IMF Lays Out the Challenges Ahead for Global Economic Recovery

How are world leaders performing in combating the global financial crisis? According to an analysis by the International Monetary Fund in its latest World Economic Outlook, they've put what roughly equates to a "good first half" from a football team. However, as this year's Super Bowl participants, the Green Bay Packer and the Pittsburgh Steelers, would certainly attest, it takes more than a strong half to win a football game. And the IMF is likewise reminding policymakers that they have to follow through and finish the job.

According to the IMF, the economic recovery in both developed and emerging markets is accelerating, with the stronger GDP growth decreasing or eliminating the output gap (unused production capacity) in emerging markets. That's the first half of the game.

But in the all-important second half, policymakers will need to address the key problems that still threaten the recovery: high unemployment and banking issues in developed markets, and growth in some emerging markets that's too strong for their own good.

A Tale of Two Recoveries

The IMF calls the commerce rebound a "two-speed recovery," with strong emerging-market growth outpacing still-slow GDP growth in the developed world.

In its latest report, compiled before the outbreak of Cairo protests aimed at ousting Egyptian President Hosni Mubarak, the IMF forecasts that the global economy will grow 4.4% in 2011, 0.2 percentage points better than its October forecast, and but slightly lower than 2010's 5% GDP growth.

Emerging markets, which include China, Russia, India and Brazil, are expected to grow 6.5%, one-tenth of a percentage point better than the October estimate, but lower than their combined 7% growth in 2010.

Developed markets, which included the U.S., U.K., Germany, France and Japan, are expected to grow 2.5% in 2011, 0.3 percentage points better than the October forecast, but lower than their 3% growth in 2010.

Although national policymakers successfully stabilized the financial system after the onset of the economic crisis in late 2007, they'll get little rest in 2011. The near-term financial and economic landscape will likely offer them no perfect options and many "lesser-of-the-two-evils" choices involving trade-offs and fiscal pain.

For example, developed world economies, particularly in Europe, will have to implement "comprehensive and rapid actions to overcome sovereign and financial troubles in the euro area" the IMF says. That suggests at least some additional cutbacks in Europe's social safety net, among other changes.

Dilemma for U.S. Policymakers

Also, nations with large budget deficits, such as the U.S. -- currently running a roughly $1.5 trillion annual deficit -- will have to focus on "policies aimed at reducing government deficits and debt accumulation," the IMF notes.

The U.S. must cut its deficit, the IMF says, and most U.S. economists agree. But deficit reduction concurrent with subpar demand growth in the private sector risks slowing the economy. But that would make it harder to trim the nation's high unemployment rate, currently 9.4%. So, the country's current fiscal condition -- absent some unforeseen factor that causes GDP growth to surge -- presents policymakers with a choice between deficits that are too big and a modest decline in high unemployment, or smaller deficits and an even slower drop in unemployment -- at best.

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That environment of tough choices is consistent with the Federal Reserve's 2011 U.S. economic forecast, which sees GDP rising between 3% and 3.6% this year, with unemployment declining only slightly, to between 8.9% and 9.1%. In its most recent minutes, the Fed added that the Bush tax cut extension's stimulative effect was offset by changes in other economic variables -- housing prices, home sales and higher oil prices, among others. The net result was that the extensions will cause little change to the medium-term GDP forecast.

Emerging markets, however, are better positioned to tackle their problems due to stronger GDP growth, but they're facing economic and financial challenges of their own. Chief among these, in the IMF's interpretation, is how they handle the capital inflows triggered by their strong growth and by low interest rates in the developed world.

Those capital inflows present both an opportunity and a challenge for emerging-market nations, the IMF says. They can decrease the costs of borrowing, which can boost domestic demand and make an emerging market less dependent on export revenue. However, if capital inflows become too strong, they can lead to overheating and asset-price bubbles.

Emerging Markets: Higher Earnings Potential

Clearly, the IMF's latest analysis suggests that due to likely stronger GDP growth, emerging markets offer investors the prospect for larger returns, all other factors being equal. Among developed world economies, the U.S. faces formidable tasks in its effort to increase GDP growth and lower unemployment.

Still, it's important for investors to keep in mind that the economic realm, like the political realm, isn't static: Conditions can change rapidly -- and unexpectedly. New sectors can sprout or evolve, creating hundreds of thousands of unexpected new jobs. Breakthrough technologies can increase productivity or lower costs. Waves of business investment and hiring can promote "herd mentality" investing in lateral sectors -- increasing both GDP and job growth. And of course, other unexpected forces can have the opposite effects.

Absent any growth-boosting unexpected events, U.S. policymakers and business executives will have to keep grinding away at building a lasting recovery the old-fashioned way.