A Failed Global Recovery

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A Failed Global Recovery
July 1, 2011
Stephen S. Roach
Morgan Stanley Asia
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 very 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.
The global economy is in the midst of its second
growth scare in less than two years. Get used to
it—there are more to come in the years ahead.
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 doubledip
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 2008-09, 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.
Post-crisis recoveries tend to be weak—leaving
them far more vulnerable to ever-present
shocks than normal cyclical rebounds.
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.
Note: This essay was published on July 1, 2011 by Project Syndicate and distributed to their global network of newspapers, magazines, and other media outlets.
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 postcrisis
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 combatting crisis than to promoting postcrisis
healing.
That is certainly true of the United States. While the
Federal Reserve’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.
Policymakers are ill prepared. They continue
to favor strategies that are better suited
to combatting crisis than to promoting
post-crisis healing.
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.
Stephen S. Roach, a member of the faculty at Yale
University, is Non-Executive Chairman of Morgan Stanley
Asia and author of The Next Asia (Wiley 2009).
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