The world has yet to achieve the macroeconomic policy coordination that will be needed to restore economic growth following the Great Crash of 2008.
In much of the world, consumers are now cutting their spending in response to a fall in their wealth and a fear of unemployment. The overwhelming force behind the current collapse of jobs, output and trade flows is even more important than the financial panic that followed Lehman Brothers’ default last September.
There is, of course, no return to the situation that preceded the Great Crash. The worldwide financial bubble cannot and should not be recreated. But if the world cooperates effectively, the decline in consumer demand can be offset by a valuable increase in investment spending to address the most critical needs on the planet: sustainable energy, safe water and sanitation, a reduction of pollution, improved public health and increased food production for the poor.
The US, Europe and Asia have all experienced a collapse of wealth due to the fall of stock markets and housing prices. There is not yet an authoritative measurement of the decline in wealth and of how it is distributed worldwide, but it is probably around US$15 trillion lower than the peak in the US, and perhaps US$10 trillion lower in both Europe and Asia. A combined decline of around US$25 trillion would be roughly 60 percent of one year’s global income. The decline in US wealth as a share of the US economy is even larger, around 100 percent of annual income, and perhaps 70 percent of annual income in Europe and Asia.
The usual assumption is that household consumption falls by around 5 cents for each dollar decline in household wealth. This would mean a direct negative shock to household spending in the US of around 5 percent of national income, and of around 3.5 percent in Europe and Asia.
The size of this downturn is so large that unemployment will rise sharply in all major regions of the world economy, perhaps reaching 9 percent to 10 percent in the US. Households will gradually save enough to restore their wealth, and household consumption will gradually recover as well. Yet this will occur too slowly to prevent a rapid rise in unemployment and a massive shortfall of production relative to potential output.
The world therefore needs to stimulate other kinds of spending. One powerful way to boost the world economy and to help meet future needs is to increase spending on key infrastructure projects, mainly transportation (roads, ports, rail and mass transit), sustainable energy (wind, solar, geothermal, carbon-capture and sequestration and long-distance power transmission grids), pollution control and water and sanitation.
There is a strong case for global cooperation to increase these public investments in developing economies, and especially in the world’s poorest regions. These regions, including sub-Saharan Africa and Central Asia, are suffering harshly from the global crisis because of falling export earnings, remittances and capital inflows.
Poor regions are also suffering from climate changes, such as more frequent droughts caused by rich countries’ greenhouse-gas emissions. At the same time, impoverished countries have huge needs for infrastructure, especially roads, rail, renewable energy, water and sanitation, and for improved current delivery of vital life-saving services, including health care and support for food production.