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World Bank Chief Economist: Global Economic Crisis Likely to Last Two More Years

By Ideas Lab Staff May 6, 2013

At a Brookings event this week, the World Bank's chief economist called for global fiscal coordination to tackle the world's economic challenges.

Current policies weren’t solving global economic problems, argued Kaushik Basu, senior vice president and chief economist at the World Bank, only mitigating immediate pain. He said the global economic crisis will “likely last two more years”.

Basu was speaking at the Ninth annual Sakıp Sabancı Lecture held by the Brookings Institution this week, where he also argued for more fiscal coordination among countries as necessary to address both immediate economic challenges and the ongoing globalized nature of the world’s economy.

Basu said that even as economies are more interconnected and dependent on one another, policy making remains fragmented. The danger of this, he said, is that what occurs in one country, and the policy interventions that country makes, has repercussions across the globe.

The liquidity that is being injected into banks will have to be paid back, and there is no sign that these funds are being invested in a way that will make paying the money back easy, he said. 

Large global economies, whether they are developed or developing, should better coordinate with each other, Basu said.  The global nature of the world economy is challenging the one country, one economy, one central bank model. Globalization has created a free flow of goods, capital, and labor, so while the global economy is united, there is no global central bank. He then equated globalization to gravity, stating that it is not something “planned, good or bad.” Rather, it is “a part of life that we must live with.”

Basu acknowledged that a single, global central bank is unlikely and not the answer—events in Europe over the past several years have made people less likely to support monetary unions. He also noted that capital flows to treasuries in countries that are seen to have strong central banks—investors see safety in government bonds that have a central bank backing them. This is why bonds for European countries are less desirable than American bonds.

Therefore, Basu argued that large economies (developed and developing) should “cluster together”, with their central banks coordinating with each other, especially at times when injections of liquidity are necessary.  This type of coordination will retain the sovereignty of each central bank, but account for the globalized nature of the economic stage. One thing banks can do together is develop a roadmap at times when liquidity injections are necessary.  Developing a coordinated roadmap would help reduce uncertainty and mitigate swings in exchange rates.

At the same time, addressing the issue of labor is vital, Basu said. The total wage bill as a share of global GDP has been shrinking. Labor is becoming a smaller part of the GDP pie and as demand for labor goes down, industrialized economies, where wage rates are highest, will feel the pressure first. We are seeing this play out in Europe and the U.S., where unemployment rates have been high for several years. In the U.S., this problem is especially pronounced because 40 percent of the unemployed are long-term unemployed.

In industrialized countries, when liquidity is injected, interest rates decline. With low capital costs in place, labor costs becomes relatively more expensive. One way to correct for this asymmetry during times of liquidity injections is to create temporary subsidies for hiring (six months to one year). If this can be implemented around the world, global unemployment rates will decline and demand for goods will rise.