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Sunday, September 25, 2016
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- It is growing increasingly likely that the world will face renewed risks of instability and slowdown before fully recovering from the so-called Great Recession. This is largely because the fragility and imbalances that have built up over recent years as a result of misguided policies in the US and Europe cannot be easily undone, regardless of the policy pursued today.
The strong growth in developing and emerging economies that we have seen since mid-2009 is not sustainable. First, it is the product of a strong policy response to the crisis whose effects are fading in several developing economies, particularly in China, which has been the locomotive for commodity-rich developing countries. At the same time, growth prospects in major advanced economies are worsening.
Second, the response to the crisis in advanced economies -excessive liquidity generation and sharp cuts in interest rates- is actually creating bubbles, not in Europe and US but in commodity markets and the developing world. This cheap money in search of yield is a major factor behind the rapid growth in several emerging economies, but it will not be there forever.
China introduced a massive stimulus programme in response to the crisis, reaching 15 percent of GDP, three times that of the US. But it focused on investments, pushing it to over 50 percent of GDP. Support to household incomes has remained moderate even though the country faces a problem of underconsumption, with private consumption hovering around 36 percent of GDP, half the level of the US. Chinese growth has also been pushed up because of large private foreign capital inflows.
China needs to reduce its dependence on exports and rely on domestic markets for growth. Its current account surplus fell from a peak of 11 percent of GDP in 2006 to around 5 percent in 2010, now lower than that of Germany. Chinese adjustment needs to be based on significantly faster-growing household income, that is, a rapid expansion of wages without a pass-through to prices, and employment. This would appreciate the currency while simultaneously creating domestic demand to offset the slowdown in exports.
China now recognises the need to shift to consumption-led growth. It has recently taken several measures related to minimum wages, wage growth, faster job creation, bolstering the service sector, improving social safety nets, etc.
What will happen if China slows down? A slide from double-digit growth to 7 percent could have a serious adverse impact on commodity exporters. On the other hand, over the longer term, a successful shift to consumption-led growth could also shift the Chinese demand from hard to soft commodities, particularly grains and meat, aggravating the global food shortage.
How will all of this end up? I can see four possible scenarios. First, these bubbles could end with an abrupt monetary tightening in the US. It could happen even before full recovery as a result of rising inflation and/or bond market pressures. No matter what, near-zero interest rates are not here forever; the question is whether they will return to normalcy gradually or abruptly.
Second, a significant slow-down of growth in China, possibly aggravated by the bursting of the credit and property bubble, could bring an end to the boom in commodity markets and capital flows. It could not only depress Chinese demand for commodities but also trigger a massive exit of speculative capital from commodity markets.
Third, a balance-of-payments crisis in a major developing economy could bring an end to the boom in capital flows by sparking contagion across emerging markets. For example, Turkey now has a current account deficit of close to 10 percent of GDP, and deficits are also high and growing in certain other emerging economies. A sudden change of mood in the markets, as we saw in East Asia in 1997, could trigger a currency and payments crisis in such countries.
But the Achilles heel of global finance is now Europe, where default is a very real possibility in the highly-indebted periphery. As long as the European Commission and the European Central Bank continue to pretend that this is mainly a liquidity crisis, the region will remain susceptible to extreme instability and messy defaults with the attendant consequences for capital flows and financial stability in emerging economies, similar to the aftermath of the Lehman collapse.
In any of these scenarios, it is highly likely that the downturn in capital flows will be associated with a reversal of commodity prices. As a result, the most vulnerable countries are those which have been enjoying the twin benefits of global liquidity expansion, that is, the surge in capital inflows and the commodity boom. (END/COPYRIGHT IPS)
(*) Ylmaz Akyuz is the Chief Economist of the South Centre. For further analysis see South Bulletin, issue 56 http://www.southcentre.org.