World economy outlook

The gathering clouds do not augur well for the next two years

Chanakya

The GDP growth numbers do not yet look too bad, but optimism is fast draining away from the hearts of the industrial world. Is the world economy poised for another depression? Stock markets are losing ground everywhere. The big corporations are announcing profit cuts one after another. Plans are afoot to reduce labour force. But policy makers refuse to believe that all this will tip them into depression: consumer spending is holding up, they say. As the inventories are wound down, investment and production will pick up again. This is not the time to panic, we are told.

Well, may be. But the portents are not good. Pessimism seems to be stalking the land in all parts of the industrial world — US, Japan, Germany, Italy and now Britain. The US economy is growing at a dismal annual rate of 0.7 per cent and capital spending dropped by 13.6 per cent in the first quarter of this year. East Asia is already facing recession, as its markets overseas disappear and Indonesia is still in political turmoil. Argentina, Brazil, Taiwan, Poland and Turkey are also in trouble. The only economy that seems to be doing well in the world seems to be China, supported by its own large internal market and its policy of using its muscle to win export markets. India is just about keeping pace, though admittedly both its industrial and agricultural sectors are looking far from rosy.

Many fear that worse is to come as the negative wealth effects from falling equity prices and job losses hit consumer spending and, the oil price rise following the threatened cuts in production by the Organisation of Petroleum Exporting Countries (Opec). So, what are the policy makers doing? All the major industrial countries are now operating within a monetarist framework, and the International Monetary Fund (IMF) is imposing the same medicine on all its clients.
Its philosophy is simple: keep inflation under control, deregulate markets, and somehow there will always be enough animal spirits to keep investments high to secure high levels of economic activity. If you find that economic activity is slowing, cut interest rates, provided, of course, there is no threat of inflation.

So people are calling for cuts in interest rates. But will they work? We have already seen how cuts in interest rates failed to revive the Japanese economy. When gloom spreads, they are in no persuasion to spend. Japan is caught up in the liquidity trap of Keynes, and no one there seems to think of a way out of it. Its saving rate is high, partly because its population is ageing and the fear of unemployment is making people save. The banks burdened by bad debts find that their credit base is poor, and investment opportunities meagre. The government is worried by the expanding public debt. Japan would rather lend its savings for financing investment abroad, and find demand for its exports — but with the rest of the world slowing down, this is not a realistic prospect.

Cuts in interest rates might keep the housing market upbeat in the US and Europe, as householders borrow, attracted by cheap mortgages. But the housing market needs to be underpinned by high employment levels, for people have to repay their mortgages even though costs might diminish from cheap interest rates. Will investment pick up from cuts in interest rates? Without a revival in markets, they are unlikely to boost investment spending.

So where will the stimulus for growth come from? Some are pining hopes on Mr Bush’s return of budget surpluses to taxpayers. Well, some of this might find its way to increased spending, but again much of the money will go to the rich whose marginal propensity to consume is low, and the poor, worried by vanishing job prospects, save what they get.

So the G-7 leaders are looking. The first instinct is to try and talk up animal spirits, by denying the seriousness of the situation. Doctored forecasts and cheerful statements can be useful. Would we allow the world economy to tip? - they say. They are also looking to new trade opportunities, as a way out of the current gloom.

Hence, the importance attached to the launching of a new WTO Round in Doha in November. To admitting China into WTO. But Europe, US and Japan remain at loggerheads. There is little willingness to give ground on agriculture, or to moderate anti-dumping measures, or to take a fresh look at accelerating commitments to reducing restrictions on textiles and the like, agreed to in the Uruguay Round. Instead, the industrial countries want to concentrate on liberalising trade in services, and bringing competition and investment policies under its net and, if possible, link environment and labour standards to trade.

The developing countries, of course, have huge stakes in all this. Industrial countries want a free run for their capital, goods and services, but want to give little ground to developing countries in areas in which the latter have a competitive advantage. They don’t realise that if the developing world does not prosper, it can hardly act as a fresh stimulus to their own economies.

Will new technologies drive investment again, a la Schumpeter’s creative destruction? My own belief is that the potential of new technologies is hardly exhausted. What we had seen was a hype of asset prices, which could not be sustained. As the losers lick their wounds, the information technology (IT) industry will get consolidated, with a few multinationals emerging as the top dogs gobbling up the weaker ones.

These IT companies — the top dogs — will be ready to drive investment again once memories of painful losses begin to recede. But this will take some time. Fears of recession will have to recede first, and investment expenditure has to revive before IT companies can begin to fan it. IT can be hardly expected to act as a new stimulus on its own in the current circumstances. It is difficult not see the gathering clouds over the world economy. The news is not good for the next one to two years.