Antiquated Economic Policy Will Strangle Wealthy Country Growth in 2013

Dean Baker

18/01/2013

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Europe and the United States can look forward to another year of weak growth in 2013 thanks to the fact that they are guiding their economies by an economic theory that was disproven more than 70 years ago. Both Europe and the United States, the former more than the latter, are obsessed with pursuing policies of fiscal austerity when modern economic theory clearly argues for stimulus. The result will be another year of near-zero growth for Europe and a growth rate in the United States that will at best be sufficient to keep the unemployment rate from rising.

In the case of Europe, eurozone economic policies are being largely determined by Germany. The European Central Bank (ECB) has essentially moved into the position of being the guarantor of peripheral country debt, but the condition of maintaining the guarantee is a continual tightening of budgets, with more taxes and less spending. With the core countries also tightening their budgets, there is virtually no prospect of renewed growth in the eurozone countries.

The ECB is not the only actor standing in the way of European growth. The United Kingdom has also opted to throw itself into a recession with contractionary fiscal policy. At best it will also only be able to maintain minimal growth in 2013.

The story in the United States is comparable. The trend path of GDP growth is approximately 2.4 percent according to most estimates. It will at best be able to sustain this growth in 2013, driven in part by a comeback of the housing market. However there is considerable downside risk in the current budget standoff. The need to reduce the budget deficit has become a matter of bipartisan agreement in Washington, in spite of the obvious need for deficits to spur the economy.

While the unemployment rate in the United States has fallen from a peak of 10.0 percent in October of 2009 to 7.7 percent in the most recent data, the employment-to-population ratio shows no comparable improvement. It is just 0.5 percentage points above the low reached in the summer of 2011, 4.7 percentage points below the pre-recession level. Even by conservative measures, output is more than 6 percent below potential GDP. The economy is unlikely to make up much, if any, of this ground in 2013.

The developing world has all the economic bright spots for 2013 as developing country governments seem less bound by antiquated economics and most now have the freedom to pursue their own economic policies. East Asia is likely to continue to have the strongest growth. The latest data from China indicate that its economy may again be accelerating, with a growth rate of close to 8.0 percent likely for 2013. The rest of the region is also likely to see rapid, if somewhat slower growth.

India and other South Asian countries will see respectable growth rates in the neighborhood of 5.0-6.0 percent. Concerns about inflation and bottlenecks in production are preventing the region from having the same sort of growth as East Asia. Most of Sub-Saharan Africa can also expect to see growth in the 5.0 percent range driven by high commodity prices and foreign investment, much of it from China.

Most of Latin America will also see a year of slightly better growth in 2013 than 2012 as countries back away from anti-inflationary policies. The major exception is likely to be Mexico. The weakness of the U.S. economy will be a serious drag on Mexico's economy in 2013.

The diverging paths of developing country and wealthy country economies is an encouraging development. In prior decades, near-recession conditions in Europe, coupled with weak growth in the United States and Japan, would virtually guarantee weak growth throughout most of the developing world. However the growth of China over the last three decades and the growth in many Latin American economies in the last decade have created a new pole of world growth. As a result, growth in the developing world is likely to proceed at a rapid pace even as antiquated economic policies lead to near stagnation in wealthier countries.

While it still too early to say for sure, it is likely that we have seen a permanent shift in the world economy where the wealthy countries are no longer needed to sustain growth. Growth in the developing world is still likely to be more rapid with the pull of strong growth in Europe and the United States, but in the future developing countries are likely to be able to sustain growth regardless of the economic performance of the wealthy countries.

It would be difficult to overestimate the importance of this development. Much of the developing world was forced to endure two decades of near stagnation from 1980 to 2000 largely as a result of economic policies imposed on them by the International Monetary Fund. If the wealthy countries can no longer dictate misguided economic policies to the developing world, then it will be free to pursue policies that result in more rapid and more equal growth.

Of course nothing guarantees that the developing world will be able to sustain steady growth. Developing countries have frequently pursued their own misguided economic policies. However, if they no longer have to contend with misguided policies from the wealthy countries as well, that will be an enormous step forward for the developing world.

- Dean Baker is co-director of the Center for Economic and Policy Research in Washington, DC. He has a blog, "Beat the Press [http://www.cepr.net/index.php/blogs/beat-the-press/]," where he discusses the media's coverage of economic issues.

(This article was originally published in Valor Econômico (Brazil) on December 19, 2012).

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