UN DESA Policy Brief 36 - Can a protracted slowdown be avoided?


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The present policy responses to the world's current economic woes are highly inadequate. Europe and the United States are mainly fixated on reducing large fiscal deficits and public debt. The concerns are serious, and the ongoing sovereign debt crises in the euro zone have been a source of continuous turmoil in financial markets.

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UN DESA Policy Brief 36 - Can a protracted slowdown be avoided?

  1. 1. UN-DESA Policy Brief No. 36Can a protracted slowdownbe avoided?T he world economy is teetering on the brink of an- other major downturn. As in 2008, economic woesin the major developed economies are weakening eco- With the Cannes Action Plan, leaders of the G20 have recognized the need for reinvigorating growth and job creation. But these are defined as medium-term ob-nomic prospects around the world. There are multiple jectives, and current policy stances are weakening, ratherconcerns, but policymakers throughout Europe and the than strengthening, aggregate demand.United States are mainly fixated on reducing large fiscaldeficits and public debt. The concerns are serious, and the Figure 1. More austerity, more debt (Changes in fiscal balance and public debt as percentageongoing sovereign debt crises in the euro zone have been a of GDP. 2009-2011)source of continuous turmoil in financial markets. Unfortunately, the present policy responses are high- Developed economiesly inadequate. Most developed economies have phased out Emerging and developing economiesstimulus measures and shifted to fiscal austerity. With un- 50.0employment rates remaining very high and financial sec- 40.0 Change in debt (in % points)tors still clogged, this approach is pulling the plug on therecovery by exacerbating the lack of aggregate demand, 30.0further weakening the prospects for jobs recovery and eco- R2 = 0.3073nomic development in the longer run. Bleaker medium 20.0and long-term growth prospects would also undermine 10.0the financial sustainability of health and pension systems R2 = 0.0051over time, thus achieving precisely the opposite of what 0.0policymakers are aiming at through fiscal austerity. -5.0 0.0 5.0 10.0 15.0 -10.0 Is there an alternative? Yes. As shown in the UN’sWorld Economic Situation and Prospects 2012, many devel- -20.0oped countries have more than adequate fiscal space for Change in primary balance (in % points)additional stimulus. If well targeted at job creation andgreen growth and adequately coordinated internationally, Source: UN/DESA calculations based upon figures from IMF, Fiscal Monitoradditional stimulus could quicken the recovery and put September 2011: Addressing Fiscal Challenges to Reduce Economic Risks.the global economy on a more balanced and sustainable Note: Positive change in fiscal balance means higher surplus or smaller fiscal deficit.growth path.Deficits, debt and growth More, not less fiscal stimulus is neededFiscal deficits have widened first and foremost because now…of the global economic crisis, not because of additional In most developed countries, high public indebtednessspending or tax cuts meant to provide economic stimulus. should be the medium-term rather than the immediateDebt has increased for essentially the same reason. Avail- concern. Governments still have plenty of fiscal space leftable evidence suggests that fiscal austerity is not helping for additional stimulus measures as most can still bor-restore economic growth or debt sustainability; countries row at very low cost. Risk premiums on public borrow-that made the biggest spending cuts to reduce fiscal defi- ing have increased significantly for Greece, Italy and a fewcits have seen their debt-to-GDP ratios rise even further other European economies, but they remain low and have(see figure). Why? Well, their economies grew even weak- decreased even further for Germany, Japan, the Uniteder, eroding debt sustainability despite fiscal austerity. States and other developed countries.Januar y 2012 United Nations Depar tment of Economic and S ocial Affairs 1
  2. 2. In economies with low financing costs, policy should (GHG) emissions and in infrastructure more resilient totherefore return to a countercyclical stance. The same the effects of climate change. Such a reorientation of stim-holds for economies that continue to run current account ulus measures has the potential to provide significantlysurpluses: by sustaining or enhancing deficit-financed greater employment effects, as renewable energy genera-fiscal stimulus, at least until GDP and job growth have tion tends to be more labour-intensive than existing, non-taken effect and unemployment rates have fallen to levels renewable energy production.at which more sustained private demand growth may beexpected, public demand should shore up faltering private …and coordinated internationallydemand. Coordinated additional short-term stimulus by economies As there may be time lags for growth effects to kick in, with fiscal space is consistent with benign global rebalanc-fiscal deficits may still widen further initially, but should ing. In Europe, instead of the present asymmetric adjust-decline subsequently as higher growth and employment ment through recessionary deflation, which concentrateswill boost government revenues and reduce pressure on most of the pain on countries in debt distress, it wouldsocial security expenditures. The fiscal balance would thus entail a more symmetrical approach of austerity and struc-follow a “J-curved” trajectory—worsening initially, but tural reform in the countries in distress combined withimproving strongly thereafter. The same applies to the de- euro area-wide reflation. The United States would equallygree of public indebtedness. need to consider such a sequenced approach. The first pri- ority should be to boost demand in order to reduce unem-… but needs to be spent wisely…. ployment, especially through public investment and moreA “J-curved” process of fiscal consolidation is quite fea- direct job creation. This would help reduce householdsible provided that the additional stimulus is carefully de- debt and boost consumption demand through incomesigned to maximize impact. A key condition is that the growth. Infrastructure investment and other structuralfiscal multiplier should be greater than one, that is, each measures would underpin strengthened export competi-dollar of additional short-term stimulus should translate tiveness over the medium run. This would give time for China and other Asian economies to rebalance towardsinto more than one dollar of additional aggregate demand. greater reliance on domestic demand growth.This condition typically exists in a downturn and shouldbe present now as well. A high multiplier effect can be fur- The analysis of the World Economic Situation andther ensured by orienting the stimulus towards infrastruc- Prospects 2012 shows that it is feasible to achieve suchture investment and direct job creation. For instance, un- benign global rebalancing with accelerated jobs recov-der the American Recovery and Reinvestment act (ARRA) ery. The coordinated short-term global stimulus, togetherof 2009, expenditure on goods and services by the United with orderly sovereign debt workouts and structural poli-States Federal Government and transfer payments to State cies aimed at stronger job creation and sustainable devel-and local governments for infrastructure had multipli- opment would lift GDP growth across the globe, reduceers ranging between 1.0 and 2.5. In contrast, tax cuts for public debt-to-GDP ratios and make up the 64 millionhigher-income households and extension of the first-time jobs deficit left by the global crisis of 2008-2009.homebuyer credit had multipliers of no more than be-tween 0.2 and 0.8. While the optimal mix of supporting demand willvary across countries (i.e., directly through taxes or income Prepared bysubsidies, or indirectly through strengthening supply-side Oliver Paddison and Rob Vosconditions, including by investing in infrastructure and For further information please contact:new technologies), direct government spending tends togenerate stronger employment effects. Rob Vos, Director, Development Policy and Analysis Division Department of Economic and Social Affairs, Rm. DC2-2020 Policy should therefore target public investments to United Nations, New York, NY 10017, U.S.A.alleviate infrastructure bottlenecks that constrain growth Tel: +1 212 963-4838 • Fax: +1 212 963-1061prospects and to supplement this policy with fiscal efforts e-mail: vos@un.orgto progressively broaden the tax base. One priority area http://www.un.org/en/development/desa/policy/index.shtmlwould be to expand public investment in renewable cleanenergy as part of commitments to reduce greenhouse gas Follow us on Facebook, LinkedIn and Twitter2 United Nations Depar tment of Economic and S ocial Affairs Januar y 2012