The $7-trillion challenge
It’s the unbalanced economy, stupid.
Not as zippy as Bill Clinton’s 1992 campaign slogan. Still, it captures the message that a significant number of high profile economists are attempting to get through to the Group of 20, as leaders assemble in Toronto to hash out whether the recovery will be secured by austerity or more fiscal stimulus.
The debate over how much to cut and how much to spend is likely to skate around an issue many economists say is central: Making structural changes economies around the world. Governments must tackle fundamental policies that make it easier to generate wealth – those aimed at building educated work forces, better roads or better access to start-up capital.
Change is necessary because the United States and the rest of the original Group of Seven advanced economies are no longer the engines of original growth they once were. The world’s older powers are still struggling to climb out of the hole left by the financial crisis.
Big employers such as auto makers are recovering, but may never return to previous levels of output, explaining why unemployment rates remain high.
That means the G7 collectively will generate gross domestic product of about $32-trillion (U.S.) in 2010, less than in 2008, according to the International Monetary Fund.
This reality is at the core of the G20 agenda. The pledge at an earlier meeting in Pittsburgh to create a “a framework that lays out the policies and the way we act together to generate strong, sustainable and balanced global growth” is a recognition that debt-fuelled consumer spending in the U.S. will no longer work as the basis for global economic expansion. China’s decision to end its peg to the U.S. dollar is part of the solution.
At stake in the global rebalancing: a staggering amount of lost opportunity that the Bank of Canada has pegged at $7-trillion.
In what was his last public opportunity to influence the G20 talks, central bank Governor Mark Carney used an appearance in Toronto Wednesday to remind leaders of the amount riding on a successful outcome. It’s the equivalent of more than five years of Canadian economic output.
“It’s 10 per cent of global GDP that is to play for,” Mr. Carney said in Toronto, emphasizing that budget cuts and debt reduction will do little unless those actions are accompanied by “underlying economic growth.”
The figure is the result of an effort by a team of Bank of Canada researchers, led by Kimberly Beaton, to make the G20’s rather abstract Pittsburgh “framework” pledge more tangible.
The framework, which leaders will attempt to make operable this weekend, is meant to get big economies to think about the global good when they design policy, rather than simply trying to generate the most wealth possible at home. The idea is to avoid the extreme mismatches in savings and spending that built up between trade-surplus countries such as China and deficit nations like the United States in the decade or so prior to the financial crisis. Previous attempts to co-ordinate economic policies had gone nowhere for lack of political commitment. To focus the mind, Mr. Carney, through his research department, attempted to put a price on failure.
Ms. Beaton’s team ran three scenarios through the Bank of Canada’s economic models for estimating global economic growth: the status quo, under which governments continue their current policies; a best-case scenario that would see the G20 successfully implement the framework; and a worst-case scenario that assumed governments would constrict spending to narrow deficits, while surplus nations do nothing to generate economic growth.
But instead of leading to a broader discussion about the changes countries need to make to replace newly frugal American consumers, the debate instead has degenerated into cross-Atlantic finger pointing over who knows best: the U.S., which is included to keep stimulus in the system, or Germany, which has appointed itself the leader of the austerity wave in Europe, even though the country is in relatively good shape.Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., calls it a “false debate” that suggests a lack of understanding of how much the world has changed in the last decade.
“The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset,” Mr. El-Erian, whose company operates the world’s biggest bond fund, wrote in a commentary on Friday. “Until they break out of it we will see little more than fruitless discussions, national policy flip-flops and a troubling lack of global policy harmonization.”
The American and German debate is really about what the world economy needs over the next few months to keep it from slipping back into recession. The risk is that the debate has become so heated that agreeing on more fundamental changes has become more difficult, if achievable at all.
“Not nearly enough attention is being paid to what needs to be done on the structural side,” said John Curtis, a distinguished fellow at the Waterloo, Ont.-based Centre for International Governance Innovation and a former chief economist at Canada’s Trade Department. The G20 “is faltering on the structural side,” Mr. Curtis said in an interview from Ottawa.
This isn’t going unnoticed within the G20 family.
According to the modelling by the Bank of Canada economists, the worst-case scenario would result in a “massive” recession, deflation and protectionism. The difference between the level of GDP in the worst-case and best-case scenarios in 2015 is about 12 per cent, which represents the $7-trillion figure.
But Mr. Carney appeared sensitive to the possibility that the politicians were drifting off course, putting the emphasis on either cutting or spending when a more complicated set of decisions is needed.
“National balance sheets are the issue, but it is not so simple as just running to the other side of the boat and everybody tightening fiscal policy at the same time dramatically,” Mr. Carney said at Wednesday’s event, a question-and-answer session. “It’s not just fiscal.”
The point that Mr. Carney was trying to emphasize is that there are two sides to the deficit-to-GDP or debt-to-GDP ratios: a numerator and a denominator. While it’s necessary to reduce the numerator, those ratios also can be made to look more favourable by increasing the denominator – or in other words, boosting economic growth.
Mr. Carney’s message was in the letter President Barack Obama sent his G20 counterparts on June 16. He said some countries could consider strengthening their social safety nets to encourage consumer spending and others should loosen labour markets to spur investment. And of course, countries with fixed exchange rates should let the value of their currencies be determined by markets, the President said.
These policies are all generally considered to be part of the formula for balanced and sustainable growth. Yet it was another part of the President’s letter that got all the attention.
Apparently in response to a wave of spending cuts in Europe, Mr. Obama called on G20 countries to be “flexible in adjusting the pace of consolidation.” In a nod to the Great Depression and Japan’s so-called Lost Decade in the 1990s, Mr. Obama said governments must avoid the “mistakes of the past when stimulus was too quickly withdrawn and resulted in renewed economic hardship and recession.”
German officials appeared to take Mr. Obama’s letter personally. Noting that excessive budget deficits were at the heart of Europe’s debt crisis, Finance Minister Wolfgang Schauble wrote in the Financial Times on Thursday that “it comes therefore as a surprise, to me at least, that one of the most passionately debated economic issues of the day should be whether Germany is acting prematurely in reining in its deficit and thereby choking the rebound at home and in our neighbours’ markets. My response is an emphatic no.”
As leaders and their finance ministers arrived in Toronto Friday, they attempted to cover differences in an effort to deflect the growing sentiment in financial markets that the world’s economic crisis committee was turning into something of a circus. A U.S. official told reporters on background that views on the economy were beginning to converge. The emerging consensus appeared to be an agreement that some countries are so desperate that they must restrain spending now, others are in a position to wait a bit, while the world’s faster growing economies were in a position to do more to foster demand.
Still missing were details about the structural changes countries plan to generate economic growth.
For Mr. Curtis, part of the problem is that too many governments for too long have relied on cutting taxes as the surest way to spark economic growth. It works as long as there is enough revenue coming in to pay for governments’ obligations or bond traders are willing to finance the spending. With the revenue from booming economies gone, and bond markets less willing to finance bloated government deficits, policy makers must now look for more complicated solutions, Mr. Curtis said.
While not as cohesive as having to face down a crisis, perhaps a shared sense of desperation about how to generate economic growth will pull the G20 back together?
“Without action our future will be disappointing global growth and periodic sovereign debt crises,” Mr. El-Erian said. “Let us hope this, if nothing else, is enough to bring the two camps together.”
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