New growth drivers required to get world economy out of doldrums, UNCTAD report says

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New growth drivers required to get world economy out of doldrums, UNCTAD report says
The “new normal” runs risk of repeating past policy mistakes – strengthening domestic demand and taming finance are urgent priorities

Geneva, Switzerland, 10 September 2014

​Six years after the onset of the global economic and financial crisis, the world economy has still not found a sustainable growth path, argues the UNCTAD Trade and Development Report, 20141.  The study, subtitled Global governance and policy space for development, calls for major changes in the way the global economy is governed and managed.

With expected growth of 2.5 to 3 per cent in 2014, the global recovery remains weak, while the policies supporting it are not only inadequate but often inconsistent, the report argues. Getting back to business as usual has failed to address the root causes of the crisis.

Breaking from a protracted period of low economic growth requires strengthening aggregate demand through real wage growth and more equal income distribution rather than new financial bubbles. The continuing dominance of finance over the real economy and the persistent decline in the wage share are symbolic of the inability to come to grips with the causes of the crisis and its abnormal recovery, the report says.

In a review of trends in the global economy, the report observes that a modest improvement in growth is expected in 2014. After expanding by around 2.3 per cent in 2012 and in 2013, world output growth is projected to rise to 2.5−3 per cent in 2014. Most of this moderate acceleration of growth stems from developed countries raising their growth rate from 1.3 in 2013 to 1.8 per cent in 2014. This in turn results from a slight pickup in the European Union, since growth in Japan and the United States of America is not expected to improve in 2014.

The report forecasts that developing economies as a whole are likely to repeat the performance of previous years, growing at between 4.5 and 5 per cent. In this group, growth will exceed 5.5 per cent in Asian and sub-Saharan countries, but will remain subdued at around 2 per cent in North Africa and Latin America and the Caribbean. Meanwhile, transition economies are expected to further dip to around 1 per cent, from an already weak performance in 2013.

Mirroring economic activity, international trade remains lacklustre. With the volume of merchandise trade increasing at a rate slightly above 2 per cent in 2012, 2013 and early 2014, the growth of international trade was even below that of global output.

The report contends that international trade has not decelerated because of higher trade barriers or supply-side difficulties; its slow growth is the result of weak global demand. Therefore, efforts to spur exports through wage reductions and “internal devaluation” are self-defeating and counterproductive, especially if several trade partners pursue such a strategy simultaneously. The global expansion of trade will be achieved through a robust output recovery led by domestic demand – not the other way round.

The apparent stabilization of growth rates across different groups of countries in the world economy may give the impression that this has managed to avert systemic risks and establish a low inflation and low, but stable and sustainable, growth path, with some observers welcoming this as the “new normal”.

There is however nothing normal about weak employment growth, stagnant wages and rising levels of household debt on the one hand and surging asset prices, growing profit shares and an unchecked bonus culture on the other. Some of the drivers of the present recovery may not be adequate for a sustainable growth process. 

In particular, the current policy mix in developed economies – which combines fiscal austerity, wage restraint and monetary expansion in the hope that labour market flexibility, greater competitiveness and the rehabilitation of banks’ balance sheets will bring sustained recovery – is dampening domestic demand. These policy measures are also encouraging liquidity expansion to work mostly through financial rather than productive investments.

Consequently, any demand-led recovery has been delayed and indirect, confined to those countries where asset price appreciation has generated a sufficiently strong wealth effect and encouraged renewed consumer borrowing.

The “new normal” has as such some worrying parallels with the conditions that led to the global financial crisis in 2008, namely rising inequalities and asset bubbles. Furthermore, the policy decisions taken in developed countries have generated a new global financial cycle, with international capital movements affecting developing countries with potentially disruptive macroeconomic impacts.

Developing countries have managed to recover from the Great Recession after 2008 faster than developed countries, in part by supporting domestic demand with countercyclical policies, but in some cases they were helped by rising commodity prices. However, there are limits to what can be achieved by countercyclical policies and gains from the terms of trade, and the idea that emerging economies have decoupled from events in the advanced economies is no longer tenable. New sources of dynamism will need to be found.

In addition to demand-side policies that raise consumer demand and may include redistribution policies, some countries need to raise domestic investment levels (public and private), and all need effective industrial policies to diversify and expand their productive capacity so as to respond to rising demand without excessive pressure on domestic prices or trade balances.

Developing countries will also have to face the challenge of persistent instability of the international financial system. Tackling this should involve prudential macroeconomic and regulatory policies, mainly applied at the domestic level, but also better regulation at the global level.

International capital flows usually generate a financial cycle in the receiving countries and often increase their financial fragility, eventually leading to a financial crisis. This is why, in an increasingly globalized economy, it is difficult to regulate domestic finance if international financial markets are unregulated. In order to establish domestic macroeconomic and financial conditions that support growth, Governments should have suitable policy instruments for managing international capital flows at their disposal.

UNCTAD’s new report insists these capital management measures should be considered normal instruments in the policymakers’ toolkit, rather than exceptional and temporary devices to be employed only in critical times. Multilateral rules in the Articles of Agreement of the International Monetary Fund and the General Agreement on Trade in Services of the World Trade Organization do allow Governments to manage their capital accounts, including using capital controls.

However, some new trade and investment agreements, whether bilateral, regional or “plurilateral” – those among individual countries from different regions, that have been signed or are being negotiated are pushing much harder for financial liberalization than is the case in multilateral agreements. Governments that aim at maintaining macroeconomic stability and wish to reregulate their financial systems should carefully consider the risks of taking on such commitments.