George Magnus argues that the financial crisis in the West has thrown down the gauntlet of structural reform for emerging markets. The prospects for the global economy, he says, depend not so much on mechanical extrapolations of GDP, than on good politics and robust legal and social institutions.
The West’s financial crisis has both caused and amplified a growing schism between the economic plight of richer industrial countries, and the economic power of major emerging nations. The Federal Reserve’s resumption of quantitative easing, for example, has unintentionally sharpened the trend towards greater currency and capital account protectionism in several major emerging nations, and given them new cause to complain, rightly or wrongly, that US economic policies are aggravating rising inflation and potential instability.
Yet the optimism about emerging markets among companies and investors is undiminished. The new economic kids on the block are already home to the production of $3000 cars, $300 computers and $30 mobile phones. They headquarter many firms that are climbing rapidly up the value chain, and are leaders in low carbon and alternative energy technologies, telecommunications, energy exploration, and aerospace. And not to forget, they will bring to market the world’s next one billion consumers.
Emerging markets are viewed as dynamic growth markets and effective competitors and rivals, not just as vast reservoirs of cheap labour and low cost brains. Is it any wonder that people assert, with enthusiasm or angst, that this is the emerging markets’, in particular Chinese, century? The answer to this rhetorical question, though, is not as straightforward as you might think.
The crisis has sent the world system into a spin, and it is not possible to determine with confidence what its contours will look like. So far, it is Western indebted nations that have been shocked into an economic and social reboot, but the dynamic of the crisis means that emerging nations will have to do likewise. Put simply, if households, banks and governments in the West are going to have to save and export more, someone else has to do less of both if the system is to function smoothly without tearing the fabric of globalisation.
The boot, then, is firmly on the foot of the emerging world, and nowhere more so than China, the world’s aspiring geo-political power, its biggest exporter and creditor nation, and second biggest economy in terms of GDP. Even if we can check all the boxes over the longer term about why China and emerging markets should out-grow us and catch us up over the next few decades, the path to the future, and especially in the coming decade, is now something of a minefield. As the proverb goes, there’s many a slip ‘twixt cup and lip.
The most immediate problem is the unsuitability of China’s economic development model of the last 20 years to the post-crisis world. There is an obsessive focus on the repressed yuan exchange rate as the problem that needs fixing. But a higher yuan exchange rate, per se, would not narrow the US-China trade imbalance much, or address the economic imbalances in either the US or Chinese economies. Instead, the real issue is the development model itself, specifically its strong mercantilist emphasis on capital investment and exports, and its tendency to extraordinarily high levels of savings and investment. In relation to GDP, these amount to about 53 percent and 46 percent respectively, the difference equating to the country’s external surplus, now rising strongly again since the decline induced by the crisis and the government’s stimulus programme.
Rebooting in China, or what is commonly called ‘rebalancing’ in China, is official government policy, and again highlighted in the new (12th) Five Year Plan draft. The gist is a redirection of the economy towards consumption and services, while targeting further investment in new industries, green projects, and alternative energy. But what this amounts to is a radical economic transformation that would shift economic and political power from companies to consumers, from cities to the countryside, and from coastal provinces to those further west. It would entail big economic reforms, including to the yuan and to exceptionally low interest rates, but also social and political reforms that could threaten the raison d’être of the Communist Party, and that are barely feasible in view of the government’s reaction to the Nobel award to dissident, Liu Xiaobo. It would most likely entail some period of higher unemployment, at least in a transition period, with the attendant risk of aggravating social instability, already characterised by about 90,000 incidents annually in each of the last four years.
With a leadership changeover scheduled in 2012, caution is likely to remain the order of the day, when a bit more boldness would be preferable. In the coming year, we should watch carefully how China addresses the problem of rising inflation for example, and how, if at all, it seeks to address the rising trend in the external surplus.
This isn’t just a Western rant. If China’s policies do not change significantly and soon, the government may well tread further down a path which Japan also followed in the 1980s, sustaining and then feeding an inflation, investment and asset bubble that will eventually burst when the People’s Bank of China is instructed to bring matters to order. We may be about to find out if China’s economy has just two speeds, full ahead and stop, and if so, whether the political capacity to generate 9-10 percent economic growth is able to deal with the consequences.
Longer term, China and other major emerging markets have undoubted demographic strengths. But important caveats pervade this assertion too. Most emerging nations are still in the ‘sweet spot’ when child dependency on the working age population is falling or low, rising old age dependency won’t become a problem until the 2030s, and meanwhile the productive labour force will continue to expand. This so-called demographic dividend is associated normally with rising levels of savings, consumption, equity market valuations and other boom-type conditions.
China is an exception. It is the fastest ageing country on Earth. Today it has 10 workers to support each citizen aged over 60, but this is going become 2.5 by 2050, lower than the US. In 30 years, China will be older than the US on every important measure. Along with rapid ageing and rising wages, China will also have to contend with the dysfunctional economic and social implications of extreme gender imbalance.
India, by contrast, where a third of the population is aged under 14, can look forward over the next decade alone to an increase in its labour force that is bigger than the entire working age population of Western Europe today. India could sustain 10 percent economic growth as China’s rate of expansion tails off. But if India’s unemployment—officially measured at 7 percent but more likely closer to 27 percent—doesn’t decline because of insufficient job creation, India’s demographic dividend might only pay in terms of social problems and stagnating growth instead. India, and countries such as Indonesia, Nigeria, Egypt and Mexico will have to reform to exploit this dividend.
Concluding, nothing said here or in my book Uprising, suggests that emerging nations won’t continue to become more prosperous, or that there is an economic flaw in their widely acknowledged attributes. But the crisis has thrown down the gauntlet of structural reform for them too. The prospects and business outlook for emerging markets, then, depend not so much on mechanical extrapolations of GDP, than on good politics and robust legal and social institutions. There is far less conviction about this than about the emerging markets’ century.