Is the Global Economy Headed for a Lost Decade? A European Perspective

Article excerpt

In the 15 years leading up to the recent crisis, the world economy's exceptional performance was driven by globalisation, rapid, export-driven growth in emerging markets, debt-fuelled consumption in major advanced economies, and a benign financial and macroeconomic environment. These, however, sowed the seeds for the financial crisis by creating unsustainable imbalances and distortions. Obstacles to future growth are likely to be retrenchment in consumption, dampened investment, and unsustainable fiscal balances. Going forward, there must be a renewed commitment to medium-term, rule-based, policies for maintaining fiscal sustainability, price stability, and financial stability. The international imbalances between savings and consumption must also be addressed through a global reform agenda discussed in the paper. Even with reform, the challenges to growth will be daunting. Without reform, however, it is likely that the global economy will suffer a lost decade.

Business Economics (2010) 45, 147-151.

Keywords: global economy, financial crisis, economic reform, financial reform, economic policy

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It is a pleasure for me to participate in this year's NABE Economic Policy Conference and an honour to be invited to debate the policy challenges facing the global economy in the aftermath of the most severe financial crisis since the Great Depression. Defining what "the new norm" of the postcrisis economic environment should be is challenging; although the global economy has recently embarked upon a recovery path, substantial fragilities remain, and the outlook is still fraught with significant risks. For policymakers, our key challenge now is to internalise the lessons of the crisis and to address its causes through long overdue reforms. The aim should be to prevent similar phenomena re-emerging and to create the conditions for sustainable and balanced long-term economic growth.

In my speech today, I will tackle three issues. I will start with an overview of the drivers and shortcomings of the pre-crisis global growth model. I will then move on to discuss what the obstacles to global growth might be in the future and what features the "new norm" should have if growth is to be sustainable. Finally, I will take stock of the reform agenda for achieving strong, balanced growth and a resilient financial system.

1. The Pre-Crisis Global Growth Model: Drivers and Shortcomings

It is undeniable that in the 15 years leading up to the crisis, the world economy achieved exceptionally high growth, combined with low levels of inflation and financial market volatility. Between the early 1990s and 2007, global economic growth averaged 3.7 percent per annum, but the volume of world trade expanded at an average pace of 7.1 percent. Global growth before the crisis was driven by several factors.

First, globalization led to increased trade openness and a larger global labour supply. Key in this process was the integration of emerging Asia and the former COMECON countries into the world economy during the 1990s, which led to a significant expansion in the global workforce. The larger labour supply reduced production costs at the aggregate level and increased the comparative advantage of Asian economies in particular.

A number of countries benefited from this environment by pursuing export-led development strategies. In the case of emerging Asia, these strategies were supported by managed exchange rate policies that directly or indirectly targeted the U.S. dollar. As a result, emerging Asian economies ran persistent current account surpluses and accumulated vast foreign exchange reserves.

Another feature was the debt-fuelled consumption booms experienced in a number of advanced economies. These booms were underpinned by positive wealth effects stemming from the appreciation of housing and financial assets. In addition, favourable credit conditions allowed consumption to be financed through a substantial rise in household indebtedness. …