SELF-INDUCED SLUGGISHNESS / THE ECONOMIST ( VERY HIGHLY RECOMMENDED READING )

The world economy

Self-induced sluggishness

This year will probably be a pretty bad one for the world economy; it doesn’t have to be

Jan 7th 2012

POLITICIANS like to promise better times ahead. But these days many are peddling gloom. In her new year’s address, Angela Merkel, Germany’s chancellor, predicted that 2012 would be more difficult for the euro zone than 2011.


Nicolas Sarkozy, France’s president, spoke of “the year of all risks”. Half a world away, Manmohan Singh, India’s prime minister, warned Indians not to take fast growth for granted.



In one way this pessimism looks a little overdone. The worst outcomes—a collapse of Europe’s single currency or a hard landing in China—are avoidable. The latest crop of statistics, particularly better-than-expected figures on global manufacturing prospects, argue against a sudden slump.


America may do a bit better than forecast. The overall effect should be sluggish, not dire: global output may grow by 3%, the slowest since 2009 and well below the average of the past decade.

But in another way, the sombre warnings are apt, and profoundly depressing. One reason why the outlook is so lacklustre is that politicians—especially in the West—will do little to help (and may harm) their economies. It could be better.

Begin with Europe, the weakest cog in the global engine. The euro zone has almost certainly already slipped into recession, which most forecasters expect to be short and shallow: a group of seers polled regularly by The Economist estimates that output will fall by 0.5% in 2012. The case for a mild downturn assumes that Europe’s policymakers, however haltingly, are on course to solve their debt crisis; that the European Central Bank (ECB) has reduced the risk of a debt calamity with its recent provision of three-year liquidity to banks; and that the impact of fiscal austerity on growth will be brief and modest.



Those hopes may be misplaced. Uncertainty about the euro zone’s future is still acute, not least because its politicians are more focused on preventing future profligacy than supporting embattled economies today. Despite the ECB’s liquidity injection, banks seem reluctant to buy many government bonds. And since Italy and Spain alone need to roll over €150 billion ($195 billion) of debt in the first three months of this year, the odds are that worries about sovereign debt will intensify.



A pernicious circle of weak growth, bigger deficits and more austerity is setting in. Look at Spain, where the new government revealed that the 2011 budget deficit would be worse than expected (8% of GDP rather than 6%) and immediately announced new spending cuts and tax increases to compensate. If these contractionary forces feed on themselves, Europe’s downturn could be ghastly.


Some emerging concerns


The euro zone is thus the darkest shadow hanging over the world economy; but it is not the only one. Emerging markets may stumble. China’s economy is clearly cooling. And even if, as seems likely, Beijing loosens macroeconomic policy deftly enough to prevent a sharp slowdown, growth this year is likely to be no more than 8%. Slower growth in China is dampening commodity prices, hitting exporters in Latin America. Add in some home-grown problems (India, for example, faces a big budget deficit, declining confidence and high inflation) and the ripple effects of the euro crisis (which will hit growth in eastern Europe and Turkey hard) and it is plausible that emerging economies will grow by only about 5%. That would be their weakest performance in a decade, aside from the global slump of 2009.



If there is a positive surprise, it is likely to come from the United States. That is not because growth there will soar, but because expectations for the world’s biggest economy are so low. The consensus among professional forecasters is that America’s GDP will grow by 2% in 2012, below its underlying speed limit, and far too slow to bring the jobless rate down.



That could prove a bit too gloomy. Unlike Europe, America has moderated the pace of its fiscal tightening, thanks to the temporary extension of the payroll-tax cut. Household-debt burdens have fallen, the housing market shows signs of stability and the labour market is showing flickers of life.


But America’s outlook, like Europe’s, is darkened by political uncertainty. The payroll-tax cut has only been extended for two months, ensuring that the rest of the year will be punctuated with fiscal skirmishes, even as nothing is done to deal with America’s medium-term fiscal mess, or to smooth the huge tax hikes and spending cuts that loom at the end of 2012 under current law. It is a recipe for crushing confidence and scaring off investors.


History teaches that financial crises are followed by years of weakness. But some of the current pain is unnecessary. There is no excuse for the lack of clarity around the euro zone’s future, nor for America’s fiscal paralysis.


Europeans do not need to compound the peripheral economies’ problems with even deeper austerity. A more calibrated approach with more financing and more structural reforms makes far more sense.


Inept politicians have placed a big burden on central banks, which will have to take more unconventional measures, such as quantitative easing.


That will ease the agony, but it won’t make up for politicians’ mistakes. It looks like 2012 will be the year of self-induced sluggishness.