The one question that does not go away is about the slow pace of the recovery in the US and the UK, to say nothing of the Eurozone crisis. In the US, the pace has now ground to a halt as far as job creation is concerned. The UK has registered near nil per cent growth for two successive quarters. There are one-off shocks?Japanese tsunami, for instance?and also some adverse weather events. But even so, both the Fed and the Bank of England are extending their QE policies, which is a confession that fiscal policy has no scope and monetary policy is at best not helping quicken the recovery but at least preventing a collapse. It is also exporting inflation to emerging economies, as I have already argued before.
The climate is growing worse, if anything. The Eurozone crisis is about to extend to Italy along with Greece, Spain, Portugal and Ireland. No Eurozone nation is big enough to bail out Italy by itself; even France and Germany together cannot be trusted by the markets to deliver a bailout for Italy. Schemes are being concocted to restructure the Greek debt so that the private creditors can share the burden of adjustment. This is trickier than it sounds because rating agencies are screaming that if that happens they will downgrade Greek debt.
The Eurozone problem is a failure of collective decision-making. The original Maastricht Treaty was written on the model of the relation between the German government and the Bundesbank, and central bank autonomy was absolute. The Bundesbank also had a rigid policy rule of low inflation achieved by a monetarist policy. It was thought that this formula would guarantee the soundness of the monetary union. This has now proved too rigid. No country can deviate from a common policy and the ECB will not bend. Greece cannot exit from the euro nor can it be thrown out.
A worse self-inflicted wound is being delivered in the US. Discussions between the White House and Congress about raising the debt ceiling, which is due by August 2, have stalled. The Republicans want cuts in budget but no tax rises and the Democrats want tax rises to take some of the heat off spending cuts. Each side is playing the dangerous game of chicken, except that they are riding in the same car together. It may yet be that sense will prevail but much more likely that, as happened with Newt Gingrich and Bill Clinton, there will be a temporary shut down of the US government and a debt default for the first time in 220 years.
The Tea Party would love to see Obama humiliated. They are on a war path and they are making the Republican leadership much more intransigent than is normal in such negotiations. Newt Gingrich?s war of 1994 cost the Republicans many seats in the following election in 1996. This may happen again but the Great Recession has much weakened the American economy. A debt default will not help and money markets may react violently around the world with all government debt.
These multiple uncertainties are just short run. In the longer run, it is becoming clear that the western countries need to save much more than they have been doing for the last 30 years. The ageing population is also living longer. This increases the pressure on pensions and also on costs of elderly care. It was assumed somewhat blithely that the costs would be borne by the welfare state. But everyone is short of money and fiscal retrenchment is the rule. So somehow citizens of the developed countries will have to emulate their Asian counterparts and stop consuming and start saving. If successful, this policy will put pressure on the exports of the emerging economies. Global growth will slow down unless the citizens of the emerging economies can consume more at home and import more from developed countries.
The shifting centre of gravity of the global economy, as it moves eastwards, may throw up new problems. Once we thought South-South cooperation was a defensive strategy in case the North was no help for poor countries. Now South-North cooperation will be required if prosperity is to be sustained. Habits will have to change on both sides, with South behaving like a nouveau riche family and the North becoming like some frugal distressed gentry.
This is the positive scenario. Along the way, there are always the negative possibilities that the US may not slide down the relative wealth ladder quietly. Protectionism and even militarism may yet rear their ugly heads. The reluctance of IMF to seriously share power between the North and the South tells us that the old world will resist any brush with the realities of economic power.
The G20 was designed to provide a forum for such negotiations. Let us hope France can provide a good forum for such negotiations.
The author is a prominent economist and Labour peer