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Davos's empty toolkit

Larry Elliott

A distinct lack of euphoria characterised the proceedings this year as a new sense of realism took root and the Chinese dominated.

Davos used to be the place where the masters of the universe came for a bit of R&R with their trophy wives. They would chew the fat, cut a few deals, nod wisely as a tame politician paid homage to the orthodoxies of deregulation, privatisation and globalisation. Perhaps they would do a bit of skiing.

The World Economic Forum has not been like that for some time. Two years ago there was concern that the seizing up of financial markets in the summer of 2007 was the start of something nasty.

By Davos 2009 it was clear that the fears were justified and that the banking crisis during the autumn of 2008 had brought the global economy to the brink of depression. The bankers wandered around the ugly concrete conference centre in a bemused state.

This year the mood was different again. Gerard Lyons, chief economist at Standard Chartered, said that if 2009 was marked by pessimism, 2010 is the year of realism.

There were 10 big themes this year. The first was a sense of relief that the outlook for the world economy is brighter than a year ago. In recorded history no precedent exists for the stimulus provided by central banks and finance ministries in the past year or so. And it has worked, because there has been no repeat of the 1930s.

But only up to a point. The second big talking point was of how fragile the recovery still is. Few were carried away by the fact that the United States economy expanded by almost 1,5% in the final three months of 2009, or that China is on course for near double-digit expansion this year. There is concern that growth almost exclusively relies on the stimulus of ultra-cheap money and budget deficits.

As a result (third theme) there is a broad consensus that the stimulus should not be withdrawn too soon. Dominique Strauss-Kahn, managing director of the International Monetary Fund, said there were risks from waiting too long before grappling with high levels of public borrowing, but these were outweighed by the risks of double-dip recession from acting too hastily. If that happened, Strauss-Kahn warned, policymakers would be powerless. “Our tool kit is empty,” he said.

Strauss-Kahn and Larry Summers, Barack Obama’s chief economic adviser, think it is important that a government has a plan to reduce the deficit over the medium term but that there needs to be flexibility in the short term.

The fourth theme was how to re-regulate the financial sector. After several months of shooting themselves in both feet, the bankers finally seem to accept the need for tighter supervision and constraints on some of their riskier activities.

The banks have recognised that the politicians—backed by public opinion—are the ones calling the shots. Obama was not physically in Davos but his plan to curb the power of Wall Street set the mood. France’s Nicolas Sarkozy had the same message: self-regulation is not an option.

Some of the banks’ reservations are valid. Peter Sands of Standard Chartered and Josef Ackermann of Deutsche Bank made the point that too heavy-handed an approach might affect the banks’ ability to provide the credit to fund a sustained recovery. But it was clear that the politicians and the regulators are not wavering in their determination to reform the financial sector.

Even so, (fifth theme) the unions present were right to see a disconnect in the proceedings. The crisis of the past 30 months not only exposed the weaknesses of the financial sector, it also cost tens of millions of jobs and highlighted the skewed distribution of income in favour of the rich and powerful.

Summers said the US was experiencing a statistical recovery but a human recession—20% of American men aged between 25 and 54 were unemployed, compared with 5% in the 1960s. His was a welcome—but fairly isolated—voice arguing for the “primacy” of job creation.

Summers said the US was relaxed about the sixth key theme of Davos 2010: the draining of economic dominance from the West to the East. The big emerging economies of Asia, China in particular, have bounced back from the Great Recession far quicker than Europe and North America. But as Britain’s experience in the first half of the 20th century shows, political power follows the money. Creditor nations call the shots; debtors live on past glory. The US, a debtor nation, still dominates Davos, but it was noticeable how self-confident the Chinese voices were.

The flipside to the waxing of China has been the waning of Europe. Sessions on China were packed; a session on the future of the Eurozone was half empty. For the Asians and Americans in Davos, Greece’s deep economic crisis was a local affair in a part of the world that matters less than it once did. A declining population and sluggish growth mean that this trend is likely to continue. The creation of the single currency may prove to be the zenith of Europe’s influence.

If this was the seventh Davos theme, the eighth was a recognition that the global imbalances remain, despite some narrowing as higher unemployment and rising saving in the US temporarily choked off Chinese exports. Zhu Min, deputy governor of the People’s Bank of China, said—unconvincingly—that Beijing was doing its bit by boosting consumption. But for there to be a structural shift in the composition of China’s growth, the exchange rate would have to be sharply revalued and there is no sign of that happening.

Neither—given the deficiencies in the system of global governance—(ninth theme) can China be pressured to export less. The IMF is mandated to investigate whether the policies being pursued by individual countries are mutually compatible and there is peer pressure through the G20 group of developed and developing countries, but a country cannot be forced to do what it doesn’t want to do. That applies to trade, financial regulation and the environment, as well as to the imbalances.

Davos this year recognised that economic recovery is weak, governments skint, financial regulation inadequate and global imbalances untackled—all at a time of profound geopolitical change.

Little wonder, then, that there was a distinct lack of euphoria. The 10th and final theme was a sense that the world is starting a long adjustment period.—

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