Stopping the Vicious Cycle

The world economy today resembles a rudderless ocean liner caught in a storm, with all the passengers frantically trying to board their own lifeboats. The Group of 20, which had intervened boldly to save the international financial system from disaster in 2008-09, has gone missing.


November 2008 — when G-20 leaders assembled for their first summit meeting in Washington DC at the invitation of the then US President George W. Bush — now seems like a very long time ago.


This month, as markets fell precipitously following Standard & Poor’s downgrade of the US and the world slid dangerously towards a second recession, instead of concerted action, there was deafening silence from the group. The only activity seemed to be a revival of a ‘G-2’ arrangement between Beijing and Washington. To mark the visit of US vice-president Joseph Biden, China promised to buy American goods and invest in US industries — for the total sum of nearly $1 billion. Having bought over $1 trillion dollars’ worth of US Treasuries, China has more than a passing interest in boosting the American economy.


But as far as notions of global governance go, the G20 group is in a state of paralysis. While the reasons for this are clear enough, its MIA (missing in action) status at this critical juncture bodes ill for the world economy. Bruised by his battle with the Republicans in Congress and facing a tough fight for a second term, President Barack Obama is ill-prepared to provide global leadership.


Fighting to save the Eurozone, sinking under the weight of debt, and worried by their re-election prospects European leaders are too preoccupied with their own immediate difficulties to focus on the rest of the world. The weakness of western leaders is compounded by an abject absence of ideas about how to rescue the world economy.


Equally striking has been the silence of the BRICS — Brazil, Russia, India, China and South Africa — the emerging powers that were supposed to be the new leaders of the world economy. After feebly claiming to have a leading role in the selection of the managing director of the IMF, the group seems to have gone into hibernation. While China has issued a warning to the US to safeguard Chinese investments in US Treasuries, India, Brazil, Russia and South Africa have quietly worried about the impact of free fall in the world’s equity markets.


In traditional Chinese calligraphy, the character for ‘crisis’ combine the symbols for danger and opportunity. This crisis has certainly provided Beijing with ample opportunity to exercise leadership befitting its new economic might, but China seems unready to rise above its narrow interest. India, too, should have taken this opportunity to exercise intellectual leadership in confronting a crisis that is certain to affect all developing countries. New Delhi’s disengagement from the issue is specially perplexing as Manmohan Singh, despite his diminished domestic standing, remains a highly respected economist among the world’s leaders (Obama called him his guru). Initiative by the BRICS to propose policy coordination to prevent the economy from stalling would not only ensure the leadership that they aspire to have, but would also offer western leaders a valuable cover to adopt policies that may otherwise be politically hard to sell to their domestic critics.


The mounting debt burden faced by the US, Eurozone and Japan has made them wary of boosting government spending to create jobs, which would only incur further deficits. The more the governments cut immediate spending for longer-term safety — as Republican deficit hawks have forced Obama to do — the greater the dangers to the economy. The only way to stop this vicious cycle of spending cuts leading to further layoffs and shrinking demand is emergency measures to expand aggregate demand. Unless jobs are created and confidence is restored among consumers who still have jobs but resist spending out of fear for the future, aggregate demand will remain depressed.

 

Indeed, it is clear that the private sector, though flush with cash, is afraid to expand fearing lack of demand. Investors, stuck with no compelling options, are fleeing to the relative safety of government bonds. However distasteful may the idea be of incurring further debt, world governments need to undertake collective action to stave off a devastating second recession while keeping to the medium-term goal of cutting deficits.