• OECD Cites Risks Amid Strengthening Global Recovery
  • June 3, 2010
  • Law Firm: Alston Bird LLP - Atlanta Office
  • In its twice yearly Economic Outlook (Outlook) published yesterday, the Organization for Economic Cooperation and Development (OECD)  reported that expansion is strengthening across OECD-area nations, and at a faster pace than expected. The report cites strong growth in developing economies and increasing global trade flows in predicting that the OECD’s 31 members will experience aggregate gross domestic product increases of 2.7% this year and 2.8% in 2011. In its last report, issued in November 2009, the OECD forecast members’ aggregate GDP growth at 1.9% this year and 2.5% in 2011.

    The OECD also raised its growth forecasts for the global economy, adjusting GDP increases to 4.6% this year and 4.5% in 2011 after prior growth predictions of 3.7% and 3.4%, respectively. Moreover, the current advance is seen as more self-sustained and less reliant on policy driven issues, leading OECD Chief Economist and Deputy Secretary-General Pier Carlo Padoan in a recent statement to declare “good news” as the predominant theme in the near term.

    Yet, Mr. Padoan also described “serious risks to be dealt with” as the current recovery proceeds. Chief among those concerns is the threat of overheating and inflation developing in emerging markets. The Outlook warns of a “boom-bust scenario” requiring a further tightening in countries such as China and India. The result would be slower growth throughout Asia, creating a dampening effect in other regions.

    While exchange rate flexibility could ease some of the pressure on monetary policy in the major Asian economies and provide a stronger base for addressing domestic inflation, instability in sovereign debt markets could still lead to overwhelming systemic shock. According to William White, Chair of the OECD’s Economic Development and Review Committee, the policies that governments have put in place to stabilize the global economy and restore growth are potentially creating the conditions for another downturn. In a recent article in which he recounted the cause of the crisis that began in 2007, Mr. White argues that damaging debt accumulation and asset price bubbles from excessively easy monetary policies and declining credit standards led to various “imbalances,” including unjustifiably high asset prices, dramatic increases in risk exposure, and uncontrolled spending that led to collapse. Because the crisis has not reduced these imbalances to manageable levels, current national programs to increase welfare spending and provide easier credit can, in the mid-term term, make the problems that caused the current crisis worse.

    Thus, while acknowledging that coordinated international efforts prevented the crisis from becoming more severe, the OECD calls for its member states to balance measures to support the recovery with the need to move to a more secure system. Chiefly, exit from emergency fiscal support should begin immediately. The OECD estimates that for every one percentage point increase in yields on government bonds, economic growth would be reduced by half a percentage point in the current and subsequent year. To avoid such increases in government bond yields, the OECD argues that governments must employ robust strategies to cut borrowing and central banks should start raising their interest rates soon, even though inflatoin risks remain mild. In most major economies, the OECD projects a normalization of interest rates starting at the end of this year.
    To support growth as budgets are being trimmed, the OECD suggests that macroeconomic, financial and structural policies must be synchronized. Spending cuts and tax rises should emphasize areas least harmful to growth. Fiscal rules should support the credibility of plans to bolster public finances. Reforming product and labor markets to enhance competition must also be part of the approach.

    The job market must also be strengthened as the number of unemployed has risen by 16 million in OECD countries in the past two years. The OECD adds that governments must make room in their budgets for cost-effective labor market programs that support workers at greatest risk of becoming long-term unemployed.