China has taken over the rotating presidency of the G20 – for the current year – at a time when the global economy is still characterized by strong dissatisfaction, weak and fragile global growth, and the feeling that the solutions deployed so far are not working. This sense of dissatisfaction is now feeding populist and protectionist sentiment that, if translated into policies, could have a very harmful impact on growth, exacerbating the problems they aspire to fix. This is a particularly perilous juncture and the need for smart global leadership is the strongest it has been since the global financial crisis.
The attitude of G20 policymakers remains widely irrational: they insist on doing what they know no longer works, and can’t bring themselves to do what they know would work. There is a growing consensus that the more creative monetary policy gets, the less effective it is. Quantitative easing has run into diminishing returns and there are serious concerns about the possible side effects of negative interest rates. In other words, there is a growing recognition that further rounds of unorthodox monetary expansion in advanced economies do little good, and could do quite a bit of harm.
This was openly discussed as the 2016 G20 kicked off in Shanghai in February. Having accepted that monetary policy is no longer boosting growth, the G20 committed to “…use fiscal policy flexibly to strengthen growth, job creation and confidence.” A sensible proposition, but an unconvincing one as well. There is no doubt that “flexible” fiscal policy should be part of the answer. In advanced economies where yields on government bonds are extremely low, governments should issue long-term bonds to finance infrastructure projects that can boost long-term growth. The priorities will differ from country to country, but there is no shortage of needs or opportunities, whether in transportation, digital networks, power generation and distribution or healthcare. Even in countries with a relatively high debt burden, financial markets would probably take a charitable view of such high-quality deficit spending.
The G20’s promise is unconvincing because governments already know what measures would work, and no one is stopping them from putting them in place – yet there is no action. A spending boost targeted to infrastructure should be complemented by structural reforms. Here again the priorities would differ across countries, but would include labor market reforms, simpler and better regulations, straightforward tax systems, the liberalization of selected goods and services markets, and a revamping of education systems. This is a much safer path than further monetary easing and such priorities can be enacted at the national level, with no need for global coordination. However, to see policymakers promise action again, as was the case at the G20, rather than taking action at home, is not reassuring.
Policymakers also have a conflicted attitude towards financial markets. The initial response to the Great Recession leveraged financial markets in an effective way, especially in the US, where the Fed’s policy aimed to raise asset prices to boost confidence and consumer spending. In the process, financial markets have become dangerously dependent on monetary policy. This dependence now needs to be phased out so that monetary policy can normalize. The collapse in commodity prices has complicated the process by fueling deflation fears – though the recent recovery in the US consumer price index and personal consumption expenditure suggests this problem might be coming to an end, at least in this key country. Policymakers also made things harder by constantly emphasizing the downside risks to global growth, undermining confidence. Financial markets keep looking for reassurance, and in the absence of other actions, this reassurance boils down to central banks committing to more stimulus.
This has created a very unhealthy codependence between financial markets and central banks. Asset prices have become overly dependent on monetary policy; and monetary policy has become overly dependent on financial market reactions: a stock market correction is often all it takes to put any plans for normalization of monetary policy on hold.
China takes a more pragmatic approach, and its G20 presidency has already served one very useful purpose: it has focused attention on the fact that Beijing takes its global role seriously. China used the Shanghai summit in February to send two clear messages. The first is that we should not expect a major renminbi depreciation. The leaders of the People’s Bank of China reiterated that there is no fundamental basis for a sharp weakening of China’s currency, given also that the country still runs a current account surplus. As the G20 host country, China emphasized that it is well aware that its domestic economic policy actions have a global impact.Beijing is determined to show that it is a responsible global player, as it has a lot at stake. And indeed, it has alleviated concerns that had become a major source of volatility in foreign exchange markets.
The second message is that China will use monetary and fiscal policy in a flexible way to support growth while maintaining stability. Beijing’s policy steps should be read as part of this difficult balancing act – nothing more and nothing less. While avoiding a sharp competitive depreciation, China is providing more domestic credit and pushing forward its “One Belt, One Road” program of infrastructure spending to support growth. It is trying to strike the right balance: prevent an excessive slowdown in growth while maintaining efforts to rebalance the economy towards consumption and reduce outstanding imbalances in investment and construction.
Indeed, China’s growth is stabilizing as the economy is responding to the stimulus measures. The most recent purchasing managers index readings indicate a recovery, in both manufacturing and in services. China’s growth will remain a source of anxiety for quite a while.as a substantial level of overcapacity in heavy industry still needs to be reabsorbed, and reform of state-owned enterprises requires further reductions in capacity. Policymakers have signaled that they intend to provide only a moderate dose of fiscal support, in line with their “flexible but prudent” approach. This will not turbo-charge growth. Even if policymakers wanted to launch a more decisive spending boost, they might find it harder than in the past: local governments would be held back by the sobering effect of the anti-corruption campaign and by recent reforms in their financing mechanisms. Private consumption and services are sufficiently robust to keep GDP growth at about 6%. Policymakers are doing the right thing, supporting growth just enough to safeguard employment while keeping reforms on track – but this means China’s growth will remain a source of trepidation.
Yet, the global economy would be better served if other G20 members took a page from China’s playbook, and were more willing to address the structural issues that are holding back economic activity. To accelerate growth, there need to be a refocus on the fundamentals: better infrastructure, a better business environment, prudent and sustainable fiscal policies can lay the basis for stronger growth performance at the national level. Flexible markets and smart, harmonized regulations can support innovation, at a time when digital technologies are finally beginning to impact industry, with changes that can boost productivity growth. G20 leaders, as well as other international policymakers, also have a responsibility to preserve the openness that has served the global economy well in the last few decades.
In the last 20 years, the global poverty rate has been cut in half, lifting one billion people out of misery; the global economy has tripled in size; global income inequality has been reduced for the first time since the industrial revolution – though it has increased within several countries. These are enormous achievements. However, more can and must be done, creating the conditions for stronger sustainable growth while improving access to opportunities. Doing it in the current political environment, where populism and protectionism are on the rise, is not easy. The G20 should step up to the challenge.
*The latest issue of Aspenia, “Cina, la grande scelta”, is available in the best newsstands and bookstores