Opinion

The rolling global crisis will come home

When productivity growth slows down, there are two choices: to invest in the future or to live within one’s means. Instead, policymakers preoccupied with short-term goals have sought easy growth elixirs and soothing words.

By: and Date: August 26, 2015 Topic: Global Economics & Governance

This article was also published in the Indian Expressindian express

Finance Minister Arun Jaitley and Reserve Bank Governor Raghuram Rajan have been quick to declare that India is well-protected from the global turmoil. It is their job to soothe investor and public nerves. And the large foreign exchange reserves are a defense against a flight of funds from India. But this is not a conventional financial crisis. We are in the midst of a rolling global growth crisis that began in 2007 and has now entered a dangerous phase.

The illusion that India actually benefits from the recent turmoil—because, for example, oil prices are low—ignores the fact that prices are low because the global economy is so weak. The pervasive global weakness ultimately does the greater harm, especially because India is not competitive. Without a robust global presence, no nation can grow. China has been the lynch pin of the global economy for a decade. If China goes into a swoon, so will India.

Unwinding global excesses

Between 2003 and 2007, the world economy was in a bubble. In the United States, easy credit fostered a property price and construction boom. The illusory sense of wealth caused consumers to go on a binge, which led to a voracious appetite also for imports. China came on stream with its unbounded cheap labor, and so the increase in global demand could be met without a spike in inflation. Buoyant world trade spread this sense of prosperity. Europeans misguidedly celebrated their recently introduced euro; exports from emerging markets such as India soared and they were applauded for their sound policies. But this was not sustainable.
The inevitable crisis started in the United States in mid-2007. After some confusion, the Americans mounted a vigorous defense. They pulled back from the abyss in early 2009.

China played a crucial role at this stage. By pumping money into the financial system, the Chinese generated an extraordinary demand for global goods. The global economy sprung back to life in 2010. Emerging market commodity producers gained, as did German and other European exporters. In its April 2010 World Economic Outlook, the IMF declared that the crisis was over. Global growth was projected to return to pre-crisis rates.
But the American economic recovery proved to be hesitant and faltering. And Europe went into a deep funk, with the banks in bad shape and sovereign debt on the rise. The Europeans, moreover, made a mess by tightening monetary policy in 2011 even as they engaged in deep fiscal austerity.

In a historic reversal of roles, emerging markets were billed as the new stars, with China as the global engine of growth. But in October 2013, this story began to come apart. As most emerging markets rapidly slowed down, forecasters claimed that Chinese growth would decline only at a gentle and carefully calibrated pace.

Why China’s growth could collapse

At the San Francisco Federal Reserve in November 2013, economists Lant Pritchett and Lawrence Summers claimed that Chinese growth could decline quickly from the heady 8-10 percent a year to between 3 and 5 percent a year. Their claim was based, at first sight, on a purely statistical basis. There was no historical precedent to maintaining Chinese-style growth rates.

But Pritchett and Summers also made a more substantive argument. As the economist Dani Rodrik has long argued, sustaining high growth rates requires a constant evolution of high quality institutions. As a market economy becomes more sophisticated, accountability in transactions and business practices becomes critical, achieving which is a non-trivial task.  Pritchett and Summers added that dismantling the existing institutions would be disruptive. In other words, undoing the plethora of informal arrangements—many of them steeped in corruption—would set growth back before a sustainable new growth dynamic could be generated.

While mindful of these strictures, the Chinese nevertheless continued to pump up growth through easy credit provision and public spending for infrastructure projects. This not only delayed the inevitable but also created new pathologies within the Chinese economy. A correction was overdue. The trigger for the correction turned out to be the announcement that the Chinese yuan would be depreciated.

India in a global growth crisis

The best explanation for the rolling global crisis is a simple one. The world mistook the economic and financial bubble in the 2000s for sustainable prosperity. Global productivity growth was low at that time—and has remained low since. Unfortunately, the numbers show that the always useful, and often dazzling, computer-based and internet applications, generate minor macroeconomic productivity gains.

And when productivity growth slows down, there are two choices: to invest in the future or to live within one’s means. Instead, policymakers, preoccupied with their short-term goals have sought easy growth elixirs and soothing words.

If the global turmoil continues, the Indian stock market will continue to fall. Corporate profitability has been abysmal and businesses have virtually stopped investing. Although Indian inflation rates are down, they are still considerably higher than in competitor countries. The accumulated inflation differential over the past decade shows up in the inability to sell even low-tech consumer goods such as garments and leather products. A necessary decline in the exchange rate—perhaps by 10-15 percent from current levels—will hurt the many companies who borrowed in dollars. That could create more stress in the banking system, which would be further aggravated by a decline in inflated property prices.

To put it simply, Indian asset prices have increased in anticipation of growth that may not materialize. Little noted in the Pritchett-Summers paper was a prediction that Indian growth rates will also fall to between 3 and 5 percent, for exactly the same reasons as in China. For now, Indian statisticians have created the dangerous illusion that Indian GDP is growing rapidly when all indicators point to the contrary.

In the meantime, the government has chosen instead to extend the hand of the state, creating uncertainty in the tax regime and threatening India’s elite educational institutions. Instead of decisively privatizing the public sector banks, it has chosen to retain ownership and control over this long-standing source of patronage at unending cost to the budget. And to increase the ruling party’s hold over state legislatures, the central government has indulged in promises of fiscal giveaways.

India has never achieved high growth without strong exports. When the global crisis comes home, we will have no one but ourselves to blame.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read about event More on this topic

Upcoming Event

Jun
28
12:30

Trade war trinity: analysis of global consequences

Analysis of the long-term impact of the trade war and its three key players: EU, US, and China.

Speakers: Alicia García-Herrero and André Sapir Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Demographics and Long Run Growth

Scholars have been investigating the relationship between demographics and long term growth, in the context of the secular stagnation hypothesis. We review recent contributions.

By: Silvia Merler Topic: Global Economics & Governance Date: June 18, 2018
Read article More on this topic

Blog Post

The G7 is dead, long live the G7

The summit in Charlevoix left behind a Group of Seven in complete disarray. The authors think that the G-group, in its current formulation, no longer has a reason to exist, and it should be replaced with a more representative group of countries. In this fast-changing world, is the G7 only a relic of the past?

By: Jim O‘Neill and Alessio Terzi Topic: Global Economics & Governance Date: June 13, 2018
Read article Download PDF More on this topic

Working Paper

European and Chinese trade competition in third markets: the case of Latin America

While Europe continues to hold important trade powers, the rise of China in the global economy has significantly reshaped international trade and competition. In this paper, the authors show that the degree of competition between both powers in Latin America has risen in the past decade due to China's increased trade of high-quality products. They address whether China is an increasingly relevant competitor for Europe in Latin America and in which sectors China-EU competition is fiercer. These findings should be a wake-up call to Europe in its quest to remain competitive at the global level.

By: Alicia García-Herrero, Thibault Marbach and Jianwei Xu Topic: Global Economics & Governance Date: June 7, 2018
Read article More on this topic

Blog Post

Trade wars: Just how exposed are EU Member States and industries to the US market?

This blog focuses on how a more restricted access to US final demand could affect EU economies and sectors, by measuring their share of value-added absorbed in the US. The exposure of the EU as a whole in value-added terms is lower compared to that suggested by gross exports to GDP and, overall, gross exports misconstrue the picture of spill-overs through trade linkages. For individual countries, the degree to which gross exports overestimate or underestimate exposure is relatively small, with the important exception of Ireland. However, gross exports significantly overestimate the exposure of EU manufacturing to US final demand.

By: Francesco Chiacchio and Konstantinos Efstathiou Topic: Global Economics & Governance Date: June 1, 2018
Read article More on this topic More by this author

Blog Post

China’s new role in the global economy

The changing role of China in the world economy has recently been highlighted by its registering of a first current account deficit in 17 years. We review the economists’ analyses of this new role and associated challenges.

By: Nicolas Moës Topic: Global Economics & Governance Date: May 28, 2018
Read about event

Past Event

Past Event

Where is China’s financial system heading? Implications for Europe

How ready is China for the transformation of its financial system and how will this effect Europe?

Speakers: Elena Flores, Alicia García-Herrero, Gene Ma, Hu Yuwei and Guntram B. Wolff Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 25, 2018
Read article More on this topic More by this author

Blog Post

The effects of Brexit on UK growth and inflation

The full consequences of Britain’s vote to leave the European Union were never going to be immediately perceptible. As we approach the second anniversary of the UK’s Brexit referendum, we can compare the subsequent economic data for the UK and the euro area and see how it diverges from the trends established before the vote.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: May 23, 2018
Read article

Blog Post

The Iran nuclear deal crisis: Lessons from the 1982 transatlantic dispute over the Siberian gas pipeline

A US president taking a unilateral decision that affects European interests; European policymakers outraged at US interference in their affairs; European businesses fearing losing access to some international markets – sound familiar? This is the story of a crisis that took place in 1982 regarding the Siberian gas pipeline project; its outcome should inspire optimism in the Europeans’ capacity to counteract Donald Trump’s decision to withdraw the US from the Iranian nuclear deal.

By: Emmanuel Mourlon-Druol and Angela Romano Topic: Energy & Climate, European Macroeconomics & Governance Date: May 23, 2018
Read article More by this author

Blog Post

The EU should not sing to Trump’s tune on trade

The US threat of trade sanctions has put the EU in a difficult position. Nevertheless, the EU must respond decisively – not just to protect its own interests but those of the multilateral trading system, and to demonstrate to the US and other partners that trade is not a zero-sum game.

By: Maria Demertzis Topic: European Macroeconomics & Governance, Global Economics & Governance Date: May 17, 2018
Read article Download PDF More on this topic

Working Paper

How big is China’s digital economy?

The rise of influential Chinese digital giants, including Baidu, Alibaba, Tencent and Xiaomi has shown the world that China is a global leader in digital innovation and it is not surprising that China has started to influence the global digital market. But is China exploiting its full potential in this area? To answer this question, the authors assess how big China’s digital economy is relative to the rest of its economy, and how China performs compared to the rest of the world.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: May 17, 2018
Read article More on this topic More by this author

Blog Post

Trade war: How tensions have risen between China, the EU and the US

The multilateral trading system has been challenged by unilateralist measures and subsequent threats of retaliation. We collect the main events that have shaped the current situation and show which trade flows have been and will potentially be affected by the various measures. We end by discussing possible scenarios moving forward for the EU.

By: Francesco Chiacchio Topic: Global Economics & Governance Date: May 15, 2018
Load more posts