If the politicians present at Davos were complacent, the representatives of business interests also struck what seemed an unduly optimistic note. It is probably easy to be persuaded in Davos’s plush surroundings that all is well with the world. Further, those who led the global economy to disaster in 2008 are, for the most part, those who have emerged from the crisis in best shape. Even some Davos participants appear to have found the renewed self-confidence of senior bankers hard to take. In truth, though, the advanced economies are still in a state of depression and would probably be suffering severely if emerging countries, and most notably China, were not delivering locomotive power to world GDP.

An economic depression is properly defined as a state of affairs where output growth is not sufficient to absorb spare resources and where official attempts to restore full-capacity working turn out to be self-defeating. The USA currently provides a classic example of a depressed economy. The proportion of unemployed and marginally attached workers, plus those working parttime for economic reasons, out of total unemployed and marginally attached workers stood at 16.7% in December. That was still very close to the 17.4% peak in this series in October 2009. To achieve such a small improvement, the Federal Reserve reduced short-term interest rates virtually to zero. It also engaged in asset purchases on a grand scale, implementing an aggregate $1.75trn programme between December 2008 and March 2010. Additionally, from the beginning of 2008 the Bush and Obama Administrations presented measures to inject, in aggregate, almost $1trn of fiscal stimulus. It was because these measures made such small impact on the spare resources in the economy that US policymakers felt obliged to come back with more measures to boost economic demand. In November, the Fed began a new programme of asset purchases, to amount to $600bn in all. Then, in December, President Obama not only agreed with Republican leaders to extend the Bush-era tax cuts but further added a cut in payroll taxes for a year, an extension in long-term unemployment benefits and tax measures to favour corporate investment. But the latest expansive actions of the Fed and the Administration are unlikely to succeed in reducing the margin of spare resources if the US economy remains in depression. Indeed, the actions could be self-defeating to the extent that they have contributed to a rise in long-term interest rates amidst rising uncertainty over soaring US federal debt and its financing. Elsewhere, Japan’s policymakers are also in a bind, having run out of room to stimulate an economy where deflation is entrenched and where GDP may have slipped back during 2010Q4. The plight of the peripheral European economies and of the UK is clear enough. In the UK’s case, the Cameron Government has little choice, in view of market constraints, but to follow a policy of fiscal retrenchment, even though this is likely to weaken growth overall and add to unemployment. At the same time, the Bank of England’s scope for stimulatory action is severely circumscribed by strengthening inflation. The rise in domestic prices partly reflects import cost pressures stemming from a currency devaluation that appears to have brought scant improvement to the UK trade balance. This is a further symptom of deep-seated economic depression.

Germany seems the exception to the rule that advanced countries remain mired in depression. German industry has benefited from the buoyant demand of emerging-country customers. The operation of the income multiplier then gives the appearance of self-sustaining growth in the German economy. However, Germany might well ultimately be more vulnerable than most advanced countries, as it was in the winter of 2008-09, to a downturn in emerging countries’ demand. China’s impressive economic growth since 2008 has not materialised without support from huge fiscal and monetary stimulation. The rest of the world should be thankful that, because China’s economy has not been in depression, these policy measures have been effective. They have generated demand not only to keep China’s economy humming but to pull in imports from China’s trading partners. The Chinese authorities, however, are withdrawing monetary accommodation and may even adopt less expansive fiscal policies. The truly depressed economic state of the rest of the world is likely to become evident in the course of this year.