Sustainable improvement possible when real economy also improves

CONFIDENCE in a prolonged turnaround will come only when a recovery in financial markets converges with a similar rebound in the real economy.

That was the cautious message given during a visit to Singapore yesterday by World Bank chief economist Justin Lin.

He was speaking amid conflicting portents for the global economy – talk of green shoots but also pessimistic signals threatening to delay or derail recovery.

Professor Lin told reporters: “Sustainable recovery requires a recovery in the financial markets and improvement in the real economy, like an increase in utilisation capacity and a reduction in unemployment.” Utilisation capacity refers to whether, for instance, factories are operating at their full potential or less.

“If both move in the same positive direction, then we can have confidence about a sustainable recovery.”

The 57-year-old is the World Bank’s first chief economist from a developing country. The Taiwanese-born economist crossed over to mainland China in 1979 by swimming 2km over to Fujian province while serving as an army officer.

He was here to speak at the Eminent Speakers Series 2009, which is supported by the Singapore Press Holdings Foundation and jointly organised by Lianhe Zaobao and Business China.

Earlier this week, the World Bank warned that prospects for the global economy remained “unusually uncertain” and cut this year’s growth forecasts for most economies.

It also recently downgraded its forecast for the world economy to a contraction of 2.9 per cent from a projection of a 1.7 per cent decline set in March.

Yesterday, Professor Lin said the “under-utilisation of capacity” was a key hurdle to sustained recovery. If not addressed, it could result in more shocks and downturns, he warned.

The University of Chicago-trained economist said: “If you have excess capacity, more assets may turn toxic, more loans may turn into non-performing loans and you may need to have more rescue for financial institutions.”

One key example is the capacity utilisation rate in the manufacturing sector. In the US, this figure hit a record low earlier this year.

Economists also caution that if excess capacity persists, it could lead to deflation – an outright decline in prices.

Prof Lin said a fiscal stimulus will be one key method of tackling this issue. However, this will require going beyond having “shovel-ready” projects which are immediately ready for construction.

Instead, governments should focus on investments which will release bottlenecks in their economies. He said they can also adopt cross-border stimulus from developed countries to developing nations to generate sufficient demand to get out of the “excess capacity trap”.

“If my proposal for cross-border stimulus can be accepted, Singapore can provide very good intellectual input about how to implement this.”

He also noted that Temasek Holdings and the Government of Singapore Investment Corp have already engaged in cross-border investments “for a long period”.

However, others at the talk said such moves could hit political resistance.

Prof Lin said recovery requires a coordinated global effort. China alone cannot lead the rally as it constitutes only about 7 to 8 per cent of the overall world economy, he noted.

“You cannot use a small horse to pull a heavy, big cart,” he added.

He praised Singapore for having a “remarkable” economy with “sound” macroeconomic fundamentals, an “effective” Government and a “very agile” business community quick to respond to a new environment.

He added: “Whether Singapore can fully recover depends on the global economic situation.”

On the H1N1 flu outbreak, he said: “Asia already has a lot of experience in controlling the flu, due to avian flu and Sars. Thus, the governments and society can react in a much more effective way. There’s a hope that we can control the possible damage, making the economic impact even smaller than (that caused by) avian flu.”

Courtesy of The Straits Times, 26 June, 2009

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