East Asia & Pacific: Risks to economic recovery from the return to business-as-usual in developed countries

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ImageThe prediction season is in full swing, and prognosticators have, as usual, appended the warning that economic forecasts at this stage are subject to exceptional uncertainty.  Such exceptional uncertainty is always with us when looking ahead – there is always a fork in the road, no matter what the circumstances are. 

The nuance this year is that, while the recovery in East Asia will depend on prospects for the rest of the world, notably in the advanced economies, the outlook for those economies hinges on policies to address the causes of the financial crisis. Thus far, it’s clear that very little has been done to redress the regulatory issues that led to a near meltdown of the global financial system – while the rebound from the financial and economic crisis has been substantially stronger than anticipated only months earlier.  And these developments explain why opinions differ on the future path of regulatory reforms and their impacts.

If regulatory reform in the U.S. and western Europe does pick up and succeeds in addressing the most egregious regulatory failures earlier, economic growth over the medium term in developed economies should be slower, not only compared with the years before the crisis (“the bubble”), but also relative to the 1990s.  With demand in developed countries expanding more slowly, growth in developing countries and the global economy should also be slower.  It is likely to be more sustainable and lead to a slower accumulation of risks.

If, however, the pace of regulatory reform remains sluggish, and fixing what was broken takes a while, the spurt in output growth could be faster as price bubbles blow up across asset classes and countries.  Given the nearly universal consensus that East Asia’s economic fundamentals are stronger than in most other regions, it is likely that the risk of these bubbles will be disproportionately spread in East Asia, complicating the genuine recovery and hampering much needed rebalancing in several of the countries, notably China.

When projecting growth in East Asia this year and next, as a result, we should remember that we will not be able to have our cake and eat it too. Limited efforts to tackle regulatory failures in developed countries will encourage banks, investors and consumers to return to their old ways faster, which will likely result in a stronger temporary growth both in these economies and, by virtue of trade and finance links, in East Asia.  Let’s not take this as a sign of a sustainable recovery.


Ivailo Izvorski

Chief Economist, Europe and Central Asia region

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