The World Economy on a Precipice

The world economy is teetering on a precipice, as both advanced and developing economies face plunging industrial production, volatile equity markets, and severely contracting trade.  The Carnegie Endowment’s Uri Dadush, EU Commission Ambassador to the U.S. John Bruton, Jörg Decressin of the IMF, and Hans Timmer of the World Bank joined in discussion about what these daunting trends mean for the G20 and the world.  The event was moderated by Sandra Polaski, Senior Associate and Director of the Trade, Equity, and Development Program at the Carnegie Endowment for International Peace.

Path to Recovery
Jörg Decressin, head of the World Economic Studies Division in the Research Department at the International Monetary Fund, painted a bleak picture of the global economy, which is forecasted in 2009 to face the largest drop in output since World War II.  Although he predicted recovery in 2010, Decressin stressed that several assumptions – that monetary easing will open credit, that fiscal stimulus will encourage spending, that housing market will rebounds – must be fulfilled for this forecast to be realized. 

Most crucial to recovery is righting the financial sector, which he recommended be approached with a three-pronged strategy: enhancing liquidity, ensuring solvency, and addressing bank’s toxic assets.  He predicted that U.S. Treasury Secretary Geithner’s recently announced plan to deal with toxic assets will likely create demand for these assets; however, he feared that banks may not be willing to sell them at steep losses from their book value. 

Impact on Developing Nations
Hans Timmer, Lead Economist and Manager of the Global Trends team in the World Bank's Development Prospects Group, described the severe damage that the financial crisis is inflicting on developing countries.  Over the past ten years, the global economy has seen strong and steady growth, lead by even more rapid growth in low and middle-income countries.  However, today’s crisis is strikingly indiscriminate, impacting every country through both its integrated and domestic markets.  

Timmer reminded both advanced and developing nation governments not lose sight of long-term economic goals.  He suggested that frenzied government response to the crisis, without regard for long-term planning, would generate debt that could deepen economic woes in the future.  Further, to rebuild confidence, leaders must paint the public a picture of how today’s projects will lead to a better economy five years down the line.  Finally, Timmer framed this crisis as an opportunity to fund much needed, long-term reforms.  He also noted that the world economy may emerge from this crisis with a new view of globalization, in which global growth is driven not by the U.S. economy but by those of Asian nations.

Need for Reform
Ambassador John Bruton, the EU Commission’s ambassador to the United States, spoke to the quickly depleting political will for government intervention.  He rebuked politicians for failing to frame bank bailouts as government support for public goods.  He likened banks to road and rail systems, which must continue to operate for a nation’s economy to function.  For this reason, he stressed, a government must support its banks. 

He acknowledged the legitimacy of concerns about mounting government debt; however, he endorsed large fiscal stimulus plans, noting that when businesses close today, they become very costly to reopen in the future.  Government’s role in economic crisis is to smooth  large variations in activity; for this reason, he encouraged politicians to frame their proposals as “stability” plans, rather than “stimulus” plans.

Prospects for Depression
Uri Dadush, Senior Associate and Director of the new International Economics Program at the Carnegie Endowment, cautioned modesty in economic forecasts for recovery.  Although recovery in 2010 is the most likely scenario, policymakers must consider the possibility of a depression, or a 10% drop in GDP over two or more years, he warned. 

Although leaders and economist often believe that we have learned the lessons from the Great Depression, Dadush highlighted several new factors that make the current crisis unique.  First, the level of indebtedness in the U.S. and UK is unprecedented. Second,  financial tools that instigated the crisis are complex and opaque.  Third, while globalization has many growth-enhancing aspects, it also makes coordination of crisis response extremely difficult.  Finally, some nations face such large public debt that they are hitting the limits of what intervention policies than can pursue.

Given this possibility of a depression, Dadush urged leaders at the upcoming G20 summit to adopt more ambitious policies.  He disagreed with Timmer’s suggestion that policymakers balance short-term crisis response with long-term planning.  Instead, Dadush recommended that the G20 leaders focus 90% of their efforts--time, money, and political capital--on stemming the current crisis, rather than on long-term reform.  He recommended that the 15 of the G20 nations that have the space to expand fiscal stimulus do so.  He also encouraged the European Central Bank to embrace quantitative easing, as the U.S., the UK, and Japan have done. 

Dadush offered tentative praise for the Geithner plan, which allows the market to price bank’s toxic assets, but noted whether it will work is still unknown.  Because fixing the ailing banking sector is an urgent need for broader economic recovery, he suggested giving the plan three months to work and, if it does not, going to plan B: nationalization of the banks.  Finally, Dadush advised G20 leaders to pledge even greater financial support for the IMF and to enhance WTO formal surveillance of trade protectionism, which is on the rise.

Although panelists disagreed as to the correct balance that G20 leaders should strike at their upcoming meeting between long-term versus more immediate relief measures, all agreed that leaders must adopt more transparent and coordinated policies in addressing this crisis.

Questions & Answers
The panel addressed questions from the audience on the role of the IMF in coordinating support to vulnerable nations.  Decressin outlined the IMF’s “Flexible Credit Line” program, in which eligible countries that have certain strong economic policies are granted pre-approved access to a credit line, which can then be spent later without any of the conditions for which IMF loans have sometimes been criticized in the past. 

Dadush, asked to identify factors that distinguished today’s crisis from those of the past, pointed to the collapse of world trade, indicating that export-driven growth will not propel nations out of recession as it has in past crises.