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<nettime> IMF/U.S./EMU - Induced World Recession? - Chakravarthi Raghavan

January 16, 1998

A group of prominent US economists warns of a severe world recession
resulting from these factors: IMF pressure on Asia to contract in response
to  financial chaos, the European scramble to meet fiscal targets, and the
end of the US boom as credit expansion slows.

     By Chakravarthi Raghavan
     Third World Network Features

A group of economists at the prestigious Jerome Levy Economic Institute,
USA, has warned that the IMF policies in Asia, the US fiscal stance, and
disinflationary policies in Europe could push the world into a recession on
a scale not seen since the severe 1974-5 downturn.

New policies and institutions are needed to ward off global recession, says
the report of the economists.

The Jerome Levy Institute (at Bard College in upstate New York, USA) is an
autonomous, independently endowed research organisation named after  Jerome
Levy, who, contemporaneously and independently of Kaletsky, had anticipated
Keynes and his well-known work. Levy's son was a well-known financial wizard
on Wall Street.

The seven well-known macro-economists who drew up the statement are: Matt
Forstater, Wynne Godley, Jan Kregel, Otto Levin-Waldman, George  McCarthy,
Dimitro Papadimitriou and L Randall Wray.

They identified these forces as combining to send the world economy
spiralling down: IMF pressure on Asia to contract in response to financial
chaos,  the European scramble to meet fiscal targets, and the end of the US
boom as credit expansion slows.

Market forces cannot be counted on to ward off recession. With America no
longer in a dominant position there is a vacuum in the governance of the
world economy.

The least America can do is sustain growth at home, use all its influence to
persuade other countries and international institutions to support expansion
globally, and lead an initiative to develop new global policies and
institutions to generate growth with balanced international trade, payments
and capital transactions.

In their statement, the scholars said that the financial chaos in Asia and
disinflationary policies in Europe mean that far too many countries outside
the US are now looking to exports as the main engine of growth, and
collectively they cannot possibly succeed.

If the IMF makes fiscal restriction a condition for providing financial
assistance to countries in trouble (as it is now doing in Asia), even when
their fiscal policy has not been lax, the recession will be aggravated.

There is a danger that the US will become part of the problem rather than
part of the solution, the scholars further warn.

Even without a downturn in the rest of the world, the US is now close to the
peak of its boom. The economy has grown for over six years, despite the
government's restrictive fiscal policy and despite the deteriorating trade
balance; but this has only happened because of a sustained growth in private
expenditure based on credit expansion which cannot continue much longer.

When the US economy turns downward, the federal budget will move back into
deficit as revenues fall. And, if the authorities respond to this by cutting
the budget further, the downturn at home will be aggravated, compounding the
forces making for recession abroad.

The statement points out that the indebtedness of US households is unusually
high relative to their income and as asset prices are inflated, any
downturn  in aggregate demand may be translated into a debt deflation.

The present position is particularly dangerous because appropriate
institutions for world governance do not exist; nor is there any consensus
about the principles according to which world production, trade, and
payments should be managed.

'We do not accept the view that unrestrained market forces, having created
an intolerable situation, will magically come to the rescue. Indeed, the
rescue package now offered in Asia is living proof that even the IMF does
not believe that "free markets" can resolve these problems.'

The proper response of the US, in the face of recession at home and abroad,
will be to maintain demand by relaxing fiscal and monetary policy. Far from
looking for budget balance early in the next century, the US should be
prepared for deficits that will arise due to a demand shortfall that could
total $200-300 billion.

At the same time the US should be using its influence to get the IMF, and
the governments of its member countries, to adopt policies which expand
demand and international trade in a balanced and non-inflationary way. And
urgent consideration should be given to the development of new institutions
for economic governance at a world level.

The scholars say their assessment is in stark contrast to the conventional
wisdom that rules current policy and analysis. Over the past decade, policy
has been guided by the view that opening domestic markets to free trade
would generate export-led growth, while fiscal retrenchment and a smaller
role for government would together generate increased private sector
investment; these factors combined would be sufficient to produce sustained
world-wide growth.

But the growth delivered by this policy stance has been lower than during
most of the post-war period. Satisfactory growth has been limited to Asia,
and, to some extent, the US, the UK and a few Latin American countries.
Analysis reveals that global growth has been caused largely by the expansion
of investment in the US, China, and the 'Asian Tigers'.

Thus, only the US and Asia have acted as 'engines of growth' in the 'new
global economy'. As a result, world economic growth has averaged no more
than 2% per year during the past decade (somewhat slower than during the
turbulent 1980s), while growth in Europe has been so slow that it lost
millions of jobs.

The economists expect that troubles among the Asian Tigers and the IMF
intervention will reduce regional demand for capital investment, which in
turn will reduce demand for imports of investment goods. Further, austerity
in Asia (combined with Japan's attempt to restructure its public finances
via the reimposition of the consumption tax) will reduce demand for
consumption goods, making it difficult to find outlets for the new
productive capacity that  resulted from high levels of investment in Asia,
in the US, and to a lesser extent in Latin America.

If European countries seriously attempt to meet Maastricht requirements and
if the US continues to move toward a balanced federal budget (and even
beyond, as some projections now show a budget surplus), world demand is even
less likely to be sufficiently high to meet existing capacity.

In sum, the global economy has been investing in a high-tech, efficient
production machine at a time when aggregate demand is likely to fall. This
would be the case even in the absence of further disruptions in financial
markets, the economists warned.

The flaws in the conventional policy analysis and IMF policy, and the basis
for our pessimistic outlook for world economies, become apparent when viewed
from a global perspective. Export-led growth combined with fiscal austerity
cannot succeed for all countries simultaneously; while one country  can have
a surplus on its trade account and a balanced government budget, this
requires that at least one country runs a trade deficit.

The increased reliance on exports as domestic demand fades is thus occurring
at precisely the moment when trade, viewed globally, is contracting. IMF
policy, relying on currency adjustment and domestic restriction, simply
cannot be the answer to the problem.

As for the prospects for the US economy, the scholars warn that the economy
will enter a new phase of recession when the impetus from private
expenditure financed by borrowing becomes exhausted. And the next recession,
when it comes, may well be aggravated by another debt deflation, perhaps
more serious than experienced in 1989.

Although the US economy has put in a good performance since 1991, any
euphoria should be tempered by the fact that the growth rates of output and
productivity have been unremarkable by historical standards. Real GDP and
productivity have only expanded at average rates of 2.8% and 1.3% per annum
respectively, since the beginning of 1991.

While the government deficit has fallen, the deficit in the current balance
of payments has risen, since 1991, by about 1% of GDP and this has
reinforced the disinflationary impact of the government's fiscal policy. So
far from being offsetting 'twins', the government and balance-of-payment
deficits have both moved decisively in the same direction so that the
financial balance of the private sector has moved from substantial surplus
into record deficit.

In the third quarter, the private sector's financial deficit - that is, the
excess of total private expenditure over disposable income - was over 2% of
GDP, with the implication that the private sector has been borrowing on an
unusually large scale.

The expansion of real GDP since 1991 has been dependent to an unprecedented
extent on the expansion of private fixed investment, which has accounted for
nearly a quarter of the rise in total final expenditure - a higher
proportion than ever before and very much higher than in the late 1980s

Personal consumption has contributed moderately to growth but, despite the
fact that there was no great rise in the flow of net lending to the
household sector, the level of household indebtedness has gone on rising
relative to income and now looks alarmingly high. Household indebtedness
(defined to include mortgages) had reached 92% of disposable income in the
second quarter of 1997 - a record level, miles higher than what it was
before the credit crunch in 1990.

Looking to the medium term, it is difficult to identify possible sources of
any sustained growth in demand. The government's intention implies that its
fiscal stance will remain restrictive in the medium term, although some
slight relaxation is supposed to take place after 1997.

Nor are the prospects for foreign trade bright. Since the middle of 1997,
exports have been showing signs of weakness, well before the rising dollar
has has its full effect... Net export demand is likely to provide even less
stimulus in the future than in the past.

Real private fixed investment has fluctuated since 1960, but the rise since
1991 has been so large as to suggest that sustained further expansion, on
anything like the same scale as in the recent past, is unlikely. The
business sector has never in the past run a financial deficit for very long
and every time it has done so there was subsequently a fall in fixed
investment led by a fall in inventory accumulation. When investment falls,
since it has been the sole source of recent economic growth, a downturn is a
likely consequence.

'Our conclusion is that the impulses which have driven the expansion so far
will peter out fairly soon... and a new period of recession is likely to
begin within the next 18 months and perhaps much sooner.'

The effects of the recession will be exacerbated by the new welfare reforms,
which will throw more people into the labour market, while spending cuts
will lower consumption demand. - Third World Network Features


About the writer: Chakravarthi Raghavan is Chief Editor of SUNS (South-North
Development Monitor), a daily bulletin, and Third World Network's
representative in Geneva.

When reproducing this feature, please credit Third World Network Features
and (if applicable) the cooperating magazine or agency involved in the
article, and give the byline. Please send us cuttings.

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     Email: twn@igc.apc.org; twnpen@twn.po.my
     Tel: (+604)2293511,2293612 & 2293713;
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