The year 2012 is Europe's moment of truth. If their dithering continues, European politicians will soon lose control of the continent's economic and financial future. After all the excitement of 2011, it is also a make-or-break year for some Middle Eastern countries in the midst of tricky political transitions. Even the United States is being shaken out of its social slumber as concerns mount about income inequality and, more generally, the fairness of the "system."
All this speaks to an increasingly bimodal outlook for the world economy in the years ahead. At one end, timely and proactive policy measures can help with the healing and put the globe back on the path toward higher growth, job creation, and better social justice. At the other, political dysfunction and financial deleveraging could lead to economic fragmentation, higher unemployment, trade wars, and social unrest.
In an attempt to shed light on the key issues in play, what follows is an attempt to identify four factors that could wreck the global economy in the next few years, and four factors that could propel it to greater stability and prosperity. Let's hope our leaders choose wisely.
THE WORST CASE
European economic and financial fragmentation: As of today, the biggest risk for the global economy this year is the disorderly collapse of the eurozone. It would bring economic and financial activity to a standstill across the continent, cause widespread corporate bankruptcies and bank runs, and destroy millions of jobs. Other countries, be they advanced or emerging, would be contaminated by the collapse in global trade, the curtailment of credit, and the spike risk aversion that would lead investors to rush into cash. A complete eurozone collapse would be both chaotic and an unmitigated disaster.
Disruptions in the Middle East: As the New York Times' Thomas Friedman brilliantly pointed out in a recent column, there are two types of destabilized countries: those that implode when highly stressed, and those that explode, affecting entire regions. Iran and Syria are of the latter type, and both are near boiling point due to internal and external developments. The greater the instability in these two countries, the higher the risk of regional contamination and, accordingly, worrisome global repercussions. This could include surging oil prices, leading to an ugly global stagflation.
Central bank exhaustion: Unconventional measures by central banks have, up to now, played a critical role in avoiding debt deflation and economic recessions in advanced economies. In the process, the banks have ballooned their balance sheets to previously unthinkable levels (from 20 percent of GDP for Britain and the United States to 30 percent for the European Central Bank). No one knows with any degree of confidence how far these balance sheets can expand safely, nor is there sufficient clarity on the collateral damage and unintended consequences. What is clear is that we are in unchartered waters and, given that they are the only agencies that have stepped up to the policy plate, the world can ill afford a loss of central bank credibility and effectiveness.
Social unrest: Enabled by social media technologies that facilitate broad-based coordination, the world has witnessed an astonishing outburst of grassroots social movements that are pressing for greater social justice -- from the Arab Spring to the Indignados in Spain, the Occupy movements in the United States, Israel's protesters, and anti-austerity riots in Greece and Italy. Having come together on the basis of legitimate grievances, these movements now face the challenge of pivoting from complaints about the past to helping to build a better future. The longer it takes the pivot, the higher the probability of frustration and of the protests turning violent -- and governments reacting inappropriately.