The Great Unwinding

IMF

Published in the Telegraph-Journal 10th May 2013

In an uncharacteristic show of pessimism, the International Monetary Fund (IMF) recently warned that an “uneven recovery is also a dangerous one” for the global economy. The IMF downgraded its growth forecasts for 2013 for a second time, while professing optimism of a substantial upturn in performance late in the year.

There is ample evidence that this pessimism is warranted. In its twice-yearly World Economic Outlook, the IMF outlined high medium-term risks arising from its skepticism about the euro zone’s ability to pull its way out of its crisis and of the ability of the U.S. to adequately reduce its public sector deficits and debt.

The IMF also recognized that some short-term risks have been reduced. Financial markets showed their approval of both the euro zone’s crisis management initiatives in 2012, and the eventual willingness of American authorities to come to terms with limiting automatic and rapid fiscal tightening under sequestration.

The IMF’s most recent downward revision was shared among emerging and advanced economies. The exception was Japan, where the IMF has become significantly more optimistic following the strenuous efforts of Tokyo to defeat deflation by revising its monetary policy.

We are beginning to see an important evolution of the IMF’s perspective over the past two years. Before 2011, it stressed how most economies were recovering at similar rates. But rather than viewing the global economy as a homogeneous entity, the IMF now believes that the world economy is running at three speeds. It views developing economies such as the BRICS as fundamentally strong. And its analysis has the performance of the U.S. improving while the euro zone lags among advanced economies.

This nuanced view of the global economy underscores how growth has always been uneven across economies and even within them. Projections by the IMF have been persistent in their optimism. Each setback has been treated as only a momentary deviation from the normal trajectory of inexorable growth. Rather than settle on an evaluation of the global economy as possessing structural weakness, each of these deviations have been assigned their own unique cause, whether the Greek bailout, falling prices in the wake of the Japanese tsunami or the uncertainty following Standard & Poor’s downgrade of U.S. debt. Optimists have been unaffected by these temporary setbacks and simply revised their forecast for 4.5 per cent world growth. The latest push-back is to 2015.

The central theme of this economic crisis is that it is a crisis of growth. Financial institutions and markets have long assumed that productivity would continue to accelerate at the pace of the late 1990’s. This is the assumption that fostered an asset-price boom that painted over a spectrum of risk to create an illusion of stability.

But the financial crisis served to unwind these artificial gains and in the process caused a great realignment across industries. This process affected regions unevenly and had no respect for companies that might have operated successfully in their markets for years. As demand declined in the wake of the subsequent recession, industries consolidated and retrenched, cutting costs until growth would return. When the recessionary pressures began to lift, new lower-cost or higher-productivity players had emerged. A new blueprint for competition had rendered the old rule-book obsolete. This is one of the chief reasons for the multi-speed recovery that the IMF now recognizes as the reality of the newest economy.

We are faced with the challenge of recognizing that the old rules no longer apply and that the new growth reality bears little resemblance to the old. In spite of this, policymakers have continued to benchmark the prospects of economic recovery to the growth performance of the pre-financial crisis period. The cardinal assumption underpinning this thinking is that we need not abandon the dynamics of past economic growth because they have merely been postponed and they will return. The greatest obstacle faced by policymakers everywhere is that we continue to justify postponing difficult decisions on the need for the resumption of the pre-crisis growth period.

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