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.
The G20, which comprises the world’s largest economies, offers the natural setting for global policy coordination. The next G20 meeting in London in early April is a crucial opportunity for timely action. The leading economies — especially the US, the EU and Japan — should establish new programs to finance infrastructure investments in low-income countries. The new lending should be at least US$100 billion per year, directed toward developing countries.
The new financing would include direct loans from rich countries’ export-credit agencies to enable poor countries to borrow long-term (for example, 40 years) to build roads, power grids, renewable energy generation, ports, fiber optic networks and water and sanitation systems. The G20 should also increase the lending capacity of the World Bank, the African Development Bank and other international financial institutions.
Japan, with a surplus of saving, a strong currency, massive foreign exchange reserves and factories without domestic orders, should take the lead in providing this funding for infrastructure.
Moreover, Japan can boost its own economy and those of the poorest countries by directing its own industrial production to the infrastructure needs of the developing world.
Cooperation can turn the sharp and frightening decline in worldwide consumption spending into a global opportunity to invest more in the world’s future well-being. By directing resources away from rich countries’ consumption to developing countries’ investment needs, the world can achieve a “triple” victory.
Higher investment and social spending in poor countries will stimulate the entire world economy, spur economic development and promote environmental sustainability through investments in renewable energy, efficient water use and sustainable agriculture.
Jeffrey Sachs is professor of economics and director of the Earth Institute at Columbia University.
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