A year ago, many hoped that the November G20 Leaders’ Summit in Cannes would be an opportunity to state that the worst was over and the world economy was on a solid growth path again.
Today, a sense of urgency over the short-term prospects of the global economy has returned. In the US, growth is weak and the fraction of the population employed is at historical lows. The eurozone is facing an existential threat and even the German growth engine is slowing, perhaps even stalling. Japan cannot get out of a now two-decade long stagnation. And the widespread confidence prevailing in emerging markets is giving way to greater anxiety.
The signs of weakening growth have significantly altered public debt dynamics. It is worth remembering that debt ratios have a numerator (the amount of public debt) and a denominator (GDP), and that debt dynamics are driven by the interaction of deficits, growth and interest rates. With interest rates already at historical lows, there is not much more favorable news that can be expected on this score. When growth slows, deficits rise because of automatic stabilizers and because of the risk of renewed contingent liabilities in banks and public pension funds. If fiscal cuts to reduce deficits also reduce growth, they can become self-defeating.
When interest rates also adjust to unfavorable debt dynamics because of sovereign risk, the room for maneuver becomes even narrower. Moreover, if uncertain debt dynamics and slow growth policies are synchronized across borders, the system in each individual country becomes even more unstable. That is what is happening now with ongoing fears of currency wars and associated worries of trade wars and additional negative growth shocks. Given this strong interdependence, the danger of simultaneous substantial retrenchment in macroeconomic policies should not be underestimated.
This new phase of the crisis presents policymakers in advanced countries with a huge challenge: how to offset deficient private demand as well as increased income concentration at the very top, while maintaining financial market confidence in the stability of public debt dynamics.
If aggregate fiscal policy is really constrained because of the potential negative impact on short-term growth prospects and hence on contingent liabilities, as well as a serious danger of social unrest in some countries, then the only way out is to pay more attention to structural policies. That is now the focus of attention in many countries.
But structural policies are notoriously difficult to implement in political terms and often take time to yield results. In Europe, the extent of progress on implementing the Lisbon agenda has been very slow. In the short term, even having a discussion on the exact nature of structural reform can generate policy uncertainty and further curtail growth.
Further discussion about aggregate fiscal measures will not be sufficient in the current context. Policymakers have to look at the distribution of income and adjust the structure of policy to achieve real impact. This debate about appropriate structural measures needs to be conducted on an international stage, because it is clearly very difficult to insulate oneself in today’s world economy.
This is both the challenge and the mission of the G20. Whereas in the past, the burden of global adjustment fell disproportionately on deficit countries that could not attract private capital flows, today it should be clear that surplus countries are also part of the problem: globally, surpluses and deficits must add up to zero, net of statistical discrepancy.
We believe structural and distributional issues are crucial for advanced economies. Emerging market economies are in a better position, but for them, too, structure and distribution matter. Developing countries must embed and complement their macroeconomic policies in proactive structural and distributional policies.
The specific conditions in different countries vary. There is no doubt, however, that the G20 will meet in Cannes amidst great worries about the world economy, worries that are reminiscent of the dark days of late 2008.
Each nation will pursue policies that reflect its own specific circumstances, historic memories and political constraints. But there is too much interdependence in the world economy to give up on the hope for greater coordination. Common ground must be found to develop policies that can lead to win-win solutions.
Kemal Dervis is vice president and director of the Global Economy and Development program at the Brookings Institution. Homi Kharas is a senior fellow and deputy director of Global Economy and Development at Brookings