Worries About the World Economy in 2014

By David Dapice

MEDFORD: As the year that saw the world's strongest economy brought to the precipice of a default comes to a close, and many wonder if 2014 promises more stability? Judging by most forecasts, including that of the International Monetary Fund, the global economy may grow about 3.5 percent, but confidence in that forecast is subject to more than usual hedging due to several policy unknowns and uncertainties. As unemployment in the developed world remains steady and growth in the emerging economies dependent on lackluster performance of the industrialized economies, a question mark hangs over economic prospects worldwide.

Start in the United States. The gradual start to tapering by the Federal Reserve - the slowing of massive purchases of mortgages and government bonds to increase liquidity and hold down interest rates - was announced this week and could have worldwide impacts. A suggestion by Federal Reserve Chairman Ben Bernanke in May that a slowdown was imminent caused bond yields to jump and credit flows to several debt-prone emerging economies to reverse. Purchases will now be reduced from $85 billion monthly to $75 billion. While Janet Yellen, nominated as Fed chief, may be more concerned than Bernanke with unemployment, it's unclear what the impact of tapering will be. Demand for investment is slack, caused in part by fiscal restraint and, perhaps, the incentives for CEOs to maximize their stock prices quickly through buybacks rather than through longer-term investments. It will be difficult to slow and end this ongoing policy without creating global financial instability.

In addition to monetary uncertainty, the US fiscal battle to reduce the deficit or implement constructive spending could face partisan gridlock. Yes, Congress approved a two-year budget this month. But government spending is still hamstrung. Congress resists infrastructure investment to repair rusting bridges and approves large corporate farming subsidies while cutting unemployment benefits and food stamps, to list just a few examples. The rocky health-care rollout has thrown a sixth of the US economy into turmoil, and the risk of a default on US debt, while reduced, is not removed. This uncertainty reduces corporate confidence and depresses investment, as low-cost debt and corporate cash flow buy up shares rather than build new factories. Five years after the initial downturn, growth remains subdued, though higher than Europe's, and job creation is stubbornly low. Hopes of stronger export growth are fading due to economic weakness among major trading partners. Government spending will remain weak but because the cuts will be reduced, it will not diminish overall demand so much as in 2013. Most states are no longer cutting budgets, and this will partly offset the federal restraint.

Both the eurozone and Japan are expected to grow about 1 to 1.5percent next year, and both face policy challenges. European banks remain loaded with shaky government and private debt supported by extraordinary measures of the European Central Bank, while Japan must cut back on its expansionary monetary and fiscal policies and implement politically difficult structural reforms in its rapidly aging society. Political turmoil in Europe's Mediterranean economies could cause further problems, but so long as the Germans allow the ECB to continue preventing collapse, slow progress is likely.

China remains a major question mark. Its growth of 7 to 8 percent has been a factor in keeping global demand relatively buoyant and helped raw material exporters in the Americas, Africa and Australia. However, weak banks, growing social expenditures and tapering of excessive investment along with slowing to zero labor force growth should mean somewhat slower growth in the medium term. Most expect 7 percent growth to continue in the next few years, but anti-pollution measures could restrict energy use or increase costs.

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David Dapice is associate professor of economics at Tufts University and the economist of the Vietnam Program at Harvard University's Kennedy School of Government.

Rights: Copyright © 2013 The Whitney and Betty MacMillan Center for International and Area Studies at Yale. Yale Global

(AP Photo)

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