Battered consumers will rip the joy from this recovery

The economic recovery is now in sight, so let's consider how the world economy will be different coming out of this recession.

There is reason to believe that we are entering a new, more challenging period with slower global economic growth and less buoyant times over the medium-term - a joyless recovery. Economic growth will return, but growth in private consumption and investment will be tepid, without the exuberant bounce-back that is usually the case after a recession.

The principal reason behind a joyless recovery is a weak forecast for growth in U.S. consumption. Representing about 15 per cent of the global economy, the American consumer is the single most important driver of global economic growth. Until last year, the average American was spending every cent (or more) of every paycheque, relying on easy credit and rising prices for their house and other assets. But that spending spree by American consumers has come to a crashing halt, and the recovery in U.S. consumption will be weak.

Why can't we rely on the U.S. consumer any more?

Americans have been slammed by the combined effect of falling housing prices, lower equity prices, much slower income growth and mounting job losses. They now have to save more, pay the bills and hope that the price of their assets will finally hit a floor and begin to rebound.

All of this is called "de-leveraging," and it's likely going to take years for robust U.S. consumption growth to return. At some point, a higher savings rate should translate into stronger self-financed investment that will add to America's growth potential, but not in the foreseeable future.

Can Asian consumption

growth offset the U.S. slowdown?

If Americans aren't going to spend as they did in the coming years, the world economy will need a new driver for global consumption growth. Consumers in the Asia-Pacific region, and specifically in China, are the obvious candidates to take up the slack. But savings behaviour is deeply rooted in most Asian cultures, and it takes time to change deep historical patterns.

Moreover, the absence of a wide social safety net in the form of retirement plans, unemployment benefits and other social welfare programs reinforces this deep savings behaviour, not to mention a one-child policy in China that reduces potential family support.

Asian economic growth will stay strong, with rising real incomes and consumption and a growing middle class; but we do not expect Asian consumers to offset the slowdown in U.S. consumption growth any time soon.

Won't government stimulus programs do the job?

Short-term fiscal stimulus is critical to the global economic recovery and is just now beginning to kick in. Fiscal stimulus, combined with record-low interest rates, will feed the recovery and will boost output growth in 2010 and 2011. But as growth is restored, governments will have to face the hard reality that fiscal stimulus comes at a price: large deficits and mounting government debt.

To bring government debt loads under control, fiscal stimulus will need to be withdrawn from economies around the globe, ideally beginning in 2011 or 2012.

Fiscal consolidation will demand much slower growth in government spending, and/or eventual increases in taxes, which will serve to slow economic growth. And if countries aren't prepared to bite the bullet in terms of fiscal retrenchment, growing government debt burdens will place upward pressure on long-term interest rates. Higher interest rates, of course, would also act as a brake on medium-term growth.

Are there other drags on global growth?

Financial markets are now healing, but financial regulations are going to be tightened in many countries - which will constrain financial innovation and credit expansion. Rising energy prices are already translating into higher prices at the pump, which will absorb a larger share of the consumer's wallet.

Increased trade protectionism is another risk factor for growth, and aging populations have already reduced the pace of labour-force growth in many industrial countries, slowly pulling down long-term growth potential.

Taken together, these factors will take the fun out of the recovery and reduce global potential growth over the medium-term, perhaps by 0.5 per cent annually.

What could offset these negative factors and add some joy to the recovery?

Faster productivity growth, sparked by wide-spread innovation, is the answer. Innovation is the spark that could drive the global economy into stronger performance. Unfortunately, there is no silver bullet that will boost innovation or generate faster productivity growth. Innovation starts with a new mindset within organizations and governments who are willing to do things differently.

Special to The Globe and Mail

Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.