• Monday, May 27, 2024
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Does growth have a future?


Michael Spence

What can we expect as the world’s economy emerges from its most serious downturn in almost a century? The short answer is a new normal, with slower growth, a de-risked and more stable core financial system, and a set of additional challenges (energy, climate, and demographic imbalances, to name a few) with varying time horizons that will test our collective capacity to improve management and oversight of the global economy. Lower growth is the best guess for the medium term. It seems most likely, but no one really knows. The financial crisis, morphing quickly into a global economic downturn, resulted not just from a failure to react to growing instability, risk, and imbalance, but also from a widespread pre-crisis inability to see the rising systemic risk.
These defining characteristics will condition the responses and the results in coming years. There are countervailing forces. The high-growth countries (China and India) are large and getting larger relative to the rest. That alone will tend to elevate global growth compared to the world where industrial countries, and the US in particular, were in the growth driving seat.

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The current crisis has come to be called a balance-sheet recession of global scope, tremendous depth and destructive power because of its origins in the balance sheets of the financial and household sectors. Extreme balance-sheet destruction is what made it distinctive. In the future, central banks and regulators will not be able to afford a narrow focus on (goods and services) inflation, growth, and employment (the real economy) while letting the balance-sheet side fend for itself. Somewhere in the system, accountability for stability and sustainability in terms of asset valuation, leverage, and balance sheets will need to be assigned and taken seriously.
Financial re-regulation should and will emphasise capital, reserve, and margin requirements; limiting systemic risk build-up by constraining leverage; eliminating fragmented and incomplete regulatory coverage and regulatory arbitrage (a huge challenge internationally); and a focus on transparency. Isolating and further constraining a portion of the banking system, so that the channels of credit intermediation are less prone to complete and simultaneous breakdown, also seems likely.
Relative to the recent past, the cost of capital will increase, debt will be more expensive and less ubiquitous, and risk spreads will not return to pre-crisis compressed levels. Assets bubbles will not disappear, but they will be less likely to be turbocharged by leverage.
American consumers will save more and spend less, abandoning the pattern of the last few years. The large hole (on the order of $700 billion or more) in global aggregate demand will have to be filled over time by a compensating increase in consumption in surplus economies, such as China and Japan. The longer this takes, the greater the incentives at the national level to capture a share of global demand via protectionist measures.
The recent increase in protectionist measures is an understandable political price for a range of stimulus packages in advanced and developing countries. But such measures may increase – and will be harder to phase out over time – in the context of a shortfall in aggregate demand.
This is the forward-looking version of the global imbalance issue. Its resolution via coordinated policy action (or a failure to resolve it through such action) will have a huge impact (for good or ill) on the multinational incentive structure surrounding the global economy – and hence on its likely growth.
Responsibility for overseeing the global economy is passing rapidly from the G-7/8 to the G-20, as it should. The latter accounts for 90 percent of global GDP and two-thirds of the world’s population, so this shift is highly desirable – indeed, essential.
But there is a risk that the interests of the remaining one-third of the world’s people (and the majority of the small countries) will not be adequately represented as the international architecture for managing the global economy evolves.
In the current crisis, a substantial fraction of countries outside the G-20 are essentially defenseless: small relatively poor economies, no fiscal capacity for stimulus, and inadequate reserves to offset the capital outflows that occurred to shore up damaged balance sheets in advanced markets. Within the G-20 countries, there are mechanisms that attend to the interests of the most vulnerable citizens. In the global economy, the most vulnerable are whole countries. Inattention to their interests is not just a moral issue, but a potentially explosive social and economic one.
As a result, the world’s international economic institutions will need to be strengthened in terms of governance and resources so that they can act as circuit-breakers in the event of future financial and economic turbulence. Entering the crisis, the International Monetary Fund (IMF) was underfunded, and it continues to lack credibility and trust in certain systemically important parts of the world. It is now in the process of being better funded, but we are eight months into a crisis in which international capital flows became volatile and were driven largely by emergency responses rather than underlying economic fundamentals.

Thus, there remains the central question of trust and confidence in the system, both of which have been badly damaged and will take time to rebuild. At the moment, the majority view in most countries is that the financial system failed badly, but that the incentives and dynamics of the broader market-based system in a relatively open global architecture remain the best avenues for wealth creation, poverty reduction, and the expansion of opportunity. There are, of course, dissidents, and the balance could shift quickly. It is not inconceivable that the baby will be thrown out with the bath water.
There is no magic bullet for today’s crisis. Pragmatic, steady progress at the national and international levels in improving the regulatory architecture and increasing our collective ability to avoid non-cooperative behaviour is the best course to follow. It is the course we are on. But for now, it is a journey without a clearly defined, widely accepted endpoint.
Spence is the 2001 Nobel Laureate in economics, and professor emeritus, Stanford University. He chairs the Commission on Growth and Development