Divergence of fortunes in recoveries

Prakash Loungani, M Ayhan Kose, Marco E Terrones, 24 April 2012

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The last global recession was the deepest of the four recessions the world has experienced since World War II. Each recession led to fears of economic apocalypse but the global economy recovered in a year or two. Because of the depth of the last recession, some analysts worried that the world would relive the Great Depression of the 1930s. Luckily, and through significant policy actions, the global economy has been on a path of recovery over the past three years, but still suffering from the legacies of the crisis.

There has recently been an extensive discussion about the strength of ongoing recoveries (see Foda and Prasad (2012); . How different is the current recovery from past ones? How do prospects differ between advanced and emerging economies?

How different? How Similar?

The ongoing global recovery has been quite similar to the other previous ones, despite the fact that the 2009 global recession was the most severe one. In fact, if the 2012 IMF growth projections of world per capita real GDP are realised, recovery from the Great Recession will have been slightly faster than after the previous global recessions.

The path of global recovery, however, masks a very critical difference between advanced economies and emerging market economies (Figure 1).

  • The recovery in advanced economies has been on the path to become the weakest one compared to past recoveries. Per capita real GDP in several of these economies has not yet rebounded to its pre-recession level and is not forecasted to do so even by 2014. The weakness in output growth is reflected, on the spending side, in both consumption and investment.
  • In contrast, the recovery in the emerging market economies has been the strongest to date. Per capita output growth in these economies has already out-paced the growth seen during previous global recoveries, and is projected to continue to do so in coming years as well. Notable exceptions are the emerging European economies, which are on a recovery track similar to that in the advanced economies.

Figure 1. Dynamics of Global Recoveries: Selected Variables

(Years on x-axis; t=0 in the year of the trough; indexed to 100 at the trough; in real terms unless noted otherwise)

Source: IMF staff estimates.
Notes: Aggregates for GDP are purchasing-power-parity-weighted per capita real GDP indices. Aggregates for total trade are trade-weighted real trade indices. Aggregates for unemployment rate are labor-force-weighted unemployment rates in percent.

There are many reasons why the advanced and emerging market economies are performing differently in the ongoing global recovery. First, the advanced economies experienced significant financial imbalances in the run-up to the crisis. Not surprisingly, when the crisis hit these economies, the damage was significant and the recovery ended up being weak and protracted. In contrast, the emerging markets—which had better macroeconomic fundamentals prior to the crisis—were mostly affected by the spillover effects from the advanced economies. Second, while advanced countries had limited policy buffer to stimulate their economies during the recovery, the growth in emerging market economies has been driven by buoyant domestic demand, vibrant asset markets, strong capital inflows, and expansionary policies.

Advanced economies: Reliving the early 1990s?

Despite the fact that the Great Recession was more severe than the 1991 global recession, there are many similarities between both recoveries in the advanced economies, especially those in the Eurozone (Figure 2).

  • Both recoveries were preceded by recessions associated with a bust in credit and housing markets in key advanced economies. In 1991, there were busts in credit and asset markets in the US, UK, and Japan. The recent recession was associated with severe problems in credit and housing markets in the US and a number of other advanced economies, including Ireland, Spain, and the UK.
  • Both recoveries were slowed down partly by challenges in Europe. The earlier recovery episode was shaped by downturns in many European economies during the European Exchange-Rate-Mechanism crisis of 1992–93. Interest rates had to be raised during that period in order to defend the exchange rate arrangement, and several advanced European economies were forced to reduce their large fiscal deficits. This suppressed economic activity and further depressed credit and housing markets in the region. Currently, high sovereign risk premiums are inflicting similar or even worse damage to fiscal deficits and economic activity. The recent problems are result of a confluence of factors, including deficiencies in the structure of the Eurozone, unsustainable policies, and mispriced debt. In both cases, the lack of a timely, credible, and coordinated policy strategy heightened financial turmoil.

Figure 2. Global recoveries: Advanced and Eurozone countries

Source: IMF staff estimates
Notes: Each bar represents the percent change in the respective variable in the years of the global recessions and recoveries. Growth rates of all variables are per capita and weighted for purchasing power parity. Investment in structures includes both residential investment and other buildings and structures. Figures for 2012 (global recession year 2009) are forecasts.

  • In both recoveries, there has been disappointing growth in domestic consumption and investment driven by the legacy of the financial crisis. Both episodes are also marked by persistently high unemployment and lack of competitiveness in some economies. However, considering the deep fall in output in 2009, the rise in unemployment has been more limited. This is particularly true in Europe and may well reflect policies involving more job-friendly wage setting and greater labour hoarding.

Divergence of fortunes

Although the strong rebound in world output during this global recovery is comparable with previous episodes, the divergence of advanced and emerging market economies’ fortunes sets the current recovery apart. Emerging market economies have rebounded strongly and have been the engine of world growth during this recovery. The robust performance of these economies can be explained in part by their strong macroeconomic frameworks and structural reforms.

In contrast, for advanced economies, the current recovery is predicted to be the weakest of the post-war era. The trajectory of the ongoing recovery in advanced economies has so far paralleled the recovery following the 1991 recession to a surprising degree. Both of these recoveries were hampered by housing and financial market problems in these economies. And both recoveries were slowed down partly by challenges in Europe. These problems are likely to continue sapping the strength of the recovery unless policymakers adopt stronger policies to address them.

Authors' Note: A more detailed anaylsis of global recoveries is available here. The views expressed in this article are those of the author(s) and do not necessarily represent those of the IMF or IMF policy.

References

Claessens, Stijn, M. Ayhan Kose, and Marco E. Terrones (2012), “How Do Business and Financial Cycles Interact?” Journal of International Economics, forthcoming.

Foda, Karim and Eswar Prasad (2012), “A fragile and fickle recovery”, VoxEU.org, 23 April.

Kose, M. Ayhan, Prakash Loungani and Marco E. Terrones (2009), “Out of the Ballpark,” Finance & Development, 25-28.

Kose, M. Ayhan, Prakash Loungani and Marco E. Terrones (2012), “The Global Recovery: Where Do We Stand?” IMF World Economic Outlook, April.

Topics: Global economy
Tags: emerging markets, eurozone, recovery

M Ayhan Kose

Assistant to the Director in the IMF Research Department

Senior resource manager and advisor in the IMF's Research Department

Marco E Terrones

Deputy Division Chief, Research Department, IMF