Hamish McRae: New powers lead the growth rush, and the IMF needs to take charge before markets do

It is, however, a good time to take stock of what is happening to the world economy. Just ahead of the meetings comes the IMF's half-yearly World Economic Outlook, which is one of the three most useful pieces of economic work that comes out from the international organisations.

It made the headlines by cutting the UK and eurozone growth forecasts for this year. Our own Treasury will of course have to revise down its pre-election forecast of 3 to 3.5 per cent, and the only issue is whether it will suggest something less than 2 per cent, as most forecasters now expect something in the 1.8 to 1.9 range. Unsurprisingly, it will blame this missed forecast on the unexpected rise in the oil price and slower growth elsewhere. It remains true that the UK is growing faster than the big eurozone economies, though not some of the smaller EU nations, particularly those outside the eurozone. The IMF projections for growth this year are shown in the left-hand chart.

There are two other aspects to the IMF's work which seem to me to be particularly enlightening. One is some analysis about the end of the global imbalances, in particular the US deficit and the corresponding surpluses of China and Japan. The IMF has also brought into focus the shift of power from Europe to Asia.

On the first, it has done some calculations as to what might happen if there is no policy change. The US current account gradually gets better but only gradually. If, on the other hand, Asian countries allow their exchange rates to rise (as China has started to do), then the adjustment takes place more quickly. If the US starts to correct its budget deficit, then that helps too. And if the eurozone and Japan manage to achieve faster growth, that gives still further help.

The underlying point is a very simple one: correcting global imbalances is not just the responsibility of the US. There are two sides to every economic transaction, to every imbalance. The IMF does not quite put things in these terms but maybe it should.

If you go back to the original purpose of the institution, it was to prevent countries having to cut back demand too swiftly if they ran into balance of payment difficulties. The worry was that, if they did so, they would disrupt trade and undermine global growth. So the IMF would lend them money to tide them over and support policies to bring things back into balance.

The world has moved on. Exchange rates are no longer fixed, so the pressure to adjust is less immediate; global financial flows are much larger and the resources of the IMF much smaller in relative terms; and in the case of the US, the problem is not the ability to finance a deficit but arguably too much of an ability to do so.

Nevertheless, the principle is the same. There is a grave threat to global economic stability and it is very much in the self-interest of all players that these adjustments take place in an orderly way. The IMF has done some illustrations of what might happen if there were disruptive change, and they are not good news. The question is how to go beyond the economic analysis and find ways of prodding countries into changing their policies.

I'm not sure there is much that can be done. The only credible argument is self-interest and, since we are dealing with democracies, there is a short-term/long-term divergence. Take Germany, which now seems to have a natural rate of growth of little more than 1 per cent a year. It also has a current account surplus of 5 per cent of GDP, which is absurd. It is in the long-term self-interest of the electorate to bring in economic reforms at a swifter pace. But in the short term there are perhaps more losers than winners and the result, as we are seeing, is political paralysis.

In the US they ought to be dealing with the budget deficit, but that would mean tax rises or less money spent rebuilding New Orleans. Neither outcome is possible. Even non-democratic governments tend to look to the short term. Look at China: it would be in the long-term interest to allow a swifter rise in the yuan, but that is not what the authorities, worried about maintaining the growth of exports, currently think.

The issue is how to get mutually self-supporting action: if you do this, we'll do that. Ultimately, it may be left to the markets to push for the adjustments by punishing the transgressors. The result is larger swings, in the first instance in currencies and bond yields and then in the real economy, than would otherwise be the case. We are seeing the result of the markets doing their thing in the oil price. It is hard to know quite what is temporary and what is structural in the running up of the oil price.

There is the specific problem of loss of US production and refinery capacity, but there is also the long-term problem of rising demand (including from China and India) and lack of global supply. Around 70 per cent of the world's oil supplies come from fields discovered 30 or more years ago. Had the main consuming countries set to work earlier, then the rise in energy prices would have been more gradual. The markets will adjust supply and demand but they can do so in a brutal way.

That leads to the further point that power is no longer so exclusively in the hands of the G7. Goldman Sachs has revisited some of its earlier work on the relative size of the "BRICs" versus the G7 economies. Brazil, Russia, India and China are collectively narrowing the gap between themselves and the leading industrialised nations, particularly if you do the calculations in purchasing power parity terms (see right-hand graph). Higher energy prices shift the balance of power within the BRIC; Russia benefits, while the others suffer. But the shift overall continues and the G7 countries need to figure out ways to bring the newcomers into the tent.

Actually, that is exactly what the IMF was intended to do. It was not, as is often portrayed by people who should know better, a rich nation's club that tried to impose neo-colonialist market policies on less developed countries. It was designed to stop excessive market movements disrupting world trade and payments. It may not be the ideal forum for brokering mutually supporting economic policies, but it looks our best bet because it embraces the BRICs as well as the G7. Otherwise the markets will take charge, as they are doing with the oil price.

The tragi-comic opera of Italy and the talent going to waste

A tangled tale in Italy, where they have managed not to lose the central bank governor but a finance minister instead. Antonio Fazio was unfazed by the request from Silvio Berlusconi to resign following criticism that he had favoured a local bank in a cross-border takeover. He stayed, and is now in Washington for the IMF/World Bank meetings. In disgust, the finance minister Domenico Siniscalco duly resigned.

His successor, Guilio Tremonti, also going to Washington, was asked how he would cope with his fellow member of the Italian delegation. "I'm just going to ignore him" - or words to that effect.

It is comic opera in a fine tradition but what no one can really ignore is what happens to the Italian economy. That story can be swiftly told. When Italy dumped the lira and adopted the euro, there was an immediate boost to the nation's finances from lower interest rates. The national debt could be financed much more cheaply because there was no longer any risk of a currency devaluation. But equally, Italy lost the option of periodic devaluations to bring its costs into line with its trading partners. Those costs went on rising, Italy became less competitive, growth slowed and this year stopped altogether.

The result: calls to bring back the lira "as a temporary measure" by the Northern League. That is not going to happen in the short term because it would immediately lead to a devaluation - there is no point in leaving the eurozone unless it does devalue. But were any country to do this, that would undermine the whole concept. So it won't happen for a while.

The row over Italian financial governance is less important for what it is than for what it does. It remains one of the underlying fragilities of European financial structures. It is not just that different national governments make different fiscal decisions in the framework of a single monetary policy. It is also that different economies respond in different ways to these policies. Both Germany and Italy have excessive fiscal deficits. But Germany has gone cold turkey and cut its costs; Italy has failed to do so. Germany is inching forward; Italy is not.

There is not going to be an economic crisis as a result of these operatic scenes. The Italian economy will hobble on. But the frustrating thing for this wonderfully talented nation is that people have to struggle to deploy those talents. Not good for Italy; not good for Europe.