People's Democracy

Economic Notes

The Threat Of Global Recession

C P Chandrasekhar

AS this article is being written, expectations are that the US Federal reserve would cut interest rates by a quarter to half a percentage on top of an unscheduled and unprecedented 0.75 per cent cut it announced recently. This panic response is because of growing fears of a recession in the US, that would be steeper and longer than recessions experienced in the recent past. When on the 20th of December last year, the US Department of Commerce released figures indicating that GDP growth in the US had accelerated (to 4.9 per cent) during the third quarter (July to September) of 2007, the celebration was tempered. Growing evidence of a housing slump and a credit squeeze suggested that the economy was bound to slow down in the last quarter. But nobody was speaking of a recession then.

More recently, a series of data releases have intensified fears of a recession in the US. On January 4, the Bureau of Labour Statistics reported that the unemployment rate in the US had risen to 5.0 per cent in December, while nonfarm payroll employment had remained more or less unchanged. Home sales had reportedly declined by 20 per cent nationally during the year to November 2007, and median house prices had fallen by 12 per cent in California and 10 in per cent in Florida, though only 3 per cent nationwide. This has begun to tell on consumer spending, which had been spurred during the housing boom by the illusion of increasing wealth that rising home prices created. According to the Financial Times, Merrill Lynch has estimated that consumer spending could fall by 360 billion during 2008-09.

When the news gets gloomy, panic spreads. On the 18th of January the S&P 500 closed at 1,325, down almost 6.5 per cent from 1,416 four days earlier and from its previous peak of 1,565 on October 10, 2007. Not wanting to be seen as napping, the US Federal Reserve chairman, Ben Bernanke told the Budget Committee of the US House of Representatives that a package of anywhere between $50-150 billion—a rather wide margin—would be a “reasonable” stimulus for an economy being pushed into recession by the housing crisis and the financial collapse that had accompanied it. Soon thereafter, almost on cue, president Bush announced a package involving $145 billion in tax relief for individuals and businesses, ostensibly to provide a “shot in the arm” for the economy. Details of the programme are yet to be provided, but expectations are that, taking a leaf out of a similar package adopted in 2001, it would offer a one-time tax rebate to individuals and write-offs against investment in equipment for businesses.

In 2001 and 2002, the Bush administration had similarly sought to boost the economy with a personal tax rebate that put between $300 and $600 in the hands of individual households and followed this up with tax incentives for businesses investing in plant and equipment. Treasury secretary Henry Paulson has made clear that the administration believes that that policy not only worked, but worked quickly. This is seen as justifying this attempt at a repeat performance.

RECIPE FOR

There are three features of this recipe for revival that need noting. First, it hopes to encourage individuals and households to keep spending despite the write down in the value of their housing and financial assets, by giving them a one-time tax windfall. This borders on the optimistic inasmuch as a lot of past household spending in the US had been financed with debt, resulting in a steep decline in household savings rates. Individuals may use the windfall to repay debt rather than opt for additional spending. Moreover, if the $360 billion consumption hit forecast by Merrill Lynch is anywhere near true, even the whole of the Bush rescue package is inadequate.

Second, the package is presented in a way which conceals the role of speculation and outright financial fraud in triggering the current downturn. Rather, the downturn it is being treated by the administration as one more unavoidable cycle under capitalism. In the apologetic language of president Bush the story runs thus: “In a vibrant economy, markets rise and decline. We cannot change that fundamental dynamic. Yet there are also times when swift and temporary actions can help ensure that inevitable market adjustments do not undermine the health of the broader economy. This is such a moment.”

THE RICH

Since those responsible for the downturn are likely to be tax-paying individuals themselves and employees or owners of tax-paying businesses, the package rewards them without in the first instance having hauled them up for their errors of commission and omission. Moreover, there is a real danger that the tax benefits on offer, and the ones offered since the Bush administration took office in 2001, would be made permanent before this president leaves office. A crisis created by a section of the rich is being used to reward the rich at the expense of the exchequer. The implications of this bias in policy for income distribution are all too obvious. The wealthiest 1 per cent of Americans reportedly earned 21.2 per cent of all income in 2005, according to data from the Internal Revenue Service. This was an increase in share relative to the 19 per cent recorded in 2004, and exceeded the previous high of 20.8 per cent set in 2000, at the peak of the previous bull market in stocks. As compared with this, the bottom 50 per cent earned 12.8 per cent of all income, which was less than the 13.4 per cent and 13 per cent recorded in 2004 and 2000 respectively (The Wall Street Journal, October 12, 2007).

Finally the package does not consider the option of increasing government spending. Government spending coupled with expanded unemployment benefits would ensure that the fiscal stimulus would increase demand immediately. This can be quite crucial if a recession is indeed imminent. As Bernanke himself noted in his deposition before Congress: “To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible in the next 12 months or so.” Combining expenditure increases with income benefits or transfers to the middle class and the unemployed would ensure that the rescue does not prove inequalising. But that clearly is not a matter for concern.

These features of the package notwithstanding, governments and investors outside the US hope that it would succeed in its prime intent—combating a US recession. This is because they rightly fear that if US does experience a sharp downturn, a global recession would follow. Some like the authors of the World Bank’s annual Global Economic Prospects report for 2008 are more optimistic. They argue that global growth which slowed from 3.9 to 3.6 per cent between 2006 and 2007, would fall only marginally to 3.3 per cent in 2008. This is because “robust expansion in developing countries partly compensates for weaker results in high-income countries”. Needless to say, the Bank itself senses an element of excessive optimism that derives from assuming that the processes of growth in developing and high-income economies are unrelated, leaving growth in the South insulated from any recession in the North, especially the US. It quickly goes on to say that: “Several serious downside risks cast a shadow over this soft landing for the global economy. External demand for the products of developing countries could weaken much more sharply and commodity prices could decline if the faltering US housing market or further financial turmoil were to push the United States into a recession. Alternatively, monetary authorities might overreact to the current climate of uncertainty and overstimulate the economy. This would be particularly dangerous for developing countries if the bulk of the resulting liquidity were to move into rapidly growing developing regions, provoking the same kind of overinvestment conditions that arose in the US housing market.”

Given the role of high growth in China and India in shoring up global growth, the impact of a US recession on the global economy would depend on the effects it would have on these two countries in particular. That could be significant given the dependence of growth in these countries on US demand. For over a decade now, China’s merchandise exports to the US have amounted to a little more than a fifth of its merchandise exports to the world as a whole. And in India’s case, while the share of merchandise exports to the US were at similar levels till 2002, they have been declining since and stood at 17 per cent in 2006. These are large proportions, and a recession in the US is bound to adversely affect the volume of exports and the pace of growth in these economies.

But even this does not capture the whole story. As Catherine Mann of the Institute for International Economics puts it, “China is a value-added weigh-station for production ultimately destined for the United States and to a lesser extent Western Europe. To some degree the explosion in intraregional trade in Asia is not from ‘home grown’ demand, but rather still depends ultimately on exporting to the US market.” That is, China is the location for the final reprocessing of capital goods, intermediates and raw materials imported into the country from elsewhere in Asia, before being sent on to the US. A slowing of exports to the US from China would slow the intra-regional trade in Asia that drives the region’s growth.

Further, in India’s case, the US is also an extremely important market for its exports of services that have come to account for a large share of total exports from the country. In 2006-07, the exports of software and business services from India amounted to as much as 40 per cent of India’s merchandise exports. Around two-thirds of these exports are directed to the Americas, especially the US. Here too, a slowdown in the US can have damaging consequences.

The dependence on the US market of these two key developing country-drivers of global growth starkly illustrates the implications of a slowdown of growth in the US for the world economy. To believe therefore that a US recession would be partly compensated for by robust growth in these countries is to ignore the nature of global interdependence. Not surprisingly, most governments are willing to discount the implications of the Bush administration’s efforts at combating recession for national and global inequality, so long as they serve to stall or reverse the downturn.