‘Targeting stimulus, not exit, is the key’

05/10/2009 | Phil Thornton

Wealthy countries should focus on second wave of projects – World Bank economist

The world economy has so much spare capacity that wealthy countries should concentrate on targeting the next wave of stimulus projects, rather than worrying about when to start exiting from intervention programmes, the World Bank’s chief economist of the told Emerging Markets yesterday.

Justin Lin said governments should focus on “win-win” investment in areas that had been ignored before the crisis, such as tackling climate change and building infrastructure in small less-developed countries.

He said stimulus measures put in place this year by Europe, the US and emerging economies such as China had prevented a repeat of the Great Depression of the 1930s and stabilized the financial sector.

But, he added, “the global recovery is fragile because of the main issues that I see excess capacity in the real sectors”. He said the two driving factors behind the recovery – fiscal stimulus and restocking by manufacturers and retailers – were both temporary.

“They will disappear, but the large excess capacity will still be there and we will still be underutilizing capacity,” he said. “Because of that, the incentives for the private sector to make investment are very low, and to boost demand it is very important to prevent the economy being trapped in a depression or long and deep recession.

“At this stage it is more important to talk about the quality of the stimulus than being concerned about when to exit, because whether it will be inflationary in the future depends on how you use the money.

“If the money is used for the purpose of investment it will enhance the gross potential. Then the costs can be recovered in the future through higher growth.”

He urged high income countries to focus on areas that needed investment, but which “for some reason” governments did not spend money on earlier on. “Everyone knows that climate change and the green economy is an area you need to make investment in. A country can make investment now which will help the sustainability of the economy.”

Lin said investments that might seem insignificant in large, developed economies – in infrastructure for example – would have a greater impact in small countries.

“[Rich nations] can make investments that in the short run create demand not only for the country lacking investment but for the whole world and can enhance the growth productivity for the future. To help the developing countries at this time is a win-win situation.”

Lin said there was a contrast between emerging economies such as China that had a large pile foreign reserves to cushion against the downturn, and developing economies that were vulnerable to downturn.

“These countries will be in a more depressed situation because their export markets will be still very slow and unlikely to recover soon.” Also, “capital flows to developing countries are reducing significantly, remittances will also drop, and commodity prices are low compared to pre-crisis level”.

Among the 90 developing countries a substantial majority – 59 countries – had an external financing gap, Lin said. “So they are still under pressure and they still require external assistance in order to get over this crisis.”

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