The Global Economy

A “Synchronized” Recession

The world economy is passing through very turbulent times. But there are some silver linings—a new round of trade liberalization is to be launched. Inflation is low, interest rates are declining, many budgets are in balance, equity markets are showing signs of hope, oil prices are depressed, exchange rate regimes are becoming more flexible, and, barring Argentina, emerging market volatility appears to be in check. But all these are overshadowed by the dark clouds of recession.

Technically, a national recession is defined as two consecutive quarters (six months) of declining economic output as measured by inflation-adjusted (real) Gross Domestic Product (GDP). There is no accepted definition of a world recession, since some countries can be in recession while others could be growing and, overall, the world economy could show positive growth rates. That is what is happening now with the United States, Japan, and Europe dragging world growth rates down, and China, India, and Russia pushing them up. On balance, the world economy may still show a positive 1- to 2-percent growth in calendar years 2001 and 2002, a growth performance previously seen in 1975, 1982, and 1991.

The last time the world economy was in recession in the sense of negative growth was in the depression-hit 1930s. A more accurate description of what is happening in the world now is a “synchronized downturn” in the Big Three—the United States, Japan, and Europe—and a growth recession in the global economy. Actually, Japan has been a write-off for the past decade. So what we have to worry about are the other two, especially the United States, which is the engine of world growth. It will be a time before China replaces Europe and Japan as the rear engine.

A recent International Monetary Fund paper, “The Impact of U.S. Economic Growth on the Rest of the World: How Does It Matter?,” quantifies the U.S. role. In 2000, U.S. GDP was equivalent to about a third of world GDP, measured at market exchange rates. The United States accounted for nearly a quarter of the expansion during 1992-2000.

However, this analysis captures only part of the overall impact on growth, since it is confined to merchandise trade. Investment and capital flows, stock market performance, and business confidence and sentiment is not included. Even so, countries like Canada, Mexico, Malaysia, Singapore, and South Korea are crucially dependent on U.S. growth. India is much less so since its overall exposure to the United States is around 4 percent of GDP.

In the third quarter of 2001, U.S. real GDP registered a decline of 0.4 percent, and it is widely expected to repeat this performance during October-December 2001 as well, confirming that it is indeed in a recession after a decade of unprecedented expansion. GDP data are available only quarterly and continually revised. That is why the Cambridge, Mass.-based National Bureau of Economic Research, which tracks business cycles, looks at monthly indicators, especially on unemployment. By this measure, the United States is already in a recession. In October alone, it lost about 415,000 jobs, although that month’s joblessness rate of 5.4 percent was the same as the figure registered in December 1996.

Why is America in recession? Sept. 11 is not the cause. The real reason is the overinvestment and overborrowing spree of the 1990s. Unrealistic forecasts of productivity growth created an atmosphere of “irrational exuberance.” In a way, therefore, the current slowdown is a welcome corrective to the excesses of the 1990s.

The expectation of most analysts is that the U.S. economy will show signs of recovery by the second half of 2002. The Bush administration will use both fiscal and monetary policy aggressively to ensure that this indeed happens, although its predilection for tax cuts instead of public spending could blunt the stimulus package.

There are two other worries. First, the volume of international trade is not expected to grow in the next year. This could intensify the effect of a recession. Second, when real GDP and inflation are falling, as now, nominal GDP growth plummets. This increases fears of deflation.

In his book The Return of Depression Economics, Paul Krugman wrote that while the world economy may not be in a depression, depression economics has staged a stunning comeback. For India, while we need to be concerned about the global economy, it is not disaster or devastation time. Of course, the world slowdown will be used by the government as an alibi for our growth deceleration.