Despite all the portents of doom the world economy has been quietly mending itself.
This is not to say that the recovery is firmly entrenched or that few risks remain, but despite the rough patches in 2010, it is important to keep in mind that the economic picture looks far better now than it did a year ago.
Why do I conclude this? Well, to get an accurate picture of where the world economy now stands, we need to look at a broad set of economic data. We have gathered data from the G20 economies for three types of indicators: real economic activity, captured by GDP, industrial production, employment, imports and exports; financial indicators such as national stock market indexes, stock market capitalization and, in the case of emerging markets, their bond spreads relative to U.S. treasuries; and finally, indicators of business and consumer confidence.
By combining information from these variables using statistical techniques, we can take the pulse of individual economies as well as the world economy. And thus was born the Brookings Institution-Financial Times index for the world economy, which we have christened TIGER—Tracking Indices for the Global Economic Recovery.
The composite indexes reveal five dominant themes. First, the global economy turned the corner by mid-2009 and has strengthened gradually since then. Growth rates of many indicators have rebounded strongly after plunging into negative territory during 2008.
These high growth rates are off a lower base of course and there is still a lot of ground to be made up before the levels of these indicators are back at their pre-crisis levels. For instance, growth rates of industrial production in many G20 economies are now higher than before the crisis but, because growth rates fell sharply during 2008, the levels of industrial production are still below pre-crisis levels. Still, the recovery has clearly gathered momentum.
Second, the recovery has been rather uneven. Growth rates of industrial production and trade volumes have recovered strongly, while the recovery in GDP and employment has been modest at best. Employment growth, which tends to be a lagging indicator of the business cycle, was very weak in advanced economies until the beginning of 2010 but is now showing some signs of life. So the recovery is ever so slowly becoming more broad-based.
Third, the performance of world financial markets has outpaced that of key macro variables. In the last two months, however, financial markets have dipped as they have been rattled by the problems in Europe. This could signal prescience of financial markets about more difficult times ahead or just a temporary pullback from an earlier surge of unfounded optimism. Either way, this is not good for the recovery. Then again, a more tempered financial market performance may not be such a bad thing for the longer term.
Fourth, confidence measures have regained some of the ground they lost during the worst of the crisis. In both advanced and emerging market economies, business confidence is still rising gradually but consumer confidence in advanced economies has been stuck in a rut in recent months. Resurgent business confidence is a positive sign as it could boost investment. But weak consumer confidence and minimal employment growth could dampen the recovery if they translate into tepid growth in private consumption.
And finally, emerging markets felt the effects of the global crisis later than the advanced economies and have also recovered more sharply. Among the major emerging markets, the recoveries in China and India have been particularly strong.
So far in 2010, emerging markets are still barreling their way to a strong performance despite the problems that have beset advanced economies. Perhaps, in a long-term structural sense, they are becoming less dependent on advanced economies. But emerging markets cannot pull the world economy along by themselves. If advanced economies continue to turn in a weak performance, we are in for a long and hard slog towards a durable global economic recovery.
We are certainly not out of the woods yet and all manner of risks could still forestall the recovery. While it is easy to paint dire scenarios, it is still worth recognizing that there is a lot of positive news relative to the desperate circumstances that the world economy was in a year ago. It’s not yet time to open up the bubbly, but at least there is less need now for a stiff drink.