Sat, Jan 17, 2009 - Page 9 News List

Security under threat as economic crisis becomes human crisis

The recession is a worldwide problem that requires global coordination of a recovery package, which creates the opportunity to point the rebound in a new direction

by Kemal Dervis and Juan Somavia

As recession spreads around the world, the global production networks that arose with the globalization of the world economy have become sources of cutbacks and job losses. Postponing purchases of new winter coats in the US means job losses in Poland or China. These losses then translate into reduced demand for US or German machine tools.

Unemployment and reduced sales then feed back into new losses in banks’ loan portfolios, further weakening the battered financial sector. As a result, anxiety, hopelessness and anger are spreading, as what was a financial crisis becomes an economic and human crisis. Unchecked, it could become a security crisis.

Trying to rescue the financial sector without supporting a recovery in terms of businesses, jobs and family purchasing power will not work. What is needed is a large worldwide fiscal stimulus to counteract falling private demand.

Different countries’ capacity to act depends on their indebtedness, foreign exchange reserves and current-account deficits. Germany and China can do more than others. The US can do a lot, in part because of the dollar’s status as the main international reserve currency. Low interest rates mean that the additional debt burdens that public borrowing will create can remain manageable.

Moreover, if the stimulus succeeds and leads to an early recovery, the additional income gained may more than offset the increase in debt. Given the collapse of commodity prices and excess production capacities, there is no short-term inflation danger, even if part of the stimulus is financed directly by central banks.

The argument for a strong fiscal stimulus is overwhelming. Several countries have already announced measures, but there is a need to evaluate what they all amount to in reality. For example, some constitute “new” money, while others represent existing commitments brought forward. We also need to assess the quality of these packages.

The argument is strong for providing stimulus through increased government expenditures rather than relying on, say, tax cuts, because panicked consumers might save the money instead of spending it. Debt and inflation will reappear as medium-term problems, so it is critical that the fiscal ammunition used helps long-term productivity, growth and sustainability.

Of course, fiscal stimulus does not mean just throwing money at the problem. There needs to be a strategy, priorities must be weighed and empirical evidence analyzed. We should also remember that what growth there is in the world economy in this year and next year will come mostly from developing economies. Policies supporting their growth are critical to prospects in the advanced economies, too.

Each country may hope that others will stimulate their demand while it preserves its fiscal headroom, thereby relying on exports as the engine of recovery. Each country may also be tempted by protectionist measures, trying to preserve domestic jobs at the expense of imports. Such “beggar-thy-neighbor” policies in the 1930s aggravated and deepened the Great Depression.

The automobile industry is a good example. Measures to keep the industry afloat in one country look like unfair competition to others. But the answer is not to let a collapse in the world’s car industry fuel a deeper recession. The answer is to coordinate a global recovery package, which creates the opportunity to point recovery in the direction of a new generation of fuel-efficient and low-carbon-emission vehicles and green jobs.

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