How to Heal the Global Economy
Last year, the annual gathering of TIME's Board of Economists on the first day of the World Economic Forum in Davos was dominated by a debate over just how bad the then-gathering financial crisis would be, and whether the rest of the world would share in the economic comeuppance facing the U.S.
This Jan. 28, on a day when the lowering snow-filled skies matched the mood of those inside the Davos Congress Center, there was no such debate. In a packed room for what has become an opening-day tradition, everybody agreed with Morgan Stanley Asia chairman Stephen Roach's grim assessment that "this will most likely be the first year since the end of World War II when world GDP actually contracts." In fact, after Roach predicted 2.5% average global growth over the next three years — which still qualifies by most standards as a recession or close to it — Keio University economist and former Japanese Minister for Internal Affairs Heizo Takenaka quipped that Roach was being "much more optimistic than expected."
Depression or Recession?
Later on, Roach and Financial Times columnist Martin Wolf, who was in the audience, differed on whether we're in a "proto-depression" (Wolf) or a "global recession the likes of which we've never seen" (Roach). But that was more a linguistic debate than an economic one. There was also some disagreement over China's growth prospects. World Bank chief economist Justin Yifu Lin said he thought the country's big fiscal stimulus plans, including massive expenditure on infrastructure, would keep growth above 7% per year. No one else was that confident.
Still, it's fair to say there was a consensus on the current prospects of the global economy, and it was pretty gloomy. So the economists' discussion focused instead on what could be done to keep matters from getting much worse — and how to structure a global financial and economic architecture that's not quite so susceptible to breakdown. These are also major themes for the entire Davos conference this year, where chastened business leaders and government economic officials from much of the world are gathering to discuss how to rebuild broken systems, or, indeed, whether they ought just to start anew.
Trevor Manuel, South Africa's Minister of Finance, was among those who hoped for the latter. "We've lived through the era from 1944 to the present, and beyond this lies something different," he said. Manuel painted a dire picture of how the current crisis is affecting emerging markets. "I suppose the debate last year was about decoupling," he said, referring to the idea, briefly fashionable, that the high-growth economies of the developing world were establishing a self-sustaining growth, rather than relying on export markets in rich nations. "But now, looking at Africa, it's the risk of decoupling, derailment and abandonment together."
Turkish industrialist Ferit Sahenk, chairman of the Dogus Group, worries that those in the developing world who have borne the brunt of reform efforts may now turn against them, with social and political consequences that are potentially worrisome. He could imagine people saying, "We went through all these structural changes, all these reforms. We changed ourselves. Now why are we being punished?" It's already true that pain has been felt far from its origins. The crisis may have begun in the U.S. mortgage market, but that is by no means the only financial market that has frozen up. "Countries that have taken tough decisions of macroeconomic reform and then been able to access capital markets are now crowded out," Manuel said. "The markets are effectively closed."
The fiscal-stimulus programs and corporate bailouts now in vogue in developed economies are in some cases making things worse, Manuel argued, because they draw resources away from the developing world. "I think you'll end up with wealthy states heavily indebted and very little to show for it," he said. The World Bank's Lin countered that while "coordinated fiscal response" was a good idea, it wouldn't work unless it included some kind of mechanism to transfer resources from developed countries that can still borrow in global markets to developing ones that "don't have that fiscal space."
Sahenk spoke of how Turkey weathered a financial crisis in 2001 and 2002. Tough conditions imposed by the International Monetary Fund were part of the solution, he said, "but the main thing was that the country got together, all the stakeholders together, and stood together and supported it collectively. This is probably what we need in the grand picture in the world today: collective action."
This was a sentiment shared by everyone on the panel, although Roach was skeptical of whether it would ever happen. "We definitely need a more multilateral approach," he said. "The problem is there's no enforcement mechanism. There's no penalty for bad behavior. There's no reward for good behavior."
When Martin Wolf asked how the others hoped to see this collective action develop, the answers centered on the IMF and the G-20 — the grouping of top officials from 19 large economies and the European Union.
The problem with the current arrangement, both Manuel and Sahenk said, was that while developing countries generally had little choice but to obey the dictates of the IMF, big, wealthy nations such as the U.S. could ignore them — and the current crisis was in part a result of this. After all (and contradicting the view that the financial crisis was one of those unexpected "black swans" which nobody could predict), there has been no shortage of warnings that the U.S. economy was built on shaky foundations of personal debt and asset-price bubbles. "What can you do when countries continually ignore the advice of their peers and the advice of the multilateral institutions?" asked Manuel.
U.S. economic policy — and in particular its response to the current crisis — came under fire, and there were no U.S. officials on hand to defend themselves. Lawrence Summers, the top economic adviser in Barack Obama's White House, had planned to take part in the discussion, but canceled his trip to Davos shortly before everyone trudged their way through the snow to the Swiss mountain town. With lots of big economic decisions being made in Washington this week, especially on the shape of the Obama Administration's stimulus package, U.S. officials and lawmakers were in short supply.
Takenaka, a veteran of Japan's long and painful struggle to break out of a financial crisis, said that while it made sense to inject capital into banks — as the U.S. and several European countries have done — it wasn't going to work on its own. "What we need now is accurate assessment of assets, accurate measurement of assets," he said. "Because otherwise we cannot get the complete amount of what capital injections are needed."
Roach agreed that the key thing was to find a way to value and dispose of the bad debts on financial institutions' books. "The issue here is to develop a pricing mechanism for toxic assets," he said. That was the original goal of the Treasury Department's Troubled Asset Relief Program (TARP), introduced after the crisis really broke out into the open in September, but all the money so far has gone to capital injections. "Come on guys, let TARP be TARP," Roach said. Other U.S. bailout efforts, such as those intended to save the automobile industry, came under even more criticism. "Fiscal stimulus is exceedingly fashionable at the moment, but I cannot for the life of me resolve what tens of billions of dollars poured into the Detroit Three will do," said Manuel. "Sure, it will keep companies afloat, but what does it do for industrialization or anything else? What does it do for the real economy beyond sentiment?"
Silver Lining
Still, audience member Jacob Frenkel — a vice chairman of troubled U.S. insurer AIG and former governor of the Bank of Israel who was for many years an outspoken optimist at Davos — detected a "silver lining" in the current U.S. situation. "One of the problems we had last year was that there was an election in the United States, and we learned the lesson: Never have a financial crisis during an election year," he said. "We do not have an election year, so maybe there is a recovery."
But whether it's an election year or not, policymakers and financial institutions in the U.S. have tough choices to make — and to sell to an electorate that is seeing its employment prospects and retirement savings accounts wither. Nobody on the panel was cruel enough to blame the U.S. for the world's woes. "We got the benefit of globalization," said Turkey's Sahenk. "We all enjoyed these past 15 years. Let's stop blaming people. It's not the U.S., it's not us, it's not them." But in large measure, it could in fact be the choices that the Obama Administration now makes that will determine whether the mood at next year's Davos will be as dark as today's skies — or whether some shafts of sunlight will be apparent on the snow-covered Swiss mountains.