Premature End to Economic Stimulus

Premature End to Economic Stimulus Could Risk Double-Dip Recession, UN Warns

New York, Sep 14 2010 7:10PM Premature withdrawal of macroeconomic stimulus measures in developed countries in the face of budget deficits may trigger a deflationary spiral in the global economy, with attendant slumps in growth and employment, a major United Nations trade agency warned today.

“Ending stimulus measures too soon in an effort to restore the confidence of financial markets could be counterproductive,” the UN Conference on Trade and Development (UNCTAD) said in its 2010 report, noting that spreading fiscal austerity in Europe and lack of consensus in the G-20 group of developed and major developing economies risked a double-dip recession.

It also called on developing countries with export-oriented economies to expand domestic demand growth through increasing mass purchasing power to combat unemployment in the face of declining export demand.

With the end of the debt-financed consumption boom in the United States, which the report expects will no longer serve as an engine of growth for the global economy, and neither China, the Euro area nor Japan likely to assume this role in the foreseeable future, policies for sustainable economic growth, job creation, and poverty reduction should be based on establishing a balanced mix of domestic and overseas demand, it stressed.

Overall, the Trade and Development Report 2010 concluded that global real gross domestic product (GDP) is expected to grow by 3.5 per cent in 2010, following a contraction of almost 2 per cent last year. But economic recovery remains fragile and its pace varies across countries, with emerging-market economies, mainly in Asia and Latin America, leading the revival.

These economies had avoided large external deficits and accumulated significant international reserves before the crisis. They contained rises in unemployment during the crisis and achieved a relatively rapid recovery of domestic demand.

In transition economies in Central and Eastern Europe, recovery has been weak. Many of these economies ran huge current-account deficits and depended heavily on net capital inflows. Direct adverse effects from the crisis were exacerbated by restrictive macroeconomic policy responses to the crisis, often under programmes led by the International Monetary Fund (IMF), according to the report.

Recovery is also weak in developed countries and resembles the pre-crisis build-up of global trade and current-account imbalances. In the US, domestic demand has accelerated faster than in the leading current-account surplus countries, Japan and Germany, where recovery relies heavily on exports. Moreover, home-grown debt problems have made Europe evolve into the centre of the crisis and a laggard in the recovery.

African countries were less directly affected by the crisis because they are much less integrated into international financial markets.

“The rebound from recession will not endure if it continues to be based on temporary factors, such as inventory cycles and exceptional fiscal stimulus programmes, and if the shortcomings that caused the crisis, such as unregulated financial systems, income inequality and global imbalances, persist,” UNCTAD Secretary-General Supachai Panitchpakdi said in the overview to the report.

A premature exit from demand-stimulating macroeconomic policies in an effort to reduce budget deficits and regain market confidence means that these countries have to rely on exports for recovery, shifting the burden of sponsoring demand stimuli on to others and exporting unemployment to the rest of the world.

“Governments should withdraw stimulus only after achieving a full recovery of private domestic demand in their country,” the report warned.

It stressed the need to make job creation a priority in economic policy since unemployment is the most pressing social and economic problem of our time, not least because, especially in developing countries, it is closely related to poverty. The fallout from the global crisis has exacerbated what were already sluggish labour markets in most countries even before the crisis erupted.

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