The IMF's Misdiagnosis

The International Monetary Fund has downgraded its world growth forecast for this year by 0.2 percentage points to 3.2%. That is the fourth cut in a year, and not much more than the 3% rate that the IMF has previously regarded as a ‘technical recession’.

So why the downgrade – particularly when the IMF is predicting slightly higher than forecast grown in China, of 6.%? They cite many factors. Chinese growth is still a lot slower than it was a few years ago. Europe and Japan seem stuck in low growth despite their central banks' expansionary policies. A strong dollar has caused America to make less and import more. Then there is Greece and doubts about the Eurozone.

And the IMF solution? The world has been growing too slow for too long. It needs a boost. Central banks should keep down interest rates, print money and spend taxpayers’ money on infrastructure improvements.

Wrong diagnosis, wrong. Things always change: economies go up and down, exchange rates fluctuate, markets rise and fall. And easy money, cheap credit and government overspending is what got us into this boom-bust cycle in the first place.

What’s happening is perfectly simple. The eclipse of communism saw countries – like China – joining the world trade system and developing their production markets. Technology helped the globalisation of world trade. So stuff got a lot cheaper. But Western governments still stuck to their generous inflation targets, their central banks pumping out money and keeping down interest rates. It was a huge boom – some of it down to trade making things cheaper, right enough: but more of it down to the continuing, misguided expansionism.

So consumers bought luxuries like crazy, government built new motorways, bridges, schools and hospitals, and people invested in the land, plant, equipment and workers needed to produce these things. When the music eventually stopped, our productive assets were in the wrong places, producing the wrong things for our post-crash economies.

It might have been right to palliate that with an immediate monetary expansion. But should interest rates have stayed at ‘emergency’ levels for the past five and more years? That just perpetuates the artificial boom and means we get by, without doing much. If you want to know why productivity is falling, look no further. If we want to return to economic growth, we have to recognise that the 2000s boom made us malinvest on a huge scale. And we need to grit our teeth and write off those malinvestments. Not perpetuate them with further expansions.