Planning for recovery

How to rebalance global growth and demand:

As stimulus measures wind down, many governments are opting for austerity. According to the ILO’s World of Work Report 2010, neither approach addresses the underlying drivers of global economic instability. Gary Humphreys reports.

The end came quickly, but so did the response. Faced with the complete shut-down of interbank lending after the collapse of Lehman Brothers in September 2008, central banks slashed interest rates and provided massive support in the form of loan guarantees, capital injections and, in some cases, nationalizations. It was an expensive undertaking.

“Bailing out the global financial system is estimated to have cost the United States and the European Union a total of US$11.4 trillion – about one-sixth of world GDP,” says Raymond Torres, Director of the ILO’s International Institute for Labour Studies.

There has been much criticism of the way the banking sector was shored up. In the words of Vasailis Xenakis, General Secretary for International Affairs at Greek trade union ADEDY: “The banks created the problem but the people were made to pay.”

But doing nothing at all – letting the banking system shut down and the global economy with it – would probably have been worse for everyone. “Without these policies there was a significant risk of a slide into a second Great Depression,” says Torres.

And government support was not solely directed at the banks. Those governments that could afford it cut taxes and/or increased government spending in a stimulus drive that amounted to around 1.7 per cent of global GDP in 2009, according to ILO figures. Torres also commends policy-makers for not resorting to protectionism.

“Keeping trade flowing was crucially important and especially for developing economies which are dependent on exports to drive economic growth,” he says, pointing out that roughly 20 million jobs were saved or created1 by the policy response, which in most cases focused on stimulating demand while at the same time at least partly alleviating the social impact of the crisis.

From stimulus to austerity

But in the past year things have changed as governments have veered from stimulus to fiscal austerity. This shift in policy happened very quickly. On 23 April when G20 finance ministers met in Washington they were still talking about the need for stimulus, but by 5 June the G20 position had changed to encouraging fiscal “consolidation”.2 Between those two dates Greece came close to defaulting on its sovereign debt. It is what happened, or almost happened, in Greece that has changed the tenor of global policy discussions.

But should it have? “The reality is that sovereign states need to borrow on the bond markets, and the buyers of sovereign bonds like to know if they’re going to get paid,” says Ekkehard Ernst, an ILO research analyst, offering an explanation for the change in tack.

The creditworthiness of a country is based on the state of its accounts and so cutting back on expenditure can lower the cost of borrowing. This is what Greece is hoping to achieve in order to retain IMF and EU support. But what effect does austerity have on the broader economy of a country trying to recover from recession? What effect does it have on society?

“There is a real danger that fiscal austerity will weaken the fragile economic recovery that is under way,” says Torres, pointing out that it is the developed countries that have been hit hardest by the downturn. An unprecedented number of workers have been left without jobs and, two years after the Lehman Brothers collapse, factories are still running well below capacity.

“There is a need to think about alternatives to export-led growth, and to address the increasingly important issue of income inequality”

According to OECD estimates, the gap between capacity and output in OECD countries is unlikely to close until 2015. Unfortunately it is the countries that are struggling economically – the countries that need stimulus most – that are being forced to slam on the brakes in order raise money in the capital markets.

Laying off public-sector workers, or cutting back on welfare payments, depress consumer demand which in turn strangles businesses already weakened by tight bank credit (see next article), but it looks good in a bond issuance prospectus.

Faced with dwindling domestic demand, many governments are focusing on exports as a way out of recession, the United States being a notable example. President Obama made export growth a central theme in his State of the Union address in January and has committed to doubling US exports in the next five years. It has worked before. Sweden and Finland did the same thing in the early 1990s and the Republic of Korea, Malaysia and Thailand followed suit at the end of the decade.

But the world has changed a good deal since 1999, notably with regard to demand in developed countries.

In fact, the United States has been exporting more to emerging markets than developed ones for some time, and in order to boost exports further it will need emerging market countries, notably China, to boost domestic demand.

Foreign exchange rates play an important part in this, and the ongoing debate between China and the United States regarding the value of the Yuan is indicative of their importance. www.ilo.org