The financial crisis triggered a broader and deeper crisis of confidence among business, investors and consumers. Central banks intervened with unprecedented measures to ensure liquidity and prevent systemic collapse. In response to the ensuing global recession, governments intervened in many countries with record stimulus packages to boost demand. Though their intervention proved vital, governments now need to avoid becoming the main cause of the next crisis.
Government debt has reached historical levels for peace time in a number of advanced economies. Though necessary at the time, the costs of their interventions, combined with the long-standing burden of pensions and health spending, have left several major economies in a historically weak fiscal position with mounting debt. Collectively, G20 budget deficits now stand at 7.9% of their combined GDP4.
(4 International Monetary Fund, The State of Public Finances Cross-Country Fiscal Monitor: November 2009).
With a few exceptions, the larger advanced economies have been the most affected by fiscal crises. According to the IMF, by 2014, the average debt-to-GDP ratio of advanced economies that are members of the G20 is expected to climb from the 2007 pre-crisis level of 78% to 118%. In sharp contrast, emerging economies, with smaller governments and lower exposure to the banking crisis, kept their fiscal houses in order. According to the same IMF analysis, between 2007 and 2014 the average debt-to-GDP ratio of emerging countries that are members of the G20 will never exceed 40%. For once, and in contrast to the 1980s and 1990s, emerging economies are not causal to a global fiscal crisis.
Governments, in the US and the United Kingdom in particular, are now faced with a set of tough choices, all with consequences for future global risks. The most pressing is how to time a gradual and credible withdrawal of fiscal stimulus so that the recovery is sustained but not so late that fiscal deficits cause fears of sovereign debt deterioration and a flight to safety that could drain their economies of capital and confidence. Governments need to develop sound exit strategies and communicate them clearly to reassure investors and taxpayers.
The implications for social systems: a new social contract for the 21st century?
The difficulties posed by the combination of weak fiscal positions and long-term pressures from current social spending trajectories are considerable. A generational approach that also accounts for the fiscal burden facing current and future generations (accounting mainly for social security and government-supported healthcare) reveals huge fiscal gaps. According to one estimate5, the United States alone has to reckon with a gap of US$ 66 trillion, a figure more than five times current GDP and almost double the US national wealth. Similar outsized generational debt-to-GDP ratios are obtained for many other advanced economies.
(5 Laurence J. Kotlikoff, Is the US bankrupt? Federal Reserve Bank of St. Louis Review, July/August 2006).
Intergenerational accounting makes it clear that a business as usual approach to fiscal policy is unsustainable. Advanced economies in particular must face the difficult task of reforming their social security systems. Many current models for health, pensions, education and unemployment protection were designed to meet the needs of populations in growing economies with comparatively short life expectancies. This has changed dramatically. Today, people live longer, and the share of retired people that will have to be supported by the working population in pay-asyou-go social security schemes keeps increasing, placing huge strains on the costs and efficacy of social systems. Although some systems appear to be more effective, in particular those of Scandinavia, none are designed to meet future needs and the fiscal burden they represent was already becoming untenable before the crisis. The costs of social safety nets will have to be better shared among the population and the expectations of people in terms of health and pensions will have to be realigned. This may require politicians to implement unpopular decisions at a time when voters are suffering from the hardship of high unemployment caused by the global recession.
Click here for the full Risks Interconnection Map (RIM) 2010.
Unemployment: the long shadow of the downturn
Unemployment has risen dramatically over the past 18 months, across all sectors. Unemployment among OECD member countries alone has increased by 25.5 million since the start of the crisis and some estimates suggest that globally the increase could total over 50 million in 2010. Jobs are not created as quickly as they are lost and any protracted period of high unemployment will have adverse effect on consumption. Moreover, OECD studies show that a 1% increase in unemployment increases public debt by up to 3% of GDP over 10 years.
Though the rise may have been sharper in advanced economies, it should not be forgotten that unemployment is a global problem and that, even before the global recession, unemployment rates in North Africa, the Middle East and sub-Saharan Africa stood at 10.3%, 9.4% and 7.9% respectively in 2008 according to figures from the International Labour Organization (ILO). Even in India, with a healthy growth rate, the official unemployment rate stood at 7.2% in 2008. Population growth and the economic climate could push the numbers of poor to above the 1.4 billion estimated by the World Bank (World Development Indicators 2009). Poverty is concentrated in sub-Saharan Africa and South Asia, which are regions most prone to the effects of climate change, natural catastrophes and global health issues. This leaves almost one-quarter of the world's population in a highly vulnerable position.
A cyclical response and structural shift
The sudden rise in jobless figures seen in developed economies in 2009 was in part cyclical, as a response to the decline in demand and these jobs should therefore return, albeit slowly, as demand increases. However, the crisis also hastened structural changes. Certain industries, such as the automobile sector, were already in decline in regions where labour costs made them uncompetitive. In other industries, airlines or pharmaceuticals for example, consolidation and new business models mean an overall decrease in the numbers employed. The question will be how to compensate for these structural changes as growth returns.
Unemployment in the Eurozone is expected to reach 11% in 2010. Some countries, such as Germany, seem to have fared relatively better thus far, through moves to shorten working hours, rather than cutting jobs and to maintain people in employment, if only part-time. Most reports suggest that unemployment will fall faster in the US than in Europe. The difference is attributable to the flexibility in US labour markets but, even with this, the US will be affected by widespread plant closures and continuing bankruptcies among small and medium size enterprises (SMEs). One risk is that this crisis leaves a legacy of underemployment, where people are constrained to accept part-time jobs or jobs that do not require their level of skills. US Department of Labour statistics show that there are 9 million workers in part-time employment who are seeking full-time jobs. Unemployment can become entrenched as workers lose skills or find themselves with the wrong skills to take advantage of new jobs when they arrive.
Widespread job losses have an immediate and direct effect on economies, but also on individuals and societies. One factor, common to both the developed and developing world, is that unemployment has a disproportionately large impact on youth. Young workers under 25 make up the greatest share of the unemployed in many regions and they have been particularly hit by the job losses and poor prospects in advanced economies. Studies suggest that the effects of unemployment or poor job opportunities early on in the working life have consequences for earning power and development over the rest of an individual's career.
As debate about necessary reforms continues in the US and Europe, it should be noted that according to the International Labour Organization (ILO) only 20% of the world has what the ILO terms "adequate" social protection, only 50% of the world has any coverage at all and in developing countries that figure falls to less than 10% of their population. While advanced countries focus on reforming their social security systems, perhaps this is an opportune moment for a global dialogue on how to design health and pension systems that are sustainable and can support growth and development in all parts of the world.
Migration and unemployment
One of the less prominent risks on the landscape concerns poor labour and migration policies, and a lack of cooperation at a global level, which meets neither the needs of donor or recipient countries. Though the arrival of immigrants can spark debate in some recipient countries, global migration flows are actually not that large. The International Organization for Migration (IOM) estimates the number of migrants in the world at 193 million, or approximately 3% of the global population. In periods of high employment, migrants are often a welcome source of labour but as unemployment rises, so do pressures on politicians to "protect" jobs. As mentioned in the previous chapter of this report, there is a risk that in response to public and sometimes populist pressures, governments introduce measures to curtail immigration. However, these policies are double-edged. In the short term, they clearly affect migrants and their home economies as remittances fall. There can also be unintended consequences of the policies, resulting in the rise of illegal migration and black and grey market activity. In the longer term, if the measures remain in place they can accentuate problems around skill shortages, which will no doubt re-emerge once jobs return. Migration policies need to be long term and cannot work in isolation. Better dialogue and coordination is needed between recipient and donor countries. Recommendations from the Forum's Global Agenda Council on Economic Growth and Development highlighted the importance of migration and suggested a focus on policies such as encouraging the return of educated diaspora as a tool for development or making the ability of countries to attract immigrants a badge of success.
The twin challenge of global imbalances
Sustainable growth in the global economy is inextricably tied to sustainable fiscal balances across the world. Large macroeconomic imbalances count among the contributing causes of the current financial crisis. A number of advanced economies were, as a whole, saving less than they were investing. For example, China's gross savings rate is nearly 60% of national income, an exceptionally high rate, particularly in contrast with the low rate of about 12% recorded in the US. The low national savings rate explains why the US has become dependent on capital inflows, with foreigners financing almost one third of US investments in recent years. These savings gaps, which materialized in current account deficits, were financed to a large extent through capital inflows from emerging economies, predominantly countries in South-East Asia with excess savings. In the long run, macroeconomic imbalances must be reduced. This requires a difficult rebalancing during which emerging economies must boost domestic spending (which will reduce excess savings), while advanced economies in turn should boost savings. At the heart of this rebalancing should be a credible path towards fiscal stability that balances the obligations of current and future generations.