Imagine the world economy as a video game, one observer said. You have to complete a number of stages before you win, and the idea is to dodge all the bad stuff that can come at you at any moment. If you really get it wrong, you are zapped and you have to start all over again.
The game played by the policymakers who assembled in Davos, Switzerland, late last month should be called Global Apocalypse. It now even has its own Super Mario figure in the president of the European Central Bank (ECB), Mario Draghi.
Sad to say, it is taking those in charge of the global economy a long time to master the controls. After four-and-a-half years they have made it to the first level, but are now stuck there. Missiles rained down on them last year, and by the year’s end there was a very real fear of a wipeout as the euro crisis deepened.
A bit of clever footwork from Super Mario has averted the immediate danger. The ECB has flooded Europe’s financial system with cheap money and that has prevented banks from going to the wall. Bank of Canada Governor Mark Carney, who is also chairman of the G20’s Financial Stability Board, said on Jan. 28 that the long-term refinancing arrangements meant there was no longer the risk of a repeat of the chaos that followed the collapse of Lehman Brothers in September 2008.
However, as former British prime minister Winston Churchill said after Dunkirk, wars are not won by retreats, however brilliantly executed, and getting beyond level one is still proving challenging, at least for the developed countries in the West, where it has taken unprecedented intervention from central banks to prevent it from being game over. Martin Wolf, of the Financial Times, aptly describes it as a contained depression.
It should come as no surprise that victory has so far proved elusive. British Chancellor of the Exchequer George Osborne is right when he says that recoveries from recessions are always more difficult when the downturns are caused by excessive debt, but this slump has been accompanied by two other shocks: a big technological shift from an analog to a digital world and a big geographical shift that has seen the center of gravity move from Europe and North America to Asia. Companies such as Nokia that were world-beaters only a few years ago are finding out exactly what the economist Joseph Schumpeter meant by creative destruction, but that process also seems to be at work between countries and regions.
Even so, there is a way through the labyrinth, provided policymakers avoid obvious pitfalls and work methodically. One problem has been that they have tried to find short cuts over the past few years rather than work their way through the levels in the right sequence.
So, if getting to the first level called for urgent and aggressive action to ease monetary policy and shore up the financial system, the next phase should be to deal with the global imbalances that caused the problem in the first place.
The fundamental issue in the years up to the 2007 crisis was not the number of US subprime mortgages or even the explosion in derivatives; it was the instability caused by one half of the world running massive current account surpluses and the other half running massive current account deficits.
What needs to happen now is that the surplus countries accept the need to increase domestic demand, thereby soaking up exports from the debtor countries, resulting in more balanced growth all round.