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joyless recovery

Joyless Recovery Ahead

Glen Hodgson, Senior Vice-President and Chief Economist, Forecasting and Analysis
July 20, 2009

The economic recovery is now in sight, so let’s consider how the world economy will be different coming out of this recession. There is reason to believe that we are entering a new, more challenging period, with slower global economic growth and less buoyant times over the medium term—a joyless recovery.

A weak forecast for growth in U.S. consumption is the principal reason for this tepid outlook.

Economic growth will resume in the second half of 2009, but the recovery will be slow. The U.S. economy is expected to grow by just 1.8 per cent next year; Canada’s economy, which is better positioned for recovery, is forecast to expand by 2.7 per cent in 2010. These rates of growth are much weaker than the typical post-recession rebound, and the effects of the downturn will linger well beyond the short term.

U.S. Consumers Put Wallets Away

A weak forecast for growth in U.S. consumption is the principal reason for this tepid outlook. The American consumer represents about 15 per cent of the world economy and is the single most important driver of global growth. Until last year, the average American was spending every cent (or more) of every paycheque, relying on easy credit and the rising value of his or her house and other assets. That spending spree has come to a crashing halt. Americans now have to save more, pay the bills, and hope that the value of their assets will finally hit a floor and begin to rebound. All of this is called “de-leveraging,” and it’s likely going to take years for robust U.S. consumption growth to return. At some point, a higher savings rate should translate into stronger self-financed investment that adds to America’s growth potential, but not in the foreseeable future.

Asian Consumers Not Expected to Pick Up Slack

If Americans aren’t going to spend in the coming years as they did in the recent past, the world economy will need a new driver of global consumption growth. Consumers in the Asia-Pacific region, specifically in China, are the obvious candidates to take up the slack. But savings behaviour is deeply rooted in most Asian cultures, and it takes time to change deep historical patterns. Moreover, the absence of a wide social safety net in the form of retirement plans, unemployment benefits, and other social welfare programs reinforces this deep savings behaviour, as does the one-child policy in China that reduces potential family support. Asian economic growth will stay strong—with rising real incomes and consumption, and a growing middle class—but we do not expect Asian consumers to offset fully the slowdown in U.S. consumption growth any time soon.

Paying the Bill for Stimulus

There will be an important fiscal dimension to the joyless recovery. Short-term fiscal stimulus is critical to the global economic recovery and is just now beginning to kick in. Fiscal stimulus, combined with record-low interest rates, will feed the recovery and will boost output growth in 2010 and 2011. But as growth is restored, governments will have to face the hard reality that fiscal stimulus comes at a price: large deficits and mounting government debt.

To bring government debt loads under control, fiscal stimulus will need to be withdrawn from economies around the globe, ideally beginning in 2011 or 2012. Fiscal consolidation will demand much slower growth in government spending, eventual increases in taxes, or both, which will serve to slow economic growth. And if countries aren’t prepared to bite the bullet in terms of fiscal retrenchment, growing government debt burdens will place upward pressure on long-term interest rates. Higher interest rates, of course, would also act as a brake on medium-term growth.

As growth is restored, governments will have to face the hard reality that fiscal stimulus comes at a price.

Still other factors will be a drag on global growth. Financial markets are now healing, but financial regulations are going to be tightened in many countries, which will constrain financial innovation and credit expansion. Rising energy prices are already translating into higher prices at the pump, which will absorb a larger share of the consumer’s wallet. Increased trade protectionism may also hinder growth, and aging populations have already reduced the pace of labour force growth in many industrialized countries, slowly pulling down long-term growth potential.

Potential Growth Reduced

Taken together, these factors will take the fun out of the recovery and reduce global potential growth over the medium term, perhaps by 0.5 per cent annually.

What could offset these negative factors and pull us out of the new age of pessimism? Faster productivity growth, sparked by widespread innovation, is the answer. Innovation is the spark that could drive the global economy into stronger performance. Unfortunately, there is no silver bullet that will boost innovation or generate faster productivity growth. Innovation starts with a new commitment within organizations and governments to doing things differently.

Glen Hodgson Glen Hodgson
Senior Vice-President and Chief Economist
Forecasting and Analysis
613-526-3090 ext. 444

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