World Bank Sees Deflation Risk From Excess Capacity.

Bloomberg. July 15, 2009.

World Bank Sees Deflation Risk From Excess Capacity.

July 15 (Bloomberg) — A failure to address excess capacity in the global economy may cause a “deflationary spiral” that would prolong the financial crisis and result in more company bailouts, World Bank Chief Economist Justin Lin said.

“Once excess capacity appears, the economy gets trapped in a vicious cycle,” he said during a lecture at South Africa’s University of Pretoria.

Investments made by companies between 2002 and 2007 have now turned into surplus capacity following the worst financial crisis since the Great Depression. If excess capacity isn’t eliminated, more jobs may be lost and corporate bankruptcies surge as spending and investments slide, compounding the crisis, Lin said.

Factories in the U.S. operated at 69.1 percent of capacity in March this year, the lowest since the figures were first collected in 1967, Lin said. In Germany, capacity utilization measured 72 percent, 65 percent in Japan and as low as 50 percent in some developing nations, he added.

The global financial crisis, which began with the collapse of the U.S. subprime-lending market in 2007, has led to $1.47 trillion of writedowns and credit losses at banks and other financial institutions, according to data compiled by Bloomberg.

The World Bank’s estimate of 2 percent growth in the world economy next year may not be achieved if excess capacity isn’t reduced, Lin said.

Fiscal Stimulus

Governments around the world should direct their fiscal stimulus to projects in developing economies with “returns high enough to generate higher growth,” and which will ease infrastructure bottlenecks, create jobs and improve productivity, Lin said. “The main policy objective should be to create demand as quickly and efficiently as possible.”

Investments by developed countries into developing nations will lay the foundation for “sustainable, inclusive growth,” while helping to alleviate the crisis, Lin said. Rich nations should avoid reverting to the protectionist measures that protracted the Great Depression of 1929, he said at a seminar held in Johannesburg earlier today.

“High income countries need to act in this crisis,” Lin said. “We need to learn a lesson and maintain free trade. The Group of Eight countries need to honor pledges of maintaining free trade.”

While there are some “encouraging signs” that the world economy is improving, financial regulation still needs to be strengthened and free trade and fiscal stimulus measures continued, Lin said.

“We avoided the worst scenario. At the same time we need to be cautious and continue with the necessary reform,” Lin said in an interview.


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