OECD Says Economic Damage Is Lasting, So Stimulus Should Continue

(MoneyWatch)  Emerging-market economies are already in recovery, and the U.S. and Japan should soon follow, said the Organization for Economic Co-operation and Development (OECD) on June 25. But the next few years of recovery will be weak and fragile, and because the world's economic machinery has suffered severe damage that will cut growth potential for many years, it's crucial that governments not pull back too early on their stimulus efforts.

The OECD is a sort of trade group for the world's developed economies, which doles out advice to developing nations, and is a central source for historical data and forecasts on the world economies. It publishes an Economic Outlook twice a year and, in the issue released today, increased its forecasts for the first time in two years.

The economic shortfall in the emerging market countries has been shallow and brief, so the major EMs (Brazil, Russia, India and China) should show solid growth for 2010, the OECD says.

The developed OECD countries as a group will show positive growth in 2010, led by a comeback in the U.S. and Japan by the first quarter. In the graph below, developed nations are at the top, and emerging nations at the bottom. (Click on the graph to see a bigger version.)


The laggard in OECD-land is Europe, in particular those countries reliant on exports, such as Germany. While the U.S. is expected to contract at 2.8 percent in 2009, Europe is forecast at negative 4.8 percent, worse than the March forecast, and not predicted to be positive until mid-2010.

With such a weak economic pulse in so many nations, in its Economic Outlook editorial the OECD is beseeching governments to leave their stimulus programs in place:

With a nascent recovery hopefully in sight ... it would be tempting to relax the extraordinary policy effort of the past nine months. Tempting, but wrong...

Indeed, with the incipient recovery likely to be weak, it is important that decided fiscal stimulus actually be implemented in a timely manner and that the fiscal impulse not be withdrawn at a pace that jeopardizes recovery.

What I found most revealing about this report is the OECD's assessment of this recession's damage on the structure of the world economy.

We're not just pushing the Reset button, says OECD. Because of a collapse of investment in production, and high unemployment driving some older workers out of the labor force permanently, said OECD secretary-general Angel Gurria, rich countries have lost three percent of potential output forever, and will not be able to grow at the rates of the past decade. (In the graph, potential growth is illustrated by the horizontal black line.)

The U.S. government optimistically sets the permanent damage at one percent of potential GDP, but the U.K. has built into its forecasts a permanent loss of five percent, Ireland seven percent, and Scandinavian countries three percent.

We still need that stimulus.