countries as well.
Observing the world's leaders – and especially those governing the core capitalist nations and the major multilateral economic institutions – confront the ever closer possibility of international economic recession, provides a rather similar scenario. It is now clear beyond dispute that the slowdown in world economic growth is not just likely to be more prolonged than previously projected, but also wider, deeper and with every chance of turning into recession.
Thus, forecasts and projection of future growth have been revised downwards almost continuously over the past two years, and the IMF's latest projection follow a similar pattern. It is now predicting 3.2 per cent global growth in this year, a full percentage point lower than earlier forecasts. The United States economy, which was earlier expected to grow at more than 3 per cent over the calendar year, is now expected to increase by only 1.5 per cent or even less. Growth in the European Union is projected by the IMF to be only 2.5 per cent in 2001, while the Japanese economy is expected to expand marginally by 0.6 per cent.
The trouble is that even these projections appear to be optimistic in relation to most recent trends, and may well be revised downwards even further as the year progresses. Thus, the US economy grew at an annual rate of only 0.7 per cent over the last quarter, and the Japanese economy actually shrank by 0.8 per cent. Most recent figures from Germany suggest that industrial output started falling in the last quarter, leaving the level of industrial output only 1.1 per cent higher than it was a year earlier. In Britain, manufacturing has slipped into recession by falling for two consecutive quarters and total industrial production fell by 2.2 per cent over the year. Even France, which was performing better hitherto, has shown a drop in retail sales over the past one year.
The proximate cause of all this is of course the continuing slowdown in the only major economy which had served as an engine of growth in the recent past – the United States. Over the 1990s, the US was the only major economy that continued to expand at an impressive, even alarming rate. It therefore provided a major market for exports from both other developed and developing countries. The Latin American and East Asian developing countries in particular have been heavily dependent upon exports to the US in the recent past especially.
The UN's Project Link, which involves economics researchers from over 60 countries, has forecast global economic growth at 2.4 per cent this year, down from 4 per cent in 2000. It has blamed this deceleration on retrenchment in major developed economies, noting that "the economy of the United States has been at the heart of the current weakness in the global economy."
The recently released report of Project Link describes the spreading downturn as "an intended one, at least in its early stage, engineered by policy makers, in the first instance in the United States." The Federal Reserve's aim last year was to "put on the brakes" on the rapidly growing US economy in order to head off inflation. It is suggested that this went on for too long and was too severe, creating a downturn that has now taken on a life of its own. This is why it the downturn, which has lasted more than desired, now appears to be relatively impervious to the series of five interest rate cuts that the US Federal Reserve has already over this year.
Obviously this US downturn – which has not yet turned into recession but may still do so – is bad news in a world economy in which the other major developed countries are already shrinking or spluttering and where a whole range of developing countries depend upon such growth because their own domestic demand cannot sustain the required expansion. It can push other regions into not just recession but full-blown economic crisis, of the kind that is currently engulfing Argentina.
Given the severity of the situation, what is really surprising is the absence of activity among those who are supposedly in charge of maintaining a viable international capitalism. A decade or two decades ago, such a context would have provoked a flurry of meetings among the G-7, the major central bankers, and other centres of economic power. There would have been calls for concerted action, for co-ordinated intervention by the governments of the core capitalist countries, and there would have been much more decisive action by the dominant player, the United States.
Instead, consider what we have seen so far : only a series of interest rate cuts in the United States followed by George Bush's tax cutting measure which will provide, in the first instance, an estimated $300 more to be retained by each taxpayer. These have so far not prevented the continuing slowdown, and are not likely to do much more without other more substantial measures. Now attention is focussed on the European Central Bank which is also expected to announce an interest rate cut, as if that alone would be able to pull major economies out of recession.
It is interesting to find that Keynes's insights have been forgotten to such an extent that policy makers still believe that measures such as these can suffice. The possibility of a “liquidity trap” setting a floor for real interest rates is real, especially in the face of depressed expectations across the world, and this is amply shown by recent Japanese experience. That experience should also make it clear that when people anticipate bad times and more unemployment ahead, tax cuts can lead to more saving rather than more consumption, and thereby contribute to a further weakening of demand.
But the basic problem with the world economy is not simply the bad macroeconomic judgement of those at the helm. It is a deeper, more significant point. Charles Kindleberger had pointed out many decades ago, in his analysis of the Great Depression, that stable international capitalism requires a world leader, or at the very least a multilateral institution capable of functioning as such a leader.
Such a leader needs to fill three important economic functions. First, discounting in crisis, that is, serving as an emergency lender of last resort to economies with international liquidity problems so as to avoid a more general financial collapse. Second, providing countercyclical lending to economies facing cyclical balance of payments difficulties, including especially industrialising countries with more structural foreign exchange shortage. Third, providing markets for the exports of other countries especially in periods of economic downswing.
It is worth remembering that both the historical “golden ages of capitalism” were periods when one country fulfilled this role very clearly. During the period of the Gold Standard, broadly between 1870 and 1910, Britain functioned as such a leader, and through its capital flows enabled the rapid industrialisation of countries such as the United States. During the Bretton Woods regime of the 1950s and 1960s, such a role was played by the United States, which had by then become the acknowledged world leader.
In a sense, the International Monetary Fund was set up to achieve at least two of these aims, although its impact has been singularly limited in both. And over the 1980s and 1990s, the US economy did indeed serve as the engine of growth in terms of providing a huge market for exports of other countries.
Increasingly, however, it appears that the US is no longer willing to fill these functions, and certainly the IMF is not able to do so, nor does it have either the financial power or the breadth of vision required. In other words, we now have a phase of international capitalism without a clear leader (in the economic sense) which is able and willing to fulfil these important functions. Phases such as these have historically been characterised by great instability and quite frequently world recession as well.
So the current recessionary phase can be seen as an outcome of policy sclerosis, but this in turn reflects deeper changes in international political economy and power structures. While this may well mean a more intensified recession at the international level, this is not necessarily a bad thing for many developing countries. Another thing that history tells us is that periods of instability and confusion in the world economy are precisely those periods which also allow for some autonomous industrialisation in what has been called the Third World.
So, while world economic recession is both likely and potentially painful, it may also represent an opportunity for governments in developing countries to activate strategies of autonomous industrialisation. The extent to which this occurs will of course depend in turn on the various political economy forces which determine policy in our own countries as well.
© MACROSCAN 2001