Government spokesmen claim that, after dipping in 2008-09, the economy will accelerate again next year. But some of the world’s top economists opined at last week’s Neemrana seminar that the global economy might get worse rather than better in 2009, affecting India too.
Analysts thought initially that the global recession would end by mid-2009. After all, trillions of dollars were being pumped into economies through fiscal and monetary measures of unprecedented magnitude. This, analysts felt, would surely revive spending in flagging economies.
Alas, that’s not happened. Retail sales in the US were disastrous in November and December. One US economist at Neemrana opined that the big US economic stimulus had raised spending by $ 400 billion. But this was insufficient to fill a demand gap of $ 600 billion caused by the recession. This gap eroded sales, causing job cuts that will cut income and spending even further. Corporations don’t want to invest, and it will take time for government infrastructure investment to fill the gap in private investment.
To encourage spending, the US government sent out cheques worth $ 80 billion to consumers. But consumers spent only $ 12 billion of this, saving the rest. After years of overspending, consumers are chastened and recanting, so the stimulus is not working. President-elect Obama has promised a second stimulus of $ 300 billion. It’s unclear whether this will work any better than the Bush stimulus.
After initially sniggering at the US capitalist model, Europe finds itself in deep trouble too. Recessions create fiscal deficits, and stimulus packages even more so. But some European countries already have such high public debts that they bar the risk of defaulting on repayments as their economies sink, a fate once reserved for Third World countries. Iceland is the worst hit, but may be small enough to be rescued by the IMF. But the IMF lacks the resources to rescue all tottering East European countries.
The really bad news is that mainline Eurozone countries like Greece are now in danger of sovereign default. A sequential run on the credit default swaps of European governments seems to have begun. Market rates suggest a 10-15% chance of Greek default. Greece’s national debt is a high 90% of GDP, of which 20% has to be refinanced in a few months. It’s unclear how Greece can be rescued if it defaults.
If Greece goes under, Italy, a G-7 country, will be next in line—its public finances are almost as bad. Britain can devalue to survive a financial crisis, but this option is not available to troubled Eurozone members tied to the euro, including Ireland, Portugal and Spain. Ailing banks in Eastern Europe are mostly owned by West Europe, so a banking collapse in the former could lead to massive contagion in the latter.
Indeed, the very conceptual foundation of the Eurozone, as one where a common currency ensured credit to all on good terms, is now in doubt. Wages and pensions are way too high in some countries relative to others. The problem was masked in good times. Now that the tide is going out, it’s becoming clear who was swimming naked.
Another top economist said at Neemrana that three aspects of the global crisis had been underestimated. One was the vicious downward spiral where financial distress caused production distress, which caused yet more financial distress. Second, the vulnerability of banks had been grossly underestimated. Third, nobody anticipated the speed with which galloping commodity prices in the first half of 20008 would be followed by collapsing prices in the second half.
As a result, he said, the world faces a shock of unprecedented proportions. Growth in advanced economies will fall in 2009, for the first time since World War II. Asia may seem in better shape than other regions, but this is largely because of the lag in transmission of the crisis from the West. Soon, Asia will be hit badly too. And India will suffer along with the rest of Asia.
Another top global economist declared that the crisis was structural, reflecting a serious global misallocation of money in recent years, which had created many bubbles that had now burst. Pumping in more money could not resolve the problem, since it amounted to an attempt to reflate the old bubbles. Instead painful structural change was needed, he said, and this could take years.
The mood of these top global economists at Neemrana was far gloomier than I had expected. While hoping they are wrong, we must be prepared for their being right.
(Neemrana rules prohibit reporting on who said what. The names of Neemrana economist-participants are available in the NCAER website).