Weak demand, fiscal tightening impede recovery in developed economies – UN report

Economic recovery in developed economies may grind to a halt because of weak domestic demand and the replacement of stimulus packages with fiscal austerity measures as governments try to regain the confidence of the financial markets, according to a United Nations report unveiled today.

Conversely, developing economies have sustained their strong growth, which has mainly been based on domestic demand, the UN Conference on Trade and Development (UNCTAD) says in its annual Trade and Development Report, which this year is subtitled “Post-crisis Policy Challenges in the World Economy.”

Developing countries must, however, face financial instability and speculative capital flows generated in developed economies and will not be spared by a new recession in richer countries, according to the report.

The report shows that, after a rapid post-crisis recovery, the world economy is slowing down from a rate of about 4 per cent gross domestic product (GDP) growth in 2010 to around 3 per cent this year.

Growth performance is strong in developing economies, which have resumed their pre-crisis economic expansion trend and are growing at above 6 per cent this year. By contrast, developed economies will only grow between 1.5 and 2 per cent. Transition economies continue recovering from the steep fall in 2009 with growth rates at around 4 per cent.

As the initial fiscal stimulus programmes have gradually disappeared since mid-2010, the fundamental weakness of the recovery in developed economies has come to the fore. Private demand alone is not sufficiently strong to maintain the momentum of recovery, as unemployment remains high and wages are stagnating.

Household indebtedness also remains high and banks are reluctant to lend, the reports notes, adding that the shift towards fiscal and monetary policy tightening creates a major risk of a prolonged period of mediocre growth in developed economies, if not of an outright contraction.

In the United States, recovery has been stalling, as domestic demand has remained subdued due to stagnating wages and employment. With interest rates at historically low levels for the foreseeable future and fiscal stimulus waning, a quick return to a satisfactory growth trajectory is highly unlikely, the UNCTAD report points out.

In Japan, recovery has been delayed by the impact of unprecedented supply-chain and energy disruptions in the wake of the massive earthquake and tsunami in March, while in the European Union, wage earners’ incomes and domestic demand remain very low.

With the unresolved euro crisis, the reappearance of severe debt market stress in the second quarter of this year and the prospect of fiscal austerity measures spreading across Europe, there is a high risk that the so-called “Euro-zone” will continue to act as a significant drag on global growth, the report notes.

Expansion has remained strong in all developing regions, with the exception of North Africa. Improvements in labour markets and sustained public support have prolonged the recovery of investment and domestic demand.

East, South and South-East Asia continue to record the highest GDP growth rates – more than 7 per cent this year – increasingly driven by domestic demand. However, the region is undergoing a moderate slowdown owing to supply-chain effects from Japan, tighter monetary conditions and weak demand in some major export markets.

In Latin America, expansion continues to be robust at almost 5 per cent, spurred by consumption and investment demand and by gains from the terms of trade.

In Central American and Caribbean economies, growth will be more modest, mainly owing to their dependence on exports to the United States, according to the report.

Sub-Saharan Africa should keep growing at the same rapid pace as last year – almost 6 per cent – as a result of terms-of-trade gains, investments in infrastructure and expansionary fiscal policies. Recovery of investment and household demand helped maintain the economic upturn in the transition economies, where national disposable income improved owing to better terms of trade in some cases, and to increased worker remittances in others.

The report also warns that fiscal tightening only addresses the symptoms of the problem, leaving the basic causes unchanged. Higher public debt ratios are a consequence of the crisis, not its cause, it says, adding that the fiscal policy that supports growth is more likely to reduce fiscal deficits and to curb public debt ratios than a restrictive one.