It now appears possible that GDP in the United States might grow at a rate close to 3 per cent in 2012, compared to 1.7 per cent in 2011. Moreover, for several months, job creation has exceeded new entries into the labour force, reducing unemployment to well below 9 per cent for the first time since the employment plunge in 2009. While this is modest progress compared to the challenge ahead — it would take almost a decade to reduce unemployment to pre-crisis levels at the pace of recent months — it has triggered a significant stock market surge, reinforcing a positive dynamic in the US economy.

There also is considerable uncertainty in the outlook for Europe with median forecasts suggesting another year of zero growth. The long awaited deep Greek private debt restructuring finally took place without the catastrophic effects that some who had argued against it had forecast. The European Central Bank (ECB) provided ample medium-term liquidity to the banking system, calming markets and providing time for greater structural adjustments. A decision to augment the size of the euro zone’s financial firewall was finally taken in late March. The latter involves a temporary enlargement of the euro zone bailout system to €700 billion by setting up the new bailout fund, called European Stability Mechanism (ESM) with a permanent €500 billion in capacity, but allowing the €200 billion from the European Financial Stability Fund already committed to Greece, Ireland and Portugal, to be set aside and not be folded into the ESM as originally planned.

Growth in the emerging and developing countries has slowed, but still continues at a robust pace, with their internal growth dynamics playing an increased role compared to their exports to the advanced world.

A surge in oil prices at the start of the year, linked partly at least to political uncertainties surrounding Iran and security of supply in the Gulf, signalled a new danger in the early months of 2012. A massive surge in oil prices remains a short-term threat for the world economy, but at time of writing this threat seems to have moderated, notably because of the strong resolve of Saudi Arabia to stabilise prices, although this resolve would not be of much help if there were serious disruptions of supply routes.

Despite this mixed news there remain very serious downside risks and long-term difficulties for rapid and balanced growth of output and employment in the world economy. While there are some risks and reasons to fear everywhere, the most serious systemic risks are linked to problems in the euro zone and, notwithstanding recent progress, in the Unites States.

The massive provision of liquidity to the banking system by the ECB has been crucial in overcoming the immediate crisis that threatened in late 2011, but it cannot by itself lead to healthier and better capitalised financial institutions. For that, serious restructuring and additional capital is needed. Time has been gained, but that time needs to be used to solve the underlying problems of the banking sector. With regard to the ratios of sovereign debt to GDP, the fear is that the contractions in GDP that could be caused by too severe austerity measures would frustrate the attempts to reduce indebtedness ratios by very restrictive fiscal policies. So both the banking sector’s problems and the high debt problems remain unsolved for a number of countries.

Perhaps even more intractable than the banking sector and national fiscal problems may be the internal imbalance problem within the euro zone, within which cost structures have diverged and where some countries have lost competitiveness to an extent severely constraining their growth prospects. It is reasonably clear that the equivalent of a real devaluation is needed, but it cannot take place with the help of nominal exchange rate adjustments in a monetary union. So it must take place through ‘internal’ price and wage level adjustments. This is extremely painful and difficult, particularly if the adjustment burden is put entirely on the ‘deficit’ countries, as has so far tended to be the case. A real debate is now underway in Europe as to the economic and political ‘realism’ of current policies. The search should be on for the narrow limits of the possible between too much austerity imposed on, broadly speaking, the ‘South’, that could lead to socioeconomic ‘growth collapse’, and too little long-term fiscal adjustment paving the way to renewed crisis.

This debate is being shaped by a rapidly changing political climate in Europe. In Greece, France, the Netherlands and Germany, election results and coalition politics appear to be showing the strains of sustaining austerity programs. A new discussion of innovation and productivity growth is occurring, but against a backdrop of uncertainty over the ability of politicians to implement and sustain long-term programs.

These predominant concerns about Europe seem to have distracted attention from the very serious fiscal and long-term structural challenges that remain in the United States. The recent uptick in growth still appears to owe too much to extremely expansionary monetary and fiscal policies that will be hard to sustain. The private sector deleveraging process has made some progress but is far from completed. Fixed investment remains low despite large corporate profits and the availability of finance. And the uncertainty about future policies has been accentuated by the polarisation of the political process and the very different approach taken by the two main political parties. The United States is on an unsustainable path in terms of the combination of tax revenues and government expenditures. Many avenues for reform are possible and different policy packages proposed reflect the interests and political philosophies of different groups. What is not sustainable, however, is a prolonged stalemate. Unfortunately this is exactly what the political system has offered over the last few years.

There are of course other risks in the world economy that do not have their primary source in the US or Europe. A major slowdown in China, perhaps triggered by retrenchment in the real estate sector, would be a severe blow to the world economy.

The policy debates in Europe and the US are hugely important, not only for their immediate impact on the national and global economies. They also reflect deep disagreements among economic theorists and the difficult search for a post-crisis framework of analysis. And they reflect the big dilemma of globalisation: how can national democratic processes and election campaigns, rooted in the very ‘local’, lead to economic decision-making that takes into account our increasing global interdependence?

Perhaps the most crucial contribution the G20 process can make is to help bridge the gap between the national and the global, in full cooperation with the existing global international institutions, as well as engaging the world of academia, civil society and think tanks. There will be several new faces at the Los Cabos G20 Summit, as well as new domestic political landscapes for many leaders. The G20 is an opportunity to connect their concerns with global approaches. The atmosphere of finger-pointing at others as the source of the world’s problems can be offset by thoughtful communication about globally coherent solutions.

Kemal Dervis is Vice President and Homi Kharas is Senior Fellow and Deputy Director of Director of Global Economy and Development at the Brookings Institution, Washington. This essay is an abstract of their introduction to Think Tank 20: Perspectives on the Los Cabos G20 Summit, available here.