At the end of last week the IMF issued a warning that the world is heading for a weaker than predicted period of economic growth:
The International Monetary Fund will reduce its estimate for global growth this year on weakness in investment, jobs and manufacturing in Europe, the U.S., Brazil, India and China, Managing Director Christine Lagarde said.
“The global growth outlook will be somewhat less than we anticipated just three months ago,” Lagarde said in a speech in Tokyo today. “And even that lower projection will depend on the right policy actions being taken.” The new outlook will be announced in 10 days, after an April estimate of 3.5 percent, she said.
It is very difficult to determine exactly what the IMF considers “the right policy action”. The IMF were the main instigators of “expansionary fiscal contraction” in the European periphery which, even by their own admission, has failed. Last year I noted that the new IMF chief made some statements that appeared to set a new direction for the organisation and more recently she has been talking about the need for a “pro-growth” agenda for Europe. While that maybe the case, her organisation is still endorsing programs that deflate economies by lowering industrial production and increasing unemployment and at the same time fail to deliver on promised growth targets. It is therefore unclear, at least to me, exactly what the IMF’s chief is actually endorsing.
Either way, under the current treaties, Europe demands tighter budgets from most of its nations and the next stage of the fiscal compact includes the enshrinement of a ‘debt brake’ into national budgetary legislation. Under these arrangements many European nations have no choice but to slim down their national spending and that is what we continue to see as the new financial year begins.
From Spain we have more cuts:
Spain’s government is putting finishing touches to an up to 30 billion euro ($38 billion) package of spending cuts and tax hikes to help it meet this year’s deficit targets, sources with knowledge of the matter said.
Running over several years, the programme could involve raising Spain’s main consumer tax, a new energy levy, reforms to the pension system, pay cuts for civil servants, new motorway tolls and another drastic reduction in ministry and regional spending, the sources said.
Some measures may be announced next week, when the EU is likely to grant the government an extra year to cut its deficit below 3 percent of output, and others could be presented over the summer and included in a multi-year budget plan due to be prepared in August.
And from Italy:
Italy’s government late Thursday approved €4.5 billion ($5.58 billion) in spending cuts for 2012 aimed at slashing the size of Italy’s bloated public sector and delaying a new tax increase until after the first half of 2013.
The cuts come as Prime Minister Mario Monti fights to shore up Italian finances in line with European Union requests.
“The decree aims to reduce public spending, without hitting services to citizens,” Mr. Monti said at a news conference following a cabinet meeting, which lasted about seven hours. “It allows us to avoid a two percentage points VAT (value-added tax) increase, which should have been enacted in October, and is now delayed until July 2013.”
And although Mr Hollande is doing his best not to mention the ‘A’ word, if it quacks like a duck:
French President Francois Hollande has announced plans to raise taxes on businesses and the richest households by 7.2bn euros (£5.8bn; $9bn). He unveiled plans for a 2.3bn-euro one-off levy on households earning 1.3m euros a year or more.
There will also be a special tax on large banks and oil companies which is forecast to raise 1.1bn euros. Earlier this week, auditors had warned that the new Socialist government needed to raise an extra 10bn euros.
France has promised to reduce the gap between annual government spending and tax receipts to 4.5% this year from 5.2% in 2011.
This may seems like necessary prudent fiscal action, but as we have seen since the beginning of the European debt crisis, fiscal tightening doesn’t necessarily lead to an improving economy. The premise of the “fiscal compact” is that indebted European nations will somehow become export competitive in the same way that Germany did, but this outcome defies economic logic. Much of the reason Germany grew into an trading powerhouse over the last decade was because other European nations took on massive amounts of debt which fed back into German manufacturing. There is simply no way this can be repeated by other nations while the vast majority of their trading partners are all attempting a strategy based on spending cuts. By implementing supra-European fiscal tightening, Europe is setting the stage for years of economic underperformance and that is a serious concern for the rest of the world. Gavyn Davies gave a hint of the dynamic in his weekend post on oil price stabilisers:
The eurozone crisis has reduced the growth rate of the world’s second largest economy from about +2 per cent to about -1 per cent in the past 12-18 months. Using the normal elasticities between eurozone GDP and trade flows, this 3 per cent swing implies that the growth in eurozone imports from the rest of the world is about 10 per cent lower than it otherwise would have been. The consequent direct effect on the GDP growth rate of other regions is around -0.5 per cent. Multiplier effects will make this impact larger, as will financial spill-overs from the reduction in the balance sheets of eurozone banks in the rest of the world.
That is, the contagion that began in Greece and that has now reached the core of Europe is beginning to leak outwards to the rest of the world. In that regard I take the IMF’s warning not just a message to Europe to get its policy response in order, but also a warning the rest of us to prepare for the fact that they won’t.