Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.
NEW HAVEN – The global economy is in the midst of its second growth scare in less than two years. Get used to it. In a post-crisis world, these are the footprints of a failed recovery.
The reason is simple. The typical business cycle has a natural cushioning mechanism that wards off unexpected blows. The deeper the downturn, the more powerful the snapback, and the greater the cumulative forces of self-sustaining revival. Vigorous V-shaped rebounds have a built-in resilience that allows them to shrug off shocks relatively easily. But a post-crisis recovery is a very different animal. As Carmen Reinhart and Kenneth Rogoff have shown in their book This Time is Different, over the long sweep of history, post-crisis recoveries in output and employment tend to be decidedly subpar. Such weak recoveries, by definition, lack the cushion of V-shaped rebounds. Consequently, external shocks quickly expose their vulnerability. If the shocks are sharp enough – and if they hit a weakened global economy that is approaching its “stall speed” of around 3% annual growth – the relapse could turn into the dreaded double-dip recession.
That is the risk today. There can be no mistaking the decidedly subpar character of the current global recovery. Superficially, the numbers look strong: world GDP rebounded by 5.1% in 2010, and is expected to rise another 4.3% in 2011, according to the International Monetary Fund. But because these gains follow the massive contraction that occurred during the Great Recession of 2008-2009, they are a far cry from the trajectory of a classic V-shaped recovery.
Indeed, if the IMF’s latest forecast proves correct, global GDP at the end of 2012 will still be about 2.2 percentage points below the level that would have been reached had the world remained on its longer-term 3.7% annual-growth path. Even if the global economy holds at a 4.3% cruise speed – a big “if,” in my view – it will remain below its trend-line potential for over eight years in a row, through 2015. This protracted “global output gap” underscores the absence of a cushion in today’s world economy, as well as its heightened sensitivity to shocks. And there have certainly been numerous such blows in recent months – from Europe’s sovereign-debt crisis and Japan’s natural disasters to sharply higher oil prices and another setback in the US housing recovery.
While none of these shocks appears to have been severe enough to have derailed the current global recovery, the combined effect is worrisome, especially in a still-weakened post-crisis world. Most pundits dismiss the possibility of a double-dip recession. Labeling the current slowdown a temporary “soft patch,” they pin their optimism on the inevitable rebound that follows any shock. For example, a boost is expected from Japan’s reconstruction and supply-chain resumption. Another assist may come from America’s recent move to tap its strategic petroleum reserves in an effort to push oil prices lower. But in the aftermath of the worst crisis and recession of modern times – when shocks can push an already weakened global economy to its tipping point a lot faster than would be the case under a stronger growth scenario – the escape velocity of self-sustaining recovery is much harder to achieve. The soft patch may be closer to a quagmire.
This conclusion should not be lost on high-flying emerging-market economies, especially in Asia – currently the world’s fastest-growing region and the leader of what many now call a two-speed world. Yet with exports still close to a record 45% of pan-regional GDP, Asia can hardly afford to take external shocks lightly – especially if they hit an already weakened baseline growth trajectory in the post-crisis developed world. The recent slowdown in Chinese industrial activity underscores this very risk.
Policymakers are ill prepared to cope with a steady stream of growth scares. They continue to favor strategies that are better suited to combating crisis than to promoting post-crisis healing. That is certainly true of the United States. While the US Federal Reserve Board’s first round of quantitative easing was effective in ending a wrenching crisis, the second round has done little to sustain meaningful recovery in the labor market and the real economy. America’s zombie consumers need to repair their damaged balance sheets, and US workers need to align new skills with new jobs. Open-ended liquidity injections accomplish neither. European authorities are caught up in a similar mindset. Mistaking a solvency problem for a liquidity shortfall, Europe has become hooked on the drip feed of bailouts. However, this works only if countries like Greece grow their way out of a debt trap or abrogate their deeply entrenched social contracts. The odds on either are exceedingly poor. The likelihood of recurring growth scares for the next several years implies little hope for new and creative approaches to post-crisis monetary and fiscal policies. Driven by short-term electoral horizons, policymakers repeatedly seek a quick fix – another bailout or one more liquidity injection. Yet, in the aftermath of a balance-sheet recession in the US, and in the midst of a debt trap in Europe, that approach is doomed to failure.
Liquidity injections and bailouts serve only one purpose – to buy time. Yet time is not the answer for economies desperately in need of the structural repairs of fiscal consolidation, private-sector deleveraging, labor-market reforms, or improved competitiveness. Nor does time cushion anemic post-crisis recoveries from the inevitable next shock. It’s hard to know when the next shock will hit, or what form it will take; otherwise, it wouldn’t be a shock. But, as night follows day, such a disruption is inevitable. With policymakers reluctant to focus on the imperatives of structural healing, the result will be yet another growth scare – or worse. A failed recovery underscores the risks of an increasingly treacherous endgame in today’s post-crisis world.
See Stephen Roach expands upon the views expressed in this commentary in the Project Syndicate video (http://www.project-syndicate.org/video#roach)