The world economy
Jan 21st 2010 | WASHINGTON, DC
From The Economist print edition
A YEAR ago almost every economy in the world was being walloped. The degree of pain varied. In rich countries output plunged; in China and some other emerging economies growth slowed sharply. But the slump was as striking for its synchronicity as its severity.
The opposite seems true of the recovery. China’s rebound began earliest and has been the most spectacular (see article). America’s economy began growing in the middle of 2009 and seems to have accelerated sharply in the final months of the year. Initial GDP estimates for the fourth quarter are due on January 29th, and many analysts expect annualised GDP growth to have shot up to 5.5% or more. News from the euro zone and Japan is rather gloomier. Germany emerged from recession before America, but its number-crunchers recently suggested that growth fell back to zero in the fourth quarter. The Japanese recovery also seems to be fading.
Shifting growth patterns could have big consequences for asset prices. Sustained strength in emerging economies, for instance, could push up commodity prices further, while a rapid rebound in America’s economy relative to Europe’s could strengthen the dollar more against the euro. So a lot rides on what is driving the divergence, and whether it lasts.
In America soaring GDP growth is likely to be a one-quarter wonder, driven by a rebuilding of firms’ shrivelled inventories. Output growth will slow in 2010—the question is by how much. Optimists argue that every deep post-war recession has been followed by a vigorous recovery and that growth will be well above its trend rate in 2010. But a gloomier outcome seems all too plausible. There are few signs of job growth. Much household-debt reduction still lies ahead. And there is the risk of a correction in stockmarkets.
But even a sluggish American recovery will outpace other big rich economies. The euro zone faces two different but equally painful problems. Former bubble economies such as Spain and Ireland are suffering a painful hangover. Germany, like Japan, is bedevilled by chronically weak domestic demand. Consumers are reluctant to spend and, so far, buoyant export growth has not incited firms to invest, despite hopes to the contrary.
The degree to which America outperforms the others will depend, in large part, on whether, and how, different countries tighten monetary and fiscal policy. There is a lot of talk about fiscal discipline within the euro zone, not least because financial markets are punishing Europe’s peripheral economies for their profligacy. Greece this month announced an unprecedented fiscal squeeze over the next three years. But Greece makes up only 3% of euro-area GDP, and rapid fiscal consolidation is much less likely in the big economies. The junior partner in Germany’s coalition government is pushing for tax cuts in 2011; France is railing loudly against the idea of cutting its deficit any time soon.
America’s budget outlook is rather more uncertain, especially in the light of the Republicans’ unexpected Senate victory in Massachusetts. The current stimulus package will stop boosting GDP growth by midyear. Thanks to the requirement that they balance their budgets, states are furiously cutting spending. Although the House of Representatives has passed an additional $150 billion-worth of job-boosting stimulus, the Senate has not yet done so. And if Congress does nothing, the Bush-era tax cuts expire at the end of the year. That seems unlikely, but political gridlock could cause America’s fiscal boost to fade unexpectedly sharply.
Policy decisions will also influence the relative strength of the recoveries in the emerging economies versus the rich world. Though China’s private demand strengthened a lot in the second half of 2009, growth is still largely driven by a government-directed lending boom. China’s short-term prospects thus depend on how quickly the government damps down the lending frenzy. Fears of tighter credit in China weighed on stockmarkets this week but the signs still point to very gradual tightening—and scant dampening of growth—in China and the rest of the emerging world.
Powerful structural factors will continue to reinforce the relative strength of the emerging world. Jonathan Anderson of UBS points out that even if you exclude China and India, emerging economies grew some four percentage points faster than rich economies during the recession, about the same growth gap that existed before the crisis. Some emerging economies, especially those that relied on foreign debt finance, will face prolonged problems. The World Bank argues in a new report that tighter financial conditions, thanks to tougher regulation and higher risk aversion, could reduce developing countries’ trend growth by 0.2-0.7 percentage points over the next five to seven years. Even so, the hit to potential growth in the rich world is likely to be bigger.
Persistent relative strength in emerging economies, especially China, suggests that commodity prices will stay stable or firm. It also means their currencies should rise against the dollar, though the pace will depend, more than anything, on China’s decisions about the yuan. Within the rich world, the growing transatlantic growth divide has helped buoy the dollar versus the euro: it is up by more than 5% from its lows in November. Will that rally continue? The answer depends as much on the likely policy mix as today’s growth differentials. Other things being equal, tighter fiscal policy suggests loose monetary policy for longer and a weaker currency. So relative fiscal discipline in America would push the dollar down, and vice versa.
A multi-speed recovery could also affect imbalances between countries’ current-account surpluses and deficits. America’s current-account deficit and China’s current-account surplus have both halved from their peaks as a result of the crisis, to around 3% and 6% of GDP respectively. Whether that reduction continues depends first on oil prices and second on the pattern of global demand. Imbalances will only stay low as the global economy recovers if surplus economies, especially China but also countries like Germany and Japan, rely on domestic demand while the big borrowers, especially America, cut their budget deficits and save more. Economies are now growing at different rates. They must also grow in different ways.