Global risk and reward in 2011

NEW YORK — The outlook for the global economy in 2011 is, partly, for a persistence of the trends established in 2010. These are: an anemic, below-trend, U-shaped recovery in advanced economies, as firms and households continue to repair their balance sheets; a stronger, V-shaped recovery in emerging-market countries, owing to stronger macroeconomic, financial, and policy fundamentals. That adds up to close to 4% annual growth for the global economy, with advanced economies growing at around 2% and emerging-market countries growing at about 6%.

But there are downside and upside risks to this scenario. On the downside, one of the most important risks is further financial contagion in Europe if the eurozone’s problems spread to Portugal, Spain, and Belgium.

The United States represents another downside risk for global growth. In 2011, the US faces a likely double dip in the housing market, high unemployment and weak job creation, a persistent credit crunch, gaping budgetary holes at the state and local level, and steeper borrowing costs as a result of the federal government’s lack of fiscal consolidation. Credit growth on both sides of the Atlantic will be restrained, as financial institutions in the US and Europe maintain a risk-averse stance toward lending.

In China and other emerging-market economies, delays in policy tightening could fuel a rise in inflation that forces a tougher clampdown later, with China, in particular, risking a hard landing. There is also a risk that capital inflows to emerging markets will be mismanaged. Further increases in oil, energy, and commodity prices could lead to negative terms of trade and a reduction in real disposable income in net commodity-importing countries.

Moreover, currency tensions will remain high. Countries with large current-account deficits need nominal and real depreciation (to sustain growth via net exports), whereas surplus countries are using currency intervention to resist nominal appreciation and sterilized intervention to combat real appreciation. This is forcing deficit countries into real exchange-rate adjustments via deflation — and thus a rising burden of public and private debt that may lead to disorderly defaults.

Several major geopolitical risks loom, including military confrontation between North and South Korea and the possibility that Israel, or even the US, might use military force to counter Iran’s nuclear weapons program. There are also the political and economic turmoil in Pakistan and the risk of a rise in cyber-attacks.

In the US, slower private-sector deleveraging — given the fiscal stimulus from the extension of unemployment benefits for 13 months, the payroll-tax cut, and maintenance of current income-tax rates for another two years — could lull policymakers into assuming that large fiscal and current-account imbalances can continue indefinitely. This could generate financial strains over the medium term — and protectionist pressures in the short term.

Finally, in the face of political opposition to fiscal consolidation, especially in the US, there is a risk that the path of least resistance becomes continued monetization of fiscal deficits.

But there are also several upside risks. The US corporate sector is strong and very profitable, owing to massive labor shedding, creating scope for increased capital spending and hiring to contribute to more robust and above-trend GDP growth in 2011. The eurozone, driven by Germany, could lurch toward greater economic and political union, thus containing the problems of its periphery.

Meanwhile, growth in Germany and the eurozone “core” may further accelerate.

The attenuation of downside risks and pleasant surprises in developed and emerging economies could lead to a further increase in demand for risky assets (equities and credit), which would reinforce economic recovery via wealth effects and lower borrowing costs. Positive feedback from consumption to production, employment, and income generation could further accelerate the pace of global growth, particularly if monetary policies in most advanced economies remain looser than expected, supporting asset reflation and thus demand and growth.

Indeed, after four years (2007-2010) of either recession or subpar recovery, the process of balance-sheet repair — while not completed yet — is underway, and may result in less saving and more spending to boost growth in advanced economies. The damage from the financial crisis is still ongoing, but stronger growth can heal many wounds, especially debt-driven wounds.

So far, the downside and upside risks for the world economy are balanced. But if sound government policies in advanced and major emerging economies contain the downside risks that are more prevalent in the first half of this year — which derive from political and policy uncertainty — a more resilient global economic recovery could take hold in the second half of 2011 and into 2012. –Nouriel Roubini

Nouriel Roubini is chairman of Roubini Global Economics (www.roubini.com), professor at the Stern School of Business at NYU, and co-author of Crisis Economics

Project Syndicate

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