OECD calls Europe's crisis policy unworkable, fears 'virulent episodes' in emerging markets
OECD's chief economist says current European policies are pushing a string of countries into deflation and onto a much lower growth path
By Ambrose Evans-Pritchard, International business editor
4:35PM GMT 19 Nov 2013
The Paris-based club of rich states called on Germany and the northern creditor bloc to pull their full weight by boosting demand, insisting that Europe's North-South gap in labour competitiveness cannot be closed by putting all the burden of adjustment on the depressed states in the South. Photo: Reuters
The eurozone's strategy of trying to drive down wage costs across Southern Europe through deflation is leading to a debt trap and is ultimately unworkable, the Organisation for Economic Co-operation and Development has warned.
The OECD said the global economy remains extremely fragile, highlighting the danger of "virulent episodes" in emerging markets as the US Federal Reserve starts to withdraw global dollar liquidity.
There is a risk that any emerging market crisis could be large enough to short-circuit global recovery altogether.
The world recovery is already by far the weakest of the modern era. Output just 3pc above its 2008 peak compared 10pc in the 1990s recovery over the same time lapse, 15pc in the 1980s, and 17pc in the 1970s.
The Paris-based club of rich states called on Germany and the northern creditor bloc to pull their full weight by boosting demand, insisting that Europe's North-South gap in labour competitiveness cannot be closed by putting all the burden of adjustment on the depressed states in the South.
Pier Carlo Padoan, the OECD's chief economist, said the current policy is pushing a string of countries into deflation, and therefore onto a much lower growth path for nominal GDP. This in turn is playing havoc with debt dynamics. "Current account adjustment is advancing in the periphery but price adjustment alone will not work given the impossibility of reconciling deflation, needed to regain competitiveness, and achieving nominal growth to support debt sustainability. Much less adjustment, if any, is taking place in surplus countries," he said.
Mr Padoan said the European Central Bank must stand ready with further stimulus " if deflationary risks become more serious." He called for "symmetric" measures in Germany and the eurozone core to ease the pain, although it is unclear whether such a shift in policy is even possible in Germany now that it has written a debt-brake into its constitution. The German government has lost much of its legal discretion for Keynesian fiscal policy.
Mr Padoan's comments are certain to cause irritation in Berlin, already smarting from a rap across the knuckles by the European Commission over its huge current account surpluses. The US Treasury launched a blistering attack on German surpluses (7pc of GDP) earlier this month, saying the deformed policy structure in Europe was creating a "deflationary bias" for the world economy.
In a thinly disguised attack on EMU authorities, the OECD cautioned against thinking that the fundamental problems had been solved. "If governments are complacent, and remain behind the curve, policy action will be too little too late. Policy inaction or mistakes could have much more severe consequences than the turbulence seen to date and jeopardise growth for years to come," it said.
The OECD cut its world growth forecast to 2.7pc this year in its Global Economic Outlook, from 3.1pc in May, citing much weaker prospects in India, Brazil, South Africa, Russia, and a string of emerging market economies. Growth in 2014 has been cut from 4pc to 3.6pc. "Downside risks dominate and policy must address them," it said.
Mr Padoan said the first talk of bond of tapering by the US Fed in May had triggered a "surprisingly strong" shake-out in emerging markets, but this may just be the start. "These episodes could easily be replayed, quite possibly in a more virulent form, in the period ahead," he said.
The OECD said emerging market woes could set off a bad feedback loop, derailing global recovery. It warned that the world is now in much trickier predicament tan it was in the early phase of recovery after the Lehman crisis, when credit stimulus in Asia, Latin America, the Mid-East and Africa was helping to lift the West out of slump. This benign process has since gone into reverse, and "may now act as an amplifier and a transmission mechanism for negative shocks from emerging market economies".
Mr Padoan said "long-standing structural impediments" in a number of emerging markets had been disguised by credit growth and capital inflows, but these weaknesses are likely to be "exposed" as conditions tighten. Those most reliant on short-term capital flows are in the firing line. So are the rich countries that lent money to them.
