What can we see in the world economy in 2012? Risks galore, is the answer.
The debt crisis of the high-income countries is already four and a half years old. Yet it shows no sign of abating, particularly in the euro zone. While emerging and developing countries are in reasonably robust condition, they would be vulnerable to an intensification of the crisis, which could hit them via several channels: trade, finance and remittances. Many countries -- both high-income and developing -- are in a weaker condition than they were in 2008 and would, accordingly, find it harder to respond effectively.
The January, 2012, consensus of forecasts for this year is lower than it was in January, 2011, for all the world's significant economies, including even fast-growing China and India. The cuts for euro zone countries are dramatic: euro zone growth is now forecast at -0.3 per cent this year, against 1.6 per cent a year earlier; German growth is forecast at 0.5 per cent, down from 1.8 per cent; French growth is forecast at zero, down from 1.7 per cent; and Italian growth is forecast at -1.3 per cent, down from 1.1 per cent.
Anybody who imagines fiscal outcomes will improve against such a grim background is living in a fantasy world. Improvements in structural deficits will be largely -- if not entirely -- offset by deterioration in the cyclical balances.
Among high-income countries, the bad news is not restricted to Europe. But it is much worst there. U.S. growth in 2012 is now forecast at 2.2 per cent, a small improvement on the October consensus of 1.9 per cent, but still well below last January's 3.3 per cent. Japan's forecast has fallen least, from 2 per cent to 1.9 per cent, though that is largely because of the recovery from the impact of the tsunami.
The U.S. and Japan have their own vulnerabilities, both economic and political. Huge U.S. structural fiscal deficits and the extreme partisanship in Washington are causes for concern. But the euro zone is the epicentre of current fragility, because of the inability of its members to halt and reverse the dire interaction between financial and fiscal turmoil in a rapidly growing number of vulnerable countries.
What makes this stage of the long-running debt crises even more difficult to manage is that sovereign creditworthiness has deteriorated substantially. The more vulnerable sovereigns -- including those of Italy and Spain -- could not easily rescue their banks, should they need to do so. Even in countries whose sovereign borrowing costs remain low, such as the U.S., U.K. and Germany, it is not clear that governments would be willing -- or be permitted by domestic politics -- to intervene as aggressively, in support of their financial systems, as in 2008.
These vulnerabilities bring substantial downside risks. As the World Bank's latest Global Economic Prospects argues: "While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains. In particular, the willingness of financial markets to finance the deficits and maturing debt of high-income countries cannot be assured. Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out."
In sum, the world is certain to live for years with the consequences of the private and public debt accumulations in the high-income countries in the years up to 2007, which were themselves in part the result of the huge global macroeconomic imbalances of that era. But the economic, financial and political defects of the euro zone have hugely exacerbated the fragility. The members of the euro zone are unable either to dissolve their union or eliminate its structural frailties.
What does this actual and potential turmoil in high-income countries mean for the world economy as a whole? In response the Institute for International Finance argues in its most recent Capital Markets Monitor that "the key question for 2012 is whether the resilient parts of the global economic and financial system -- the emerging market economies and the non-financial corporate sectors -- are robust enough to cushion the potential impact of high credit risk in the mature economies".
In its latest Global Economic Prospects, the World Bank forecasts a slowdown in world trade, with the volume of growth forecast at 4.7 per cent, down from 6.6 per cent last year. It forecasts a decline in net private capital flows to developing countries, from $1,055.5-billion in 2010 and an estimate of $954.4-billion in 2011 to $807-billion this year. It has also downgraded the forecast for economic growth in developing countries to 5.4 per cent, from 6.2 per cent forecast in June 2011.
On the face of it, none of this looks too serious. Over all, that judgment is probably right. But we can identify at least two important qualifications to such comforting optimism.
First, averages conceal as much as they reveal. Even such a deterioration in external conditions would pose a substantial problem for many developing countries. Many countries have large current account deficits. Many also have substantially worse fiscal positions than in 2008. All such countries are vulnerable to even modest interruptions in the flow of global finance and the buoyancy of receipts from exports and remittances. Some of these vulnerable countries are important: Turkey, with a forecast current account deficit of around 10 per cent of gross domestic product this year, is a good example.
Second, the shocks in high-income countries might be far bigger than those in the baseline scenarios. At worst, these shocks could be as big as they were in 2008. A collapse in commodity prices, to take an example, would devastate the finances of many emerging and developing countries. Yet there is likely to be a far smaller capacity to combat such shocks in both the high-income and the emerging and developing countries than at that time.
In sum, as the World Bank argues, "developing countries need to prepare for the worst". Unfortunately, that is precisely what the non-financial corporate sector and solvent households of the high-income countries have now been doing for some years. The result has been private sector austerity in these countries and so what might best be described as a "contained depression". But containing that depression has depended on support from huge fiscal deficits and highly expansionary monetary policies. This is going to remain true in 2012.
If governments cannot - or will not - persist with providing such support, a true depression remains possible. Everybody would then be affected, including the most vigorous emerging economies. These remain difficult times: 2012 will not be the end of them.