Governments meeting this weekend for Group of 20 gathering warned of risk of ‘protracted stagnation’

THE TOP White House economic adviser said yesterday that world leaders must keep the tentative global recovery on track as Europe headed into this weekend’s G20 summit defending plans for heavy cost-cutting.

The United States and some European countries have stressed different priorities for economic policy now that the world is emerging from its worst slump in decades.

Lawrence Summers, speaking ahead of the Group of 20 meeting in Toronto, said governments must work to avoid the risk of a “protracted stagnation” which could aggravate fiscal problems.

But Summers sought to downplay differences with Europe over the need to tackle high debts and deficits as part of the way forward for policymakers. “One important aspect of that focus needs to be . . . on fiscal sustainability. Just how that’s done, just what the pacing is, is something that will inevitably vary from country to country,” he said.

European policymakers defended budget austerity plans with European Central Bank president Jean-Claude Trichet saying it was wrong to claim that budget austerity would cause stagnation. German chancellor Angela Merkel said her country would stick to plans to save €80 billion in the next four years, its biggest programme of fiscal cutbacks since the second World War.

“We’ll enact the measures that we’ve agreed upon,” Dr Merkel said in an interview with German ARD television broadcast yesterday. “I believe we should not let up.”

After winning plaudits for guiding the world economy through the financial crisis, splits have emerged among Group of 20 powers over which policy priority ought to take precedence now – supporting still-shaky growth or shrinking budget deficits.

Markets remain jittery about the debt crisis and the risk of an economic slowdown in the run-up to the meeting of G20 leaders this weekend, with the cost of protecting government debt against default hitting a record high for Greece and jumping in other peripheral countries such as Portugal.

The draft version of the Toronto summit communique, obtained by Reuters and dated June 11th, said the recovery was “uneven and fragile” and warned against complacency. “Fiscal challenges in many states are creating market volatility, and could seriously threaten the recovery and weaken prospects for long-term growth,” it said.

The United States has warned against withdrawing support too soon, mindful of when the government slammed the brakes on spending in the 1930s, prolonging the Great Depression.

But Europe is set on a different path. A market backlash against countries seen to be dragging their feet on cutting debt and deficits has sparked budget cutbacks all over Europe as governments try to rein in spending.

French unions staged a nationwide strike yesterday over plans to reform the pension system following similar protests in Spain and Greece, where ministers were due to meet yesterday to discuss their own pension reforms.

Spanish economy minister Elena Salgado said she was confident the minority government’s budget would pass the national parliament in September, when unions have also scheduled a general strike.

G20 leaders must also forge consensus on how to harmonise financial regulatory reforms and Mr Trichet said he was confident the G20 was on the right track.

But Europe’s efforts to present a united front on regulation hit a roadblock yesterday when EU lawmakers and diplomats failed to agree on new hedge fund rules.

In an interview with Italy’s La Repubblica newspaper, Mr Trichet rejected any threat to growth from austerity measures and urged governments to push on with budget and structural reforms.

“As regards the economy, the idea that austerity measures could trigger stagnation is incorrect,” he said, describing the German budget plans as “good” and repeating calls for more fiscal discipline in the 16-nation euro zone. “I firmly believe that in the current circumstances, confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today,” he said.

German finance minister Wolfgang Schäuble said he could not understand criticism from abroad that Germany was “wrecking the recovery with austerity measures” because Berlin is doing a lot to stimulate growth.

“There is an implicit accusation that we’re not living up to our international responsibilities as far as economic policies are concerned,” Mr Schäuble wrote in a guest column for the Handelsblatt newspaper.

“I cannot understand this argument because Germany has taken sweeping measures since 2008 to stabilise the economy. We’ve done that on top of all the automatic stabilisers we have [such as higher social welfare spending] that play a much smaller role in countries from which we’re now being criticised.”

Mr Schäuble pointed to Germany’s budget deficit climbing to 5 per cent of gross domestic product (GDP) as evidence of its commitment to growth-boosting measures and said the first consolidation measures won’t take effect until 2011.

The G20 groups the world’s biggest economies and covers two-thirds of the world’s population. It includes Australia, Argentina, Brazil, Indonesia, Japan, Mexico, Russia, South Korea, Saudi Arabia, South Africa and Turkey in addition to the big European economies, the United States and Canada.