The world economy seems finally to be on the mend, with global economic growth forecast at 4.2 percent this year and 4.6 percent in 2012, according to the OECD’s latest Economic Outlook.

But there are still many risks to recovery and handling these successfully will require far-reaching structural reforms in national economies, says the OECD’s Chief Economist, Pier Carlo Padoan.

“There is a recovery under way, and it is becoming stronger and more broad-based,” Padoan told INSEAD Knowledge in an interview at the OECD Forum in Paris.

“However, it is a multiple-speed recovery, because emerging economies are growing faster than advanced economies and within the group of advanced economies, some are growing faster than others,” says Padoan. “And, most OECD countries are facing very important fiscal consolidation, which rules out using fiscal policy for short-term expansion.”

Barring new setbacks, the OECD expects growth in the United States next year of 3.3 percent, after a forecast of 2.7 percent in 2011, and 2.2 percent in the Euro area against 2.1 percent in 2011. Japan can look forward to growth of 2.2 percent next year after seeing its economy shrink by 0.9 percent this year because of the tsunami. In Germany, growth is expected to slow slightly to 2.5 percent next year after 3.4 percent in 2011. Growth rates in the major emerging economies will continue to be markedly stronger, with China forecast to grow by 9 percent this year and 9.2 percent in 2012, India projected to show 8.5 percent GDP growth in both 2011 and 2012, and Brazil forecast to grow by 4.1 percent this year and 4.5 percent in 2012.

In a wide-ranging interview, Padoan touched on the effects of the tsunami in Japan, noting that while expectations are for a recovery in Japanese output in the second half of this year there are still uncertainties about the impact on the global supply chain of production problems in Japanese companies. He emphasised the need to help develop economic and social institutions in the countries of the Middle East and North Africa that are now undergoing political change, so that they can build on the human capital advantage of their large population of young people. And he stressed the significance of new environment-friendly approaches to economic growth in marking a gear-shift in globalisation.

“There is a growing understanding of how to reshape growth in ways that are favourable to the environment,” Padoan commented. Combined with the availability of a large population of young people in emerging countries and the urgent need to develop new ways of producing and consuming energy, this provides major opportunities for all countries, he said. “Green growth can mean a dramatic change in consumption patterns, in preferences, in production patterns and in the way technology is put to the service of growth.”

But consolidating the recovery will require determined efforts on the part of governments to tackle structural weaknesses in their economies, Padoan said. Unemployment, though slowly declining, is still high. In the U.S., unemployment is projected to fall to 7.5 percent by the end of 2012, from 9.6 percent at the end of last year. In the European countries that use the Euro as their currency, however, it will remain above 9 percent, and it will continue to hover at around 4.5 percent in Japan. In almost all OECD countries, there is a risk that without structural reforms to release productive potential, long-term unemployment, particularly among young people, could become structurally entrenched.

Other threats to continued recovery include persistent current account imbalances and budget deficits in major OECD countries and emerging economies and the risk of higher oil prices and continued problems in housing markets. “If downside risks interact, their cumulative impact could weaken the recovery significantly, possibly triggering stagflationary developments in some advanced economies,” the OECD’s Economic Outlook warns.

In this tricky environment, the persistence of current account and fiscal imbalances is a particularly worrying potential source of future instability. The U.S., for example, faces a current account deficit next year equivalent to 4 percent of its gross domestic product, after a deficit of 3.7 percent of GDP this year, while its budget deficit is forecast to fall only slightly, to 9.1 percent of GDP, only slightly down from 10.1 percent this year. Japan, meanwhile, is expected to have a current account surplus of 2.5 percent of GDP next year, against 2.6 percent this year. China’s current account surplus is predicted at 4.4 percent of its GDP in 2012, little changed from 4.5 percent this year, while Germany is forecast to have a current account surplus of 6 percent GDP in 2012, up from 5.5 percent in 2011.

Imbalances, in and of themselves, are not necessarily bad, Padoan points out. “In general, we need some imbalances, because they indicate that savings are being reallocated globally,” he says. “That is good, because in the long term it supports growth.” Without balanced growth, however, imbalances threaten to become unsustainable as deficits pile up and countries become increasingly indebted. Low growth and high debt interact negatively, so it is important to get out of debt in order to grow, and to grow in order to get out of debt, Padoan asserts.

To achieve that objective, Padoan says, governments in deficit countries need to encourage productive investment. Recent OECD analysis has identified ways in which structural economic reforms can lead to increased capital flows directed towards productive investment. The choice of reforms will vary from country to country, but if well-chosen they can pay multiple dividends.

In China, which continues to have a large current account surplus, better provision for pensions and healthcare could prompt people to save less and spend more, boosting growth through increased consumption, Padoan suggests. In Germany, by contrast, measures to liberalise the services sector could encourage investment, which would similarly reduce the current account surplus while boosting growth.

For the moment, in the wake of the crisis, it is clear that most governments have little appetite for such reforms. “Countries are suffering from the fatigue of having to deal with the recession,” Padoan acknowledges. “However, we are living in an environment in which the traditional policy instruments – fiscal policy, monetary policy -- cannot be used any more to boost growth, which is badly needed.

Structural reforms must be adopted because most OECD countries are facing very important fiscal consolidation requirements, which rules out the possibility of using fiscal policy for short-term expansionary purposes.”