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The IMF is seriously worried

15 April 2016

The International Monetary Fund wants governments to broaden their attack on sluggish growth and inequality, writes Tim Colebatch. The alternative could be another recession

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Growth “too slow for too long”: chief economist Maurice Obstfeld releasing the IMF’s half-yearly outlook for the world economy. International Monetary Fund 

Growth “too slow for too long”: chief economist Maurice Obstfeld releasing the IMF’s half-yearly outlook for the world economy. International Monetary Fund 


The International Monetary Fund never forecasts that the world is heading for recession: that would become a self-fulfilling prophecy. But it is now worried, seriously worried, about the risk of it happening in the next two years.

The IMF’s latest half-yearly outlook for the world economy, released this week, once again trimmed its forecasts for world economic growth, not just for 2016 but for the next five years. Global growth last year was just 3.09 per cent, compared to an average of 5.1 per cent in the five years before the global financial crisis. The new forecast for 2016 is for the world’s output to grow by just 3.16 per cent – and Australia’s rate will remain stuck at around 2.5 per cent.

And those forecasts assume that China will sail through its gathering storm of problems without missing a beat. Given that the IMF is counting on China to generate more than a third of the world’s growth this year and almost a third in the next five years, you wouldn’t want that part of the forecast to be wrong.

To me, what was more alarming than the now-routine downgrading of the forecasts was the pessimism of the report, of many of its medium-term forecasts, and of the IMF’s chief economist, Berkeley professor Maurice Obstfeld, who frankly told the press conference he didn’t believe his own forecasts.

Economic growth, he said, has been “too slow for too long.” Because of that, the world has become “more exposed to negative risks.” The IMF’s forecasts have become more pessimistic, and even its latest prediction looks “less likely to materialise compared with some possibly less favourable outcomes.” 

That’s a pretty severe warning to be handing out with a brand new set of forecasts. But Obstfeld rattled off a long list of reasons why he worries whether the world will muddle through this time.

Oddly, his concerns didn’t include the risks facing China and India, for both of which the IMF’s forecasts are at the optimistic end of the range. On these figures, the two Asian giants would generate almost half the world’s growth over the next six years; China would average 6.1 per cent growth a year to 2021, and India 7.6 per cent. Those are high targets for countries with so many problems hanging over them.

Instead, Obstfeld cited two main concerns: the turbulence in global financial markets, which, if it continues, could trigger a new financial crisis, and the sharply deteriorating political environment in Western countries.

High among the political danger signs were the erosion of the sense of common purpose that has created the European Union – a result of the failure of most of its economies to recover from the global financial crisis – along with the strains created by the Syrian refugee crisis and terrorist attacks, and the serious risks posed by the possibility of Britain voting to leave the union.

“The result in Europe has been a rising tide of inward-looking nationalism,” Obstfeld said. “The political consensus that once propelled the European project is fraying.” In the United States, similarly, “a backlash against cross-border economic integration threatens to halt or even reverse the postwar trend of ever more open trade.” He didn’t mention the possibility of President Trump; he didn’t need to.

Much of this reaction, Obstfeld argued, in a diagnosis increasingly shared by other economists, stems from a growing belief that ordinary people in the West are not getting their fair share of their country’s growth: “In many countries, the lack of wage growth and greater inequality have created a widespread consensus that economic growth has been mainly to the benefit of economic elites and mobile capital – that they have benefited disproportionately, leaving too many others behind. Lower growth reinforces this turn towards inward-looking nationalistic attitudes. In brief, lower growth means less room for error.”

Pessimistic as Obstfeld is, he added reassuringly: “We are not presently in a crisis… we [at the IMF] are not in a state of alarm but a state of alert.” His language was not as bleak as how IMF expressed itself in early 2008, when it clearly sensed a global recession coming. But the world’s prime economic institution is clearly worried, seriously worried.

Possibly the IMF feels more free to voice its concerns about other countries than it does about China and India. There, the numbers are bleak enough. Over the seven years from 2014 to 2021, it predicts, real output per head will decline 6 per cent in Brazil, remain flat in Russia and most Middle East oil exporters, and rise only gradually in the United States and most Western countries. Even in 2020, it expects, unemployment would still be 19 per cent in Greece, 16 per cent in Spain, and 9 to 10 per cent in France and Italy.

At first sight, Australia looks in better shape than most, with growth forecast to average 2.75 per cent over the seven years. But that mostly reflects high population growth. GDP per head is forecast to grow by a mediocre 1.1 per cent a year.

On the IMF’s forecasts, this year, for the first time, Australia will produce less than 1 per cent of the world’s output. By 2021, we might well drop out of the twenty largest economies (as measured by the volume of output, rather than its price). Within a decade or so, that seems bound to happen, as highly populated countries such as Nigeria, Thailand, Pakistan, Bangladesh and Vietnam achieve rapid rates of “catch-up” growth. Our place in the G20 will be hard to justify by 2030.

As the IMF sees it, four countries will generate most of the world’s growth: China, India, the United States and Indonesia. But the Americans are now only a distant third, expected to generate less than 10 per cent of global growth in the years ahead. Japan would generate barely half a per cent, Brazil would go backwards, and Russia would take until 2021 to get back to where it was in 2014.

The fifth- and sixth-biggest sources of global growth are expected to be Mexico and Turkey. The IMF’s forecasts count on a lot of midsize developing economies, along with China and India, to do more than their share to pull the world along. Bangladesh, Egypt, Iran, Malaysia, Pakistan and the Philippines are each expected to generate at least 1 per cent of global growth, with Vietnam, Nigeria, Poland and Thailand not far behind. With the West still winded by the global financial crisis, developing countries would generate more than 75 per cent of the world’s growth.  

What is to be done?

The good news, as the IMF sees it, is that there are things the West can do to lift its game. It rolls out its familiar litany of advice. Stop relying solely on monetary policy. Rather, adopt a three-pronged approach to try to stoke the economic fire, using structural reforms and selective fiscal (budgetary) stimulus as well as low interest rates.

The structural reforms it wants to see are partly those that would open up new areas to competition (where it sees Australia and New Zealand as exemplars for other Western countries) and those directed at helping get more people into jobs – which would also involve its second prong, a fiscal stimulus.

It suggests four priority areas where governments should loosen their budgets to try to lift growth and jobs:

  • Reduce taxes on work, such as payroll tax and tax on income derived from working.
  • Put more resources into helping people find jobs.
  • Increase investment in infrastructure projects.
  • Increase innovation by lifting R&D activity, particularly by increasing support for new firms, and for employment of researchers.

The problem is that we’ve heard this song before. The IMF has been advising its members for several years to focus on structural reforms and relax fiscal stringency to increase infrastructure investment and innovation. It made similar suggestions in its report on Australia last year, which was ignored by federal and state governments. Other governments keep ignoring it, too. Why?

Put simply, the economic priorities clash with the political priorities – and when that happens, the political priorities win.

Take one example: the steep decline in government investment in infrastructure since 2012. For most of that time, with rising urgency, the IMF and economists in Australia have been urging state governments to borrow and build. Our population is growing very rapidly, our infrastructure is increasingly unable to cope, our governments have very low debt levels, and the economy needs serious insurance against the risk that the collapse in mining investment could flatten economic growth. Assuming you choose the right projects, the economic arguments to borrow and build are very strong.

But the economic arguments run into political brick walls. Borrowing more means increasing debt, and – if you are a Labor government – that means you are labelled as reckless and spendthrift. Look at what happened to Anna Bligh when her government sensibly stepped up infrastructure spending in the wake of Queensland’s massive population growth in the ’00s. The ratings agencies – which seem unable to distinguish investment from consumption – stripped the state of its AAA credit rating. The Liberals and Nationals then screamed out that Labor was unfit to govern the economy. Premier Bligh panicked and committed to selling off government enterprises the electorate wanted kept in public hands. And Labor was swept from office.

While the IMF and others have urged more spending on infrastructure, our governments have kept cutting spending. Australian governments’ investment in transport infrastructure peaked in 2012 at $18 billion. By last year, it had shrunk to just $13.65 billion, down by 24 per cent, or almost a quarter. Queensland accounted for much of that fall; the Newman government slashed investment in transport infrastructure by 40 per cent. Victoria, under its one-term Coalition government, cut transport investment by 26 per cent. In New South Wales, the O’Farrell and Baird governments reduced the state’s investment by 17 per cent.

In Queensland and New South Wales, that investment is still falling. In Victoria, it crept back marginally in 2015, but from a very low base. Measured as a share of total spending in the state economy, Victoria’s infrastructure effort for decades has been by far the weakest of the three main states. In the past decade it averaged just 0.66 per cent of state final demand, roughly half the 1.25 per cent in New South Wales and 1.37 per cent in Queensland. At a time when Melbourne’s population has grown by a third in fifteen years, this is a ludicrous set of priorities.

Victorian treasurer Tim Pallas recently floated a compromise policy that would no longer try to reduce debt, but instead would permit it to rise towards the maximum level allowed within the AAA credit rating. It is a step in the right direction, but if population growth continues at this pace, Victoria will soon find itself at that maximum level, confronting the same barriers again.

The states in general are trying a mix of measures to buy themselves some fiscal space to increase future infrastructure spending without jeopardising their credit ratings. In Sydney, the NSW government has agreed to a privately run, publicly subsidised train line that won’t connect to the rest of the system. This spares it the capital cost of building a new line that does connect to the system, but – since banks know that companies are a bigger credit risk than governments – it means higher borrowing costs, which will ultimately be paid by NSW taxpayers.

Spurred on by former treasurer Joe Hockey’s offer of big subsidies to encourage them to privatise government enterprises, the states and territories have been flooding the market with electricity companies, ports, betting agencies and so on, and plan to use the proceeds to build some overdue infrastructure. But that can last only while they still have enterprises to sell. Victoria has hardly any left that are not core government businesses.

Australia might be close to having the highest ratio of household debt to household income in the world, but another IMF report released this week, its Fiscal Monitor, shows that Australia’s governments are in the unusual position of having low debt combined with high deficits.

Only six other Western countries – five of them in or around Scandinavia – have a lower ratio of net debt to GDP. Yet take out interest bills, and only five were running bigger deficits as a share of GDP. Adjust for the business cycle as well, as the IMF does, and only two have bigger deficits (excluding interest bills). Federal governments of both sides have failed to take enough hard decisions to get us back in the black.

The IMF warns that governments might not have as much time as they think to get their fiscal house in order. Its fiscal affairs director, Vitor Gaspar, told a press conference at his report’s launch, “Overall, risks have materialised; prospects have been marked down; and downside risks are now more pronounced than before.” The report urged policy-makers to prepare for the danger of bad times ahead by building “fiscal resilience” now. It proposes broadening the tax base, “scaling back or ending ineffective tax incentives,” “cutting poorly targeted and wasteful spending,” and improving efficiency in the delivery of government services.

The IMF’s pessimistic chief economist issued a similar warning. While urging policy-makers to make reforms that will increase growth, Maurice Obstfeld added a second priority. “Policy-makers should not ignore the need to prepare for possible adverse outcomes,” he told journalists. “They should identify mutually reinforcing fiscal and structural policies to deploy collectively in the future in case downside risks do materialise.”

You get the sense he thinks there is quite a chance that they will. •

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And another thing: Malcolm Turnbull addresses cabinet in Perth yesterday. Richard Wainwright/AAP Image

And another thing: Malcolm Turnbull addresses cabinet in Perth yesterday. Richard Wainwright/AAP Image