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Justin Yifu Lin

Excess Capacity Is the Bane of the Economy

Excess Capacity Is the Bane of the Economy

Source:Chieh-Ying Chiu

The World Bank's chief economist considers the difficulties imperiling the global economy's fragile recovery, the conundrum of fiscal stimulus, and government's important role in piloting structural change.

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Excess Capacity Is the Bane of the Economy

By Sara Wu
From CommonWealth Magazine (vol. 449 )

The global economic outlook is filled with uncertainty and volatility. CommonWealth Magazine recently asked World Bank chief economist Justin Yifu Lin to assess the current bearing of the world economy. One of the insights he shared was that the greatest risk comes not from the financial system, but from excess capacity, and that now is an excellent time for countries with high foreign reserves to develop.

Following are highlights from the interview.


Q: Do you think it's possible that the global economy will see a double dip?

A: My first worry certainly is recovery -- is about whether we are going to have a sustainable recovery. In other words, I'd like to say, the foundation for the recovery is very fragile, and there's a possibility, and the possibility is real, we may have a double dip.

The second is that if you look, beyond the immediate term, we may find that we are going into a period of quite uncertain or even volatile global economy and also maybe foreign relations.

The trouble of the global recovery, I would say clearly is the excess capacity in the world. Such excess capacities will be there for a long time. And according to our studies, the excess capacity, underutilization of capacity may be with us up to 2014 if the recovery is weak.

To deal with this problem, we need to have some kind of demand to support a rebound. But if you look into the demand for maintaining the momentum, the forces will not be there.

According to data, we find industrial production in the high-income countries, the growth rate, started to decelerate in August last year. And in the emerging markets, it started to decelerate.

Certainly, you still had growth, but the growth rate was declining in September last year. And the deceleration happened faster than we had expected. And it reflects the inventory cycle may be coming to an end.

And the other force will rely on the fiscal stimulus, but we know the fiscal stimulus may result in a debt build-up. And that's how some countries may exit from fiscal stimulus. And if that occurs, certainly demand will be reduced.

Even if countries maintain their fiscal stimulus efforts, they cannot increase the intensity. So what does this mean? In the second half of last year, fiscal stimulus drove hopes for recovery, so the projected growth rate appeared to be a little bit higher. And even if we maintain the fiscal stimulus at the same intensity, the second half of this year may see a slowdown in the growth rate.

So if you put that whole scenario into perspective, I think a second dip is a very likely scenario. To reiterate, I see three big reasons for concern.

The first relates to excess capacity in the high-income countries, certainly also in the emerging markets. Unemployment will continue to rise. Under that kind of situation, governments in high-income countries will continue this very relaxed monetary policy, interest rates will maintain at a low level. In fact, the U.S. is close to zero.

And we know that if you maintain a low interest rate, the purpose is to stimulate the economy. In 2001 and in 2006, during that period of time, low interest rates, you know, resulted in about six years of prosperity, because low interest rates stimulated housing demand. But this time, because of excess capacity, even if you have low interest rates, the private sector will not come into the market. And it's another kind of situation. Most of the liquidity will go into speculative types of activity. We see the boom in the equity market, but without a real resolution of excess capacity, there tends to be a bubble.

Second, problems in the banking sector have not fundamentally been addressed yet. We are going to hear sporadical news about the collapse of banking sectors maybe in high-income countries and also in certain emerging markets. Some stories like Greece, those kinds of things may come, you know, here and there.

And a third uncertainty relates to a possible rise in protectionism in response to excess capacity, because of unemployment issues. And certainly so far, most countries, most countries still engage in this kind of protectionism. But as long as you have those kinds of incidents, it may cause some kind of tension bilaterally. And that is also another concern.

In terms of how to extract ourselves from these problems, I think we are moving beyond a mere financial crisis. From what I see, the main trouble now is in real sectors. The real trouble relates to excess capacity. And unless we address this, the foundation for a sustainable growth will be very weak.

Q: Which geographical regions of the world do you see as having the most pronounced risks for engendering a double dip?

A: You know, it very much depends on whether a country has the ability to carry out a second fiscal stimulus.

As I mentioned, if you exit from fiscal stimulus, you are going to have a dip. If you maintain the stability of a fiscal stimulus, it may not be intense enough. And if a country has the ability to introduce a second fiscal stimulus, certainly they will be able to maintain a reasonable level of growth.

And you look into the possibilities – I think the emerging markets may be in a better situation, especially those emerging markets that have some fiscal production, as well as large external reserves. And under that kind of situation, certainly they have the room to engage in a second stimulus.

But for the high-income countries, you know, I think it's very hard to increase the intensity. So under the current situation, I think a slowdown in growth may be likely in the medium term. And in other developing countries, if the external situation does not improve, then the ability to make stimulus is quite limited. So the recovery is indeed fragile.

Q: You just wrote an article about how governments can identify latent comparative advantage and facilitate structural change. Can you explain this?

A: Many developing countries have the potential to grow faster than the developed countries and are now confronted with the challenge of finding new sources of growth in the context of a multi-polar growth world. In that regard, the role of developing countries' governments in inducing and accompanying structural change (industrial upgrading and economic diversification) to promote growth, employment, and poverty reduction must regain center stage. Indeed, historical evidence and economic theory suggest that while markets are indispensable mechanisms to allocate resources to the most productive sectors and industries, government intervention is important too. Such public-sector support can come in the form of the provision of information, coordination of hard and soft infrastructure improvements, and compensation for externalities. Those types of measures are indispensable for helping economies move from one stage of development to another.

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