Five years after the onset of the financial crisis, four years after the collapse of Lehman Brothers and in the wake of 10 IMF meetings and four G20 summits, the world economy is still in a mess.
The United States is seeing an anaemic, jobless recovery, Europe is fragmenting and the once-exuberant emerging market countries are looking a little peaky.
“We are going through difficult times and complex financial situations,” Spanish finance minister Luis de Guindos said during a visit to London last week where he got heckled by angry young Spaniards furious over soaring unemployment.
What has gone wrong? Advice from international policymakers, who are gathering again in Tokyo this week, is certainly not lacking.
According to Stephen King, global chief economist at HSBC, the problem is that the action taken to deal with the impacts of the first stage of the crisis did not have the desired effect.
“When it looked as though the primary problem facing economies in the developed world was a lack of demand, a combination of interest rate cuts, fiscal stimulus and quantitative easing seemed to be the perfect way of bringing some sanity back to proceedings,” he says. “Alas, the approach has not worked as well as expected.”
At the root of the problem is the fact that the world economy is no longer behaving as it should do. Deep recessions such as the one in 2008/09 are normally followed by powerful recoveries.
But growth is relatively weak, yet inflation is high in some places; global imbalances are reducing yet all economies are seeing a synchronous slowdown.
King is worried that the recession has destroyed a large chunk of the productive capacity of the economy, through both persistently high employment and a lack of capital investment.
STRUCTURAL SHIFT
One of the major impacts has been the inability of emerging economies to repeat the rescue effort they performed in the first four years after the crisis.
Capital Economics, a London-based consultancy, expects emerging market growth to slow to around 4.5% next year, with only a modest pick-up to 5.0% in 2014. This would be some way below average growth of 6.1% seen since 2000.
Roger Bootle, its managing director and former UK government adviser, says that lower emerging market growth will become a permanent feature of the global picture.
He too blames a structural, rather than a cyclical shift. “The structural element of the current slowdown is reflected in the fact that unemployment remains low in most parts of the emerging world, suggesting that underlying productivity growth has slowed.”
The slowdown is most obvious in Asia. The OECD’s composite leading indicator for the “major five” - China, India, Indonesia, Japan and South Korea - has fallen to its lowest level since 2009.
But the big concern is with China, where an average annual growth rate of 10.5% a year between 2001 and 2010 has given way to a growth target of 7.5%.
The People’s Bank of China has cut both the main policy rate and the reserve requirement ratio – the percentage of deposits that banks must keep with the central bank as a reserve - twice this year, while Beijing has also added fiscal stimulus through CNY1 trillion ($160 billion) in infrastructure spending.
“That fiscal support may take some time to kick in, but should give growth a foot-up next year,” says Philip Shaw, global economist at the South African bank Investec.
“In the meantime we may see the Chinese authorities fine tune policy further in pursuit of the 7.5% 2012 growth target.”
The latest grim evidence from China was the reading of 49.8 for the official manufacturing PMI in September on a scale where any number below 50 denotes contraction.
While the reading was slightly better than August’s 49.2, that was not convincing analysts. “That still means a slowing economy,” says Gerard Lyons, chief economist for Standard Chartered. “Here in Asia, China’s cooling is main focus.”
SLUMP IN DEMAND
The brake on growth in China and other Asian countries is coming from a slump in demand for exports to Europe.
The World Trade Organization has down graded its 2012 forecast for world trade growth to 2.5% from 3.7% and scaled back the 2013 estimate to 4.5% from 5.6%.
The driving force is a “significant weakening” in demand by EU companies which has so far this year seen import demand fall at an annual rate of 3.5%.
“We have seen a big rise in inventories, firms cutting back on production in Asia, notably Taiwan and South Korea,” HSBC’s King says. “One consequence is that output of manufacturing has deteriorated quite dramatically.”
“The problem is that China is not growing as fast it was in 2009 and 2010 and it can’t offer the kind of stimulus to the rest of the world that was in place back then.”
Nariman Behravesh, chief economist at IHS Global Insight, says that the worry is that monetary policy is having less of an impact than it did in the downturn three years ago.
“A growing concern is that growth could remain stuck in the 7-8% range because of structural imbalances in the economy and a rapidly aging population,” he says
King says that emerging nations’ economic prospects have “dimmed” in the near-term across the board because of their vulnerability in the face of a major, eurozone-induced slowdown in world trade.
One of the most worrying signs of the impact came from the move by the Australian central bank to cut rates by a quarter-point to 3.25%, a move that few economists had expected.
In his statement Governor Glenn Stevens said that one reason was that growth had been “dampened” across Asia generally as a result of the moderation in Chinese growth rates.
But he went further, saying that another reason for the cut was the decline in commodity prices – a key part of Australian GDP.
The growing consensus that emerging markets will enjoy moderate rather than red-hot growth, means that the onus is even more on the developed world to take on the role as the engine of growth.
This seems wishful thinking. The eurozone is largely expected to enter its second recession in three years, the Japanese economy looks set to follow it, while the US is struggling to achieve a sustainable recovery.
US UNCERTAINTY
The outlook for the US is obscured by the uncertainty over the outcome of next month’s presidential and congressional elections.
The outcome of those will in turn have a direct bearing on whether Washington can resolve the so-called “fiscal cliff” that is rapidly approaching.
The combination of the expiry of tax cuts and falls in federal spending that are pre-programmed to take effect next year will impose a 4.6% fiscal contraction that may trigger a double-dip recession.
Gustavo Reis, chief global economist at BofA Merrill Lynch says that the cliff looming over the US economy is the biggest “known unknown” facing the markets.
The bank’s latest survey of fund manager clients showed that the cliff was now the number one concern of investors, with those worried about that issue (35%) overtaking those fretting over the eurozone (33%).
“From an international contagion standpoint, jumping over the cliff would be a major shock,” he says. “The fiscal cliff is a wholly US-made crisis. This means that US fiscal contraction would hit the global economy as a brand new shock.”
Behravesh says that there is little hope that anything will be resolved until after the elections. “Congress is likely to punt the fiscal cliff problem down the road, prolonging uncertainty over fiscal policy and deterring risk-taking well into 2013.”
The danger for the world economy is the “newness” of the shock, he says. If US growth suddenly weakened, global activity would be affected through confidence, finance and trade channels – just as it was after the collapse of Lehmans.
Of course, the US is not the only major economy facing a leadership transition. The Chinese Party Congress will meet on 8 November – the day after the result of the US election is confirmed - to name China’s new leadership team.
The outcome of the meeting will almost certainly move Xi Jinping into the Party Chairmanship and Presidency of China to succeed Hu Jintao, and Li Keqiang to the Chinese Premiership, replacing Wen Jiabao.
While this handover is normally precisely controlled by the Communist party, this one has been chaotic. First the criminal trials of Bo Xilai and his wife Gu Kailai over the murder of British businessman Neil Heywood took attention away from normal business.
Secondly fears about political stability resurfaced when Xi disappeared from public view for more than 10 days, fuelling rumours he was ill, dead or sidelined.
“The mystery increases the chances that the transition may not be smooth,” says Robin Bew, chief economist of the Economist Intelligence Unit. “This would have serious implications for China’s growth prospects, at least in the short term.”
EURO PROGRESS?
Meanwhile the eurozone crisis seems to be only inching towards some sort of resolution. The decision by Mario Draghi, president of the European Central Bank, to unveil his Outright Monetary Transactions plan that would involve unlimited purchases of sovereign bonds of countries that agreed to further austerity has taken some of the panic out of the markets.
There are also signs that Europe is moving towards a banking union that would see the continent’s banks sit under the aegis of one regulator.
Behravesh says that the ECB has offered a “lifeline” for Italy and Spain. “A clear manifestation of this has been the substantial decline in 10-year Italian and Spanish government bond yields,” he says.
Yet, again the world economy appears to be in a limbo period.
The aggressive action by the US Federal Reserve in embarking on more quantitative easing and the ECB’s promise of unlimited sovereign bond purchases have taken the global economy “a step back from the precipice”, according to Behravesh.
“Nevertheless, it is still too soon to celebrate, since the foundations under the global recovery are still quite shaky,” he says.