Tue, Sep 18, 2007 - Page 9 News List

Imbalances pose threat to global economic growth

By Jomo Kwame Sundaram and Rob Vos  /  COPYRIGHT: PROJECT SYNDICATE

Today's ongoing financial market turmoil comes as no surprise to those who have been warning about the risks to the world economy from the end of the housing market bubble in the US. Back in January, the UN's outlook for the global economy raised concerns about the economic pain this might impose on heavily indebted US households. It also emphasized how weakly regulated, closely interconnected global financial markets, together with persistent global macroeconomic imbalances, jeopardize growth and development prospects in the world economy, including poorer countries.

The US current account deficit has been the most widely discussed indicator of global imbalances. For the past five years, the US has been sucking in more than US$2 billion a day of other countries' savings, as the easy provision of domestic credit on an unprecedented scale has allowed households to spend more than they earn. Such borrowing was especially attractive as asset (housing and equity) prices kept rising, interest rates remained low and succeeding generations of financial market innovators could convince investors that they had mastered the exigencies of risk. Thus, further lending, even against over-valued collateral, was "sold" as a sign of good times ahead.

Warnings about irrational market exuberance were largely ignored, especially as US consumer spending helped fuel strong growth across the global economy. Robust exports from Japan and Europe supported economic recovery and steadied investor confidence, providing, in turn, further export opportunities for newly industrializing countries, most notably China.

Meanwhile, heightened international competition kept the lid on inflation and interest rates remained low, giving a further boost to consumer spending and completing what looked like a virtuous growth circle. Even many of the poorest countries seemed, at long last, to be joining in, posting strong growth on the back of rising energy and raw material prices, renewed mining investments from abroad and increasing fiscal revenues.

Winning formula

Although the numbers were never as rosy as market enthusiasts seemed to think, they did divert attention away from the shaky foundations of the newfound prosperity. The growing need for measures to correct global imbalances was met with disbelief by influential policymakers and market analysts alike: "Why change a winning formula?"

The fate of the rest of the world depends on the responses to the unfolding financial turmoil. The contraction of property and stock markets will undoubtedly dampen US household borrowing and demand, potentially triggering a downward spiral. If protection is sought through tariff and other trade-related measures, then the knock-on effects could have even more devastating consequences for everybody.

In recent weeks, leading central bankers have injected more than US$300 billion into the financial system, lowered the rates at which they lend to private banks and announced that such activism will continue until calm returns. This may be enough to calm financial markets for now, but it will not redress the more fundamental problems behind the current turmoil. In today's interdependent world, a coordinated strategy is needed to avoid recession and to return lasting stability to financial markets.

Indeed, the fact that the world is again worrying about the economic fallout from financial shocks highlights the lack of progress since the Asian crisis a decade ago in moving toward a new international financial architecture. While there has been some progress on harmonizing standards and extending surveillance, there has been far too much emphasis on strengthening governance in developing countries and not enough on systemic problems linked to unregulated private capital flows.

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