G20 summit dilemma: Stimulate economic growth or rein in deficits?

The chief question at this weekend's G20 summit will be how to keep the world economy growing. The Europeans are cutting government spending, ignoring President Obama's call for more stimulus.

World leaders are preparing for three days of meetings in Canada at the G20 summit, where the major theme will be the state of the world economy.

Is the globe looking at a second recession that might require another burst of government stimulus? Or is the economy safe enough so that world leaders can begin to rein in their budget deficits to calm financial markets?

These will be two of the major questions discussed starting Friday when world leaders meet in Canada – first the Group of Eight (G8), comprised of the major industrial nations such as the US and Germany, and then the G20, which includes such countries as Indonesia and Saudi Arabia.

“The theme that will dominate both the Toronto G20, and probably the G8 Muskoka Summit as well, is governing the global economy at this precarious time,” says John Kirton, director of the G8 Research Group in Toronto.

On one side of the table, the United States is set to argue that now is not the time to slow or even contract government spending on such things as roads and employment programs. On the other side are nations, such as Britain and Germany, intent on reducing budget deficits to avoid the financial market turmoil that beset Greece, which was forced to cut its spending and then saw riots in its streets.

The two approaches are sure to result in some lively debate – if not a conclusion.

“The big story here is that they cannot identify what the problem is – not enough fiscal stimulus or too much,” says Jeffrey Kopstein, a political scientist at the University of Toronto. “You can’t agree on a solution if you can’t agree on the problem.”

Obama's message to G20 colleagues

In a letter to his G20 colleagues June 16, President Obama wrote, “Our highest priority in Toronto must be to safeguard and strengthen the recovery.” What that means, he wrote, is “we should reaffirm our unity of purpose to provide the policy support necessary to keep economic growth strong.”

Less than a week later, the United Kingdom’s new Conservative Prime Minister, David Cameron, presented a budget that dramatically shrinks government spending and raises taxes. Some major UK programs could shrink by 25 percent if the budget is adopted.

Mr. Cameron’s Chancellor of the Exchequer, George Osborne, called it an emergency budget. The emergency? The UK is borrowing one pound for every four pounds spent, he explained.

The danger for Mr. Osborne: The belt-tightening in the UK could sap economic growth when the spending cuts and tax hikes go into effect next year.

However, Jay Bryson, an international economist at Wells Fargo Securities, says he doubts it will drive the country into a recession. In a report issued Thursday, he notes that other Conservatives in the past (notably Margaret Thatcher) have cut the deficit and then watched the economy grow.

Behind Mr. Obama’s request for other countries to hit the gas pedal once more are concerns that the global economy may shrink.

Aside from less fiscal stimulus by other European nations, the Chinese government is trying to deflate a real estate bubble. “The big fear is that the government’s effort to bring real estate prices down to more realistic levels could result in a hard landing of the Chinese economy,” writes Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Mass.

At the same time, some parts of the US economy are beginning to wobble. The US housing market is contracting again now that tax benefits for first-time home buyers have expired, consumers are still being careful about their spending, and the financial markets are jittery.

However, as Mr. Kirton notes, the global economic picture is not completely negative. The economies of Brazil and India are booming. “They could offset the sluggish performance from one or two countries,” suggests Kirton.

Neither is the US picture all negative.

US economy 'not in free fall'

“At this point, the base case still sees continued growth,” says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. “It’s just that the pace is a little lower than we thought a few months ago and the risks are more to the downside. The good news is that we are not in free fall.”

Nevertheless, the risk of a global double-dip recession has risen slightly from 15 percent to 20 percent, estimates Mr. Behravesh, who assumes the euro crisis does not become worse and the Chinese economy has a soft landing.

Behind the shrinking European budgets is concern that the euro will continue to fall, as the currency did when Greece was unable to borrow more money. The falling euro could present a risk to standards of living.

The problem of global debt is something that will not be resolved at one G20 summit. World debt, both public and private, now amounts to $222.5 trillion, equal to 362 percent of global GDP, writes David Rosenberg, an economist at Gluskin Sheff, a Toronto wealth management firm.

“The bottom line is that all levels of society, and across most countries in the industrialized world, have far too much debt and far too much debt-servicing costs in relation to income,” he writes in a recent report on the company’s website.

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• Does the US need more economic stimulus, or less?