The year 2009, the worst year for economic performance in recent memory, ended on a positive note with most of the world’s major economies growing again. Although most projections show a continuation of positive growth in 2010, questions about the strength and sustainability of the recovery remain.
To provide an economic outlook for the new year, Carnegie hosted a distinguished panel of the heads of forecasting at their respective institutions. Panelists included Hans Timmer of the World Bank, Jörg Decressin of the IMF, Phillip Suttle of the International Institute of Finance, Desmond Lachman of the American Enterprise Institute, and Uri Dadush of the Carnegie Endowment. Carnegie’s Pieter Bottelier moderated.
Why 2009 Turned Out to be Better Than Expected
In January of 2009, the IMF forecasted that advanced economies would not exit the recession until the middle of 2010. However, these economies posted growth of about two percent in the third quarter of 2009, and growth in emerging economies accelerated to eight percent in the second and third quarters—two percent higher than forecast. Additionally, global trade and industrial production are on a sharp recovery path.
Dadush highlighted several factors behind this stronger-than-expected recovery:
- Most importantly, unprecedented stimulus and financial rescue efforts in advanced economies largely worked.
- Asia, where fundamentals like financial sectors and public budgets were healthy before the crisis, recovered rapidly, helping pull the rest of the world to recovery.
- The world succeeded in avoiding large-scale contagion effects, including sovereign debt crises, competitive exchange rate devaluations, and trade wars.
- The recovery also reflects the depth of the contraction. At the start of the panic, all commitments and purchases that could be deferred—from houses to cars to industrial equipment and inventories—were deferred. Even today’s stabilization and modest pickup represent a marked improvement.
Timmer noted that, despite these improvements, production levels across the world remain 7-10 percent below pre-crisis levels, unemployment in many countries is around 10 percent, and fiscal positions have deteriorated significantly: ultimately, there is still a long way to go.
What to Expect for 2010
Suttle and Dadush offered optimistic outlooks for 2010, citing several supporting factors:
- The growing role of emerging economies, which did not suffer a financial crisis and remain fundamentally strong, will support the global recovery.
- The corporate sector, particularly non-financial firms in the United States, reacted quickly and aggressively to the crisis, registering better than expected earnings in 2009. As a result, a significant turnaround is expected soon in their labor, inventory, and investment demand, with employment expected to improve by the middle of 2010.
- Policy will remain supportive. Much of the fiscal stimulus has yet to enter the market, with only one third of the U.S. stimulus package spent so far. Financial rescue is being withdrawn gradually in response to market signals. In addition, as risk appetites increase, low policy interest rates will be much more effective in increasing consumer and investment demand.
Lachman, however, presented a grimmer picture, projecting a very subdued recovery with a return to recession possible in the United States:
- With unemployment close to 10 percent in advanced economies, low wage and income growth will depress consumption. The weak private sector will struggle to support the recovery.
- Banks, still suffering from huge losses, will be forced to cut credit. Additionally, regional banks in particular will likely be hit by commercial property market weaknesses.
Risks to Forecasts
Participants agreed that the current outlook has both upside and downside risks. Dadush noted that risks, especially on the downside, were much smaller than a year ago. Suttle argued that upside risks are important in the near term, while downside vulnerabilities will play a larger role in the second half of 2010.
- Upside Risks: Lachman pointed to a sharp fall in commodity prices—which would raise real incomes in advanced economies—and well-coordinated policy responses as potential upside risks. Both Suttle and Dadush argued that the synchronized nature of the global recovery, and a long history of forecasters underestimating growth at the turning point, represent upside risks. Worries about inflation and asset bubbles are building, but on a country by country basis.
- Policy: Dadush argued that monetary policy tightening, which will inevitably expose weaknesses, poses the biggest downside risk. Suttle suggested that new regulations (such as higher capital requirements), if imposed too early, may hurt the banking sector, which still needs support.
- Euro Area: Lachman and Suttle both warned of tensions in the Euro area. Greece, Ireland, Spain, and Portugal are all struggling to address deficits and large debts; without independent monetary authorities or the flexibility of a floating exchange rate, these countries may be forced to “tough out” budget cuts for an extended period. This will likely strain relations with other Euro area members, and could fracture the currency zone if any of these countries is forced out.
- Debt Burdens: Decressin stressed that debt burdens will weigh on other major economies, including the United States and UK. Heavily indebted economies must consider all options, including tax increases, spending cuts, and structural changes to return to a more sustainable fiscal position.
- Protectionism: Dadush and Lachman agreed that protectionism also bears careful monitoring, especially if unemployment remains elevated. The trade bickering between the United States and China is dangerous.
Advanced Versus Emerging Economies
Major differences have emerged between advanced economies and emerging markets. Emerging economies, which are increasingly driven by domestic growth factors rather than exports, are now contributing significantly more to growth and investment than advanced countries.
- Decressin noted that both groups saw growth from 2007 to 2009 contract by approximately 6 percent, falling from 3 percent to -3 percent in advanced countries and from 8 percent to 2 percent in emerging markets. They remained “cyclically” coupled, though the underlying growth rate in emerging markets is much higher.
- At the same time, there was much heterogeneity among the emerging economies. While Asia—and China in particular—has led the recovery, Eastern Europe (with the exception of Poland) has been less successful, with little sign of recovery. Latin America paints the most diverse regional picture, with countries like Brazil faring relatively well and others, like Chile, lagging behind.
- Decressin argued that as long as the differences between the advanced economies, which are weighed down by both structural and cyclical weaknesses, and emerging ones persist, capital will continue to flow to emerging markets.
Panelists agreed that China must evolve to fit this new paradigm. China is already or may soon be the world’s second largest economy and the largest trader and emitter of C02. Bottelier argued that China must embrace this new role and take a more prominent leadership role in crucial areas such as global trade reform and climate change.
Domestically, China should pursue structural reform and a more flexible exchange rate. Dadush noted that a flexible and appreciated exchange rate is in China’s interest, as it will help rebalance the economy towards consumption and reduce long-run inflationary pressure. However, placing external imbalances at the center of policy dialogue is misguided.
Speakers outlined the challenges that policy makers face in the coming year, and offered suggestions for solutions:
- Fiscal policy should remain stimulative in the near term, but panelists agreed that leaders need to begin engineering a shift in demand from public to private sources. Timmer stressed that while fiscal stimulus can provide a short term boost, it is not an effective growth strategy.
- Similarly, Suttle commented that monetary policy should remain supportive, but given the unprecedented nature of recent policy—particularly quantitative easing in the United States and UK—leaders must exercise caution.
- More should be done to promote credit. Banking sector lending remains depressed and credit must be available once demand picks up.
- Policy should accommodate the permanent shift in the structure of the world economy caused by the crisis, and support demand moving from traditional industrial powers to emerging markets. Timmer noted that these shifts—if managed with long-term considerations like climate change in mind—have the potential to create new sectors, such as “green industries,” that will help drive future growth.
- Suttle noted that policy action should be consistent with stated goals. For example, requiring banks to lend more while simultaneously increasing capital ratios pulls in different directions, and may do more harm than good.