The global economy presents a mixed picture at the end of the year. On the positive side, economic growth has been better than what most forecasters had expected a year ago. Indications are that the world output would increase by 5 per cent in 2010, well above its recent trend rate. Economic recovery is corroborated by the renewal of investor confidence in many parts of the world.
There has been a pick-up in cross-border capital flows. Manufacturing activity at the global level is strong and stock markets, though remaining volatile, have posted smart gains. Even more significantly, investors and the markets are shrugging off news which just a few months ago have caused havoc. Yet, all is not hunky-dory. The key question is whether last year's growth will be sustained in 2011.
The flip side
There is a flip side to the global growth story in 2010. Perhaps the most important negative factor is that there is a marked lack of cooperation among countries in fixing the problems of the global economy. In normal times, a growth rate of around 5 per cent will be impressive by itself.
Factors underpinning it will be secondary. But during the crisis period and after, cooperation among major economic powers was sought for and obtained, notably at the G-20 summits. In fact, co-ordinated actions by major economic powers, as for instance in their stimulus programmes, saved the day during the crisis and helped in the initial recovery to some extent.
As the global economic crisis abates, countries have fewer reasons to cooperate with one another. That is unfortunate because even as recently as the November G-20 summit at Seoul, it was assumed that global cooperation, however elusive, was the only way forward. At the summit, countries pledged to continue working together but will not be constrained by any rigid timeframe. It is clear that the major economic powers have given up coordination on their economic policies as a means to move forward.
A few points merit attention.
(a) There are a number of pressing problems that require a global solution.
(b) Without harmonising their policies, the initial gains from the recovery may well dissipate. High up in the list of problems is the task of re-balancing the global economy. The solution to the highly publicised currency wars — not confined to China as well as the U.S and a highly visible manifestation of the global imbalance — lies in global cooperation.
(c) Other concerns remain even though they appear less threatening than they did a year ago. For instance, serious concerns over financial sector regulation have only partially been attended to in the U.S. and other developed countries.
Another serious threat arises from the uneven nature of global recovery. The three principal groupings (admittedly an arbitrary though convenient division) — the U.S., the euro zone countries and the developing countries — have vastly different growth rates. Consequently, the policies they adopt over the short-term will be rooted through domestic concerns rather than international concerns. This in turn will suggest that highly desirable goals such as finding solutions to the global imbalance will have to wait until the more pressing short-term concerns are addressed.
The developing economies have been in the forefront of the recovery but their future growth depends to a large extent on the developed economies. The point is relevant for India too. Though India's exports as a proportion of GDP are small, any contraction in demand in the principal markets — the U.S. and Europe — will have major negative impact. Besides, as seen so well during the financial crisis, external shocks arising from the western world can have systemic implications even for banks in the developing countries.
The U.S. is beset with historically high unemployment rates and a low level of domestic demand. To counter these, it has embarked on an ultra loose monetary policy with key interest rates pegged at historically low levels.
Recent tax cuts announced by President Barack Obama are the outcome of a political compromise but they ought to be viewed as stimulus measures.
In contrast, the expansionary policy in the U.S. and Europe has embarked on a programme of austerity.
Within the euro zone, the growth rate is highly uneven. Germany is posting a scorching growth rate while some of the peripheral economies, Ireland, Greece and Portugal, are reeling under a high level of indebtedness.
Since major European banks have high exposures to the sovereign debt of these countries, there is a major risk of a global financial crisis if one or more countries default. Besides, more than ten years after it was introduced, there are serious question marks over the future of the euro.
Any drastic realignment involving one or more countries getting out of the monetary union will have major unforeseen consequences for not only Europe but also the rest of the world. More to the point, what has often been touted as an outstanding example of economic cooperation is not working. The troubles in Europe cast serious doubts over the integration process. This in a larger sense is symbolic of the way the major players are unable to harmonise their policies for their common benefit.
Some of the consequences of putting short-term national interests over medium-term global ones are already apparent.
The sharp rise in dollar denominated inflows into India and other emerging countries is posing major policy challenges for these governments. Evidently, such capital finds vast parts of Europe risky. There are also growing signs of protectionism in the U.S. and a few other developed countries. The Doha development round of trade talks is highly unlikely to move forward.