The prospect of imminent execution concentrates the mind wonderfully, the English writer Samuel Johnson said some 230 years ago.
The threat of economic Armageddon in the wake of the collapse of Lehman Brothers certainly spurred leaders of the G20 to take action at their 2009 London summit, unveiling multi-billion dollar stimulus packages and making $1 trillion available through the International Monetary Fund.
Some three years on and, for many, the threat of a terminal economic shock from the collapse of the eurozone seems even more chilling.
Yet the G20 appears split from top to bottom over how it should respond: with further injections of cash and the bolstering of safety nets, or through meaningful attempts to reduce public deficits that others see as the fast-approaching threat to the global economy.
This battle between advocates of austerity and supporters of stimulus may come to a head at the leaders’ summit in Los Cabos.
CENTRE OF CONFLICT
The main battleground is the eurozone, where policymakers at a national and collective level have pushed through drastic cuts in spending to head off threats of a worsening of the debt crisis. Just six months ago at the Cannes summit, the desire to avoid a split enabled the G20 to sign up to a bland communiqué that kept all options open.
Yet in the past few weeks the balance of the argument has shifted in favour of pro-growth policies: at their meeting in Washington last month the leaders of the G8 devoted the opening paragraph of their communiqué to one simple statement: “Our imperative is to promote growth and jobs.”
The reasons for this were simple: economics and politics. On the economic front, the eurozone economy had taken a serious downward move.
The 17-country area escaped recession by the skin of its teeth thanks to flat GDP growth in the first quarter, but indices of consumer confidence and industrial output fell sharply. Unemployment has risen, with more young people in Spain and Greece now looking for work than in a job.
The politics are even more significant: the victory of Socialist candidate Francois Hollande over Nicolas Sarkozy – who was supported by German chancellor Angela Merkel – in the French election, changed the whole tenor of the debate.
“There was no mistaking the fact that the emerging growth-vs-austerity debate – fuelled by political developments in France and Greece, and by fears surrounding financial stresses in Europe – was the issue,” says Robin Bew, chief economist at the Economist Intelligence Unit. “The consensus of international opinion is shifting towards the need for growth-focused policies, but it is also clear that fiscal consolidation will remain paramount.”
Hollande pledged to renegotiate the EU’s “fiscal compact”, which effectively writes budget cutting into the Brussels rulebook, to include economic stimulus. Germany has hinted it is prepared to countenance pro-growth moves, while British prime minister David Cameron – the leading austerity advocate outside the eurozone – has talked of the need to invest in infrastructure.
Martin Lueck, a senior economist at UBS, says the crucial question for policymakers is how fiscal consolidation can be reconciled with growth. “While most politicians, central bankers and economists now agree austerity alone will not be enough to get Europe back on track, the question of how growth can best be maintained or restored while fiscal consolidation goes on remains wide open,” he says.
Amar Bhattacharya, director of the G24 group of emerging and developing nations, is worried that a loud minority view coming out of Europe led by Germany will export its own brand of austerity into the G20. “If you look at Hollande, [Mario] Monti and [Mariano] Rajoy, there is a majority of countries that now feel that you do have more for growth,” he says. “This is not just austerity with growth – it is growth. The story in Los Cabos will be how much pressure is brought on Europe to bring clarity to their own situation.”
Christine Lagarde, managing director of the IMF, appeared to use a visit to the UK last month to move the debate on. While a year ago she was full of praise for the UK’s tough austerity programme, the double-dip recession led her to hint the government could take measures to help stimulate growth.
While the first line of defence should be quantitative easing and easier monetary policy, this could be followed by purchases of bank assets and fiscal moves such as temporary tax cuts. “If the economy turns out to be significantly weaker than forecast, fiscal easing should be considered,” Lagarde said.
Bew says any shift to a more integrated view of the relationship between growth and austerity could presage the introduction of more balanced policymaking. “The need to balance austerity with more stimulatory policies is now a global one.”
Few experts believe revolution is on the cards. Holger Schmieding, chief economist at Berenberg Bank and a former economic adviser to the IMF, warns against reading too much into the G8’s assessment. “The communiqué is a compromise into which different countries can read different things,” he says. “It does not indicate how much Berlin will soften its position.”
He says the key will be the use of more nuanced language. “We are not seeing a genuine move away from austerity,” he says.
However, he does detect some shifts as policymakers in Berlin, Frankfurt and Brussels learn key lessons.
First, policies that merely suppress demand – austerity – are not enough. They need to be complemented by policies that strengthen supply, such as labour market reforms and infrastructure investment. “Austerity is the right medicine, but the patient should not swallow an overdose,” he says.
But while Europe may dominate the debate, any agreement of a shift from austerity to growth is going to need the agreement – and participation – of all the major countries.
PRESSURE ON CHINA
Three years ago China, the world’s second largest economy, launched a RMB4 trillion stimulus package ($568 billion at 2009 exchange rates or 12% of GDP). However, it looks increasingly clear Beijing has neither the resources nor willingness to carry out a similar exercise so close to a leadership transition.
“I can see that the pressure [from other countries] is definitely there,” says Brian Coulton, emerging market economist at Legal & General Investment Management, a major global investor with $757 billion under management. “But I think they look back at that episode and think it was a mistake, as it went too far and created a lot of the inflation problems that they are now struggling to deal with. So I am not sure they will play ball, even if they get pushed very, very hard.”
Recent weeks have seen a run of poor Chinese economic data that has forced the authorities to use fiscal and monetary policy to stimulate growth for domestic rather than global reasons.
Infrastructure investment projects are being brought forward or speeded up, and new funds are being made available to build affordable housing. There may also be a new round of subsidies for consumer goods and, possibly, another “cash for clunkers” trade-in scheme for cars.
Coulton says the total package would amount to no more than 1–2% of GDP. “That would be a big number of dollars, which is what the G20 want for their press release, but I am not sure they are going to do even that,” he says.
Beijing has made clear it is no longer fixated on achieving double-digit GDP growth but is content with 7–8% or reportedly even 6%. “China is simply doing what is right for China,” says Julian Jessop, chief international economist at Capital Economics. “There is no way it is a signal for a coordinated move by the G20.”
In the meantime, says Schmieding, China’s most important contribution would be to continue a rapid but non-inflationary expansion of domestic demand, offering countries on the euro periphery and elsewhere the chance to offset domestic austerity by exporting more.
Jessop says China will also be unwilling to push for a global stimulus at a time when there is a lack of willingness among developed G20 countries. “We have seen the European Central Bank not moving, the Bank of England not moving and [Federal Reserve chairman] Ben Bernanke failing to signal any move on quantitative easing,” he says.
For Jessop the real evidence was the dog that did not bark. After a high-profile phone conference of G7 finance ministers this month there was no statement. The US, as the G7 chair, said simply that they had agreed to “monitor developments closely” ahead of the G20 summit in Los Cabos.
“This is about as bland as it gets,” says Jessop. “If the smaller, closely aligned group of G7 advanced economies cannot agree any coordinated response, what chance is there that the larger, more diverse G20 can do any better?”
One reason for a lack of willingness to take coordinated action is that the outlook is not as terrifying as it was three or four years ago. Coulton says that, for the Chinese, the current downturn has left export growth flat compared with precipitous falls of more than 20% in the wake of Lehmans.
However Bhattacharya says the action China has taken is positive: “They are doing this from a self-interest point of view, but it is good for the global economy.”
BETTER THAN LAST TIME?
Meanwhile a new systemic risk measure constructed by researchers at NYU Stern School of Business echoes the view that stresses are bad – but not as bad as 2008. Running multiple stress tests, they computed the amount of capital firms would need if the stock market dipped 40% in six months.
According to Bank of America Merrill Lynch (BoAML), the potential capital shortfall for the 10 largest global financial institutions measured this month is “high, although not as daunting as in 2008”.
Gustavo Reis, its chief global economist, says the “true nightmare” for policymakers is not a Europe crisis but a systemic global crisis similar to 2008. While that is not on the cards now, Reis points out that the G20 has less “policy ammo” than it did four years ago. “While they can work on contingency plans, they will likely save bullets for later as the war chest is not exactly full,” he says. “If a severe confidence crisis hits the markets, it is possible that they try to maximize the impact of their remaining tools by coordinating.”
While hopes of a dazzling display of coordinated stimulus and a clear shift away from austerity fade, some experts hope that the G20 can help push for measures that will ease the current situation. “Businesses and households need to be confident that policymakers will get the major global problems under control,” says Schmieding.
He says the most important measures would be an ECB guarantee not to allow any solvent sovereign to become illiquid in any irrational market panic, and a credible bipartisan plan to reduce the burgeoning US fiscal deficit gradually over time.
“Unfortunately, neither will happen, at least not yet. So we’ll have to live with economic and financial uncertainty for a while.”
While this is unpleasant, it may not contain enough of the cold fear of imminent execution that would meet Samuel Johnson’s test.