People's Democracy

THERE is general agreement that the world economy, which has been experiencing a deceleration in growth over the past few months, is currently on the verge of sliding into recession. Most international institutions have revised downwards their forecast of growth during 2001. When the IMF was preparing the World Economic Outlook that was released in October, it had estimated that global growth would be marginally lower than it had predicted in May this year. Global growth was at that time projected to touch 2.6 per cent in 2001, which was 0.6 percentage points below the Fund’s May projections and more than 2 percentage points below the unexpectedly high (4.7 per cent) rate of growth recorded in 2000. Much has happened since those estimates were prepared, including the September 11 terrorist attacks in New York and Washington.

In a note on the prospects for the global economy following the incidents of September 11, prepared for the International Monetary and Financial Committee in early November, the Managing Director of the IMF stated that the staff’s revised baseline projections envisage that the global slowdown will be more prolonged than foreseen in the October 2001 World Economic Outlook, with recovery being delayed until around the middle of 2002. As a result, global GDP growth has been revised downward by 0.2 percentage points to 2.4 per cent for 2001 and by 1.1 percentage points to 2.4 per cent for 2002.

This is, however, not attributed solely to the destabilizing effects of the September 11 incidents. Rather the note argues, "Since late last year, growth has weakened sharply in most regions of the world, accompanied by a marked decline in trade growth and deteriorating financing conditions in emerging markets. Before the terrorist attacks of September 11, it appeared that there was a reasonable prospect of recovery in late 2001. However, more recent data indicate that the situation before the attacks was weaker than earlier projected in a number of regions, including the United States, Europe, and Japan, as well as a number of emerging market economies in Asia and Latin America."

It is now clear that prior to the September 11 attacks, sluggish and even declining consumer spending, softening demand for labour and falling profits, had pointed to a downturn in the US economy, that was bringing to a close one of the longest booms in recent history. In the course of that boom, as compared with an annual average rate of growth of GDP of 2.9 per cent during the decade 1982-91, the US economy has expanded at an average rate of 3.7 per cent during 1992-2000 and 4.2 per cent during 1999 and 2000.

Moreover, there had been only 2 years during the 1990s (1993 and 1995) when growth in the US had been lower than it had been on average during the 1980s. One factor driving this boom was the much higher rate of growth of private consumer expenditure in the US, when compared with other leading developed economies. Such growth had helped reduce unemployment from 7.0 per cent during the 1980s and 7.5 per cent during 1992, to the historically low level of 4.0 per cent in 2000. And despite high growth, inflation in the US was running at well below 2.5 per cent through most of 1990s, as compared with 3.7 per cent during the 1980s.

This suggested that declining unemployment, which can otherwise lead to "tight" labour market conditions in which real wages increase, did not contribute to inflation because of increases in productivity. Protagonists of the "new economy" began to argue that a change in the inner nature of capitalism and its basic working, would now make the ideal combination of high growth, low unemployment and moderate inflation the norm under capitalism.

Both the actual experience and the perceptions about the economy have changed significantly by now. Inflation in the US has risen to 2.7 per cent and is projected to touch 3.2 per cent in 2001. Unemployment is currently placed at the 1995-96 level of 5.6 per cent. And quarterly rates of growth of

real GDP (relative to the corresponding quarter of the previous year) have fallen from 4.2 per cent in the first quarter of 2000 to 3.6, 1.8 and 0.8 per cent respectively in the three quarters of 2001. Expectations are that the figure for the last quarter of this year would be negative, indicating the onset

of recession.

This turn of events in the US has meant, as the IMF’s World Economic Outlook had noted, that: "Over the last four quarters the major advanced countries have for the first time since the early 1980s experienced a broadly synchronised growth slowdown." The expected extent of such synchronisation is visible from the projected growth performance of these economies in 2001 and 2002.

What factors have accounted for the dramatic end to the long US boom of the 1990s, that has generated a synchronised crisis? As noted earlier, the most striking feature of economic trends during the 1990s was that the US experienced strong growth while most of the other economies in the world system languished. The 1990s were characterised by slow growth in Japan and across much of the world. According to IMF estimates, the average rate of world economic growth during the 1990s was only 3 per cent, which is below the 3.5 per cent average of the 1980s and the 4.5 per cent of the 1970s. The figures for 1982-91 and 1992-1999 stood at 2.6 and 1.9 per cent respectively in the case of the European Union and 4.1 and 1 per cent in the case of Japan.

Looked at from the point of view of unemployment, the US economy reflected a phase of near continuous buoyancy with declining unemployment rates (from 7.5 to 4.0 per cent) starting in 1992.

Meanwhile, Japan has recorded a continuous increase in unemployment rates from 2.1 to 4.7 per cent between 1991 and 2000, while unemployment rates in Germany and France have been declining after an initial sharp increase, but are still above their early 1990s levels. Thus within the developed "triad", the good days had been largely confined to workers in the US, and to an extent in the UK.

It is now widely accepted that the principal factor underlying the dramatically different outcomes in the US when compared to the rest of the world (barring exceptions like the UK) was the fact that confidence in the US dollar had made American capital markets a haven for the financial investors.

Given the substantial direct and indirect (through pension funds) participation of many American households in the market, the sharp rise in stock market indices implied a substantial increase in the value of their savings. Since this inflated their wealth position, Americans turned confident about the future, and went out to spend, resulting in the fact that personal savings rates turned negative.

Further, with private markets flush with funds, even relatively unknown and obviously risky start-ups, especially in the now busted dotcom area, had no difficulty in mobilising capital for investments.

One consequence of these large financial flows into American debt and equity markets, was the strengthening of the US dollar even in the face of growing external deficits of the US. In turn aggravated the tendency for the deficit on the current account of the US balance of payments to widen. Current account deficits in the US have risen quite consistently from 82 billion dollars in 1993 to a record 449 billion dollars at present.

With consumption and investment demand sustained in this fashion, the facts that the Federal budget was in surplus and that the Fed during the mid-1990s consistently raised interest rates to pre-empt inflation, did not do much to restrain the boom. Growth rates remained high and productivity rose in the course of the boom. The boom also led to misplaced confidence among policy makers, fed by "new economy" gurus. Rather than set aside surpluses for expenditures that can prove crucial when the boom exhausts itself, they were sought to be translated into tax cuts that would sustain the consumption splurge.

These trends made the latter half of the 1990s unique in the history of post-war capitalism in another sense. In the past the country with the international reserve currency had an advantage beyond that of seignorage. It did not face any national budget constraint because it could print money and spend it across the world, since everyone was willing to accept and hold such money.

As a result, the government of the country with the reserve currency routinely resorted to deficit spending to keep the world economy moving. That is, the US economy played the role of locomotive of world growth by sustaining deficit-financed spending. In the 1990s, however, the US, despite being the country with the international reserve currency, chose to curtail its deficits initially. And when the US government was confronted with surpluses in the course of the boom triggered by private spending, it chose to hand over those surpluses to the private sector in the form of tax cuts.

This reversal of deficit-spending policies in the leader of the global economy was all the more damaging because, unlike the US whose currency was the reserve currency, other economies were finding it difficult to pump-prime their economies in a liberalized world of fluid finance. As far as the developing countries were concerned this problem was compounded by the fact that the periodic financial crises faced by them since the beginning of the wave of liberalization in the late-1970s and 1980s, had necessitated stabilization and structural adjustment polices that slowed down growth substantially.

Initially, this was confined largely to Africa and Latin America. But in the latter half of the 1990s the problem has become more generalized, especially after the East Asian crisis in 1997. All this has had two implications. First, though private expenditure-led growth in the US had as its corollary a rise in demand for international goods, resulting in the widening of the deficit on the US balance of payments, the combination of a rush of capital away from the rest of the world into the US and of the loss of the stimulus provided by US budget deficits was proving inimical to growth in the US. Second, the slowing of growth in the developing countries as part of stabilization and structural adjustment strategies was substantially transforming the structure of the world’s balance of payments.

At the start of the 1990s, the developed countries as a group still had large current account surpluses, the developing countries as a group large deficits, the transition countries with little access to finance small deficits, and the emerging market countries other than those currently showing surpluses (that are also included in the developing countries group) an extremely small surplus. By the end of the 1990 this was changing quite substantially. Rising deficits in the US, UK and Germany and falling surpluses in Japan and France, were resulting in a situation where by 1999, the developed countries

as a group were recording large and burgeoning deficits on the current account.

At this time, however, the stagnation wrought by neoliberal policies in developing countries was resulting in a sharp fall in their current account deficits, which in facts turned into an aggregate surplus in 2000. The same is true in the countries in transition which, once they had been provided access to foreign finance, had been registering rising current account deficits. But the crises that resulted forced them to deflate as well, transforming their deficits into a surplus in 2000. Finally, emerging market economies, still receiving finance, and not therefore showing a surplus on their current account, were characterized by falling deficits.

This is a very significant shift, because it implies that developing economies and economies in transition as a group are now net capital exporters rather than recipients of capital inflow. This inevitably meant that the growth process in such economies as a group would be correspondingly restrained.

This change in the structure of global current account deficits had one other significant implication: Stimulus to growth in the developed countries that came from the large deficits in the balance of payments of the developing countries (however financed) was now non-existent. All these changes have had important implications as the US boom lost steam. Once the rising current account deficits moderated confidence in the US dollar and the collapse of the dotcom bubble took a toll on tech stocks, the spur provided by the US financial boom to consumption and investment spending, employment and incomes in the rest of the economy diminished. Unfortunately, it was perceived that US government spending could not be raised since tax cuts were eating up surpluses and deficits were seen as unacceptable.

The only instrument that was at hand to stall the slowdown was a cut in interest rates. However, despite close to a dozen rate cuts by the Federal Reserve in the course of a year, investment failed to respond, resulting in stagnation in output and a rise in unemployment. Unfortunately slow growth in the US only worsens the position of the rest of the world economy, as recent prognoses of global economic developments have come to accept. It is in this context that the aftermath of the September 11 incidents take on a wholly new significance. Developments prior to September 11 had made it clear that government spending to pump-prime the system and revive demand was the only real option to stall the slowdown in US growth and therefore of the world economy. But conservative fears that this would contribute to inflation and adversely affect financial confidence, as well as the Bush administration’s commitment to abjure deficit spending even while cutting taxes, had foreclosed that alternative.

The September 11 incidents have changed that mindset in two ways. To the extent that there is unanimity in the US on the need to quickly restore normalcy, reconstruct the damaged buildings and compensate those likely to suffer commercial losses on account of the assault, purse strings are likely to be loosened and fears of deficits are likely to disappear. The much needed increase government expenditure is likely to materialise, though for reasons that were best not there. Estimates put the additional expenditure that is being undertaken and planned at more than 100 billion dollars.

Further, with the Bush administration committed to its war against terrorism in Afghanistan and elsewhere, even when the enemy and the targets are not clearly defined, spending is likely to increase even if at the cost of many innocent lives. Whether the relaxed monetary stance of the Fed and the rise in government expenditure would be adequate to neutralise the many factors that contributed to the slowdown prior to September 11 and the elements of the tragedy on that day that are likely to aggravate that sluggishness, is anybody’s guess. But tragedy has brought with it the macabre medium-term prospect that a recovery in the US may be one of the pieces picked out of the rubble in New York and Washington.