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 article More on this topic More by this author

Opinion

ASEAN Against the World: Strength in the Numbers

Corporate debt in emerging markets has long been perceived as a relevant risk for the global economy. In reality, this perception might be true for some large emerging economies, especially China, but not for its neighboring countries, namely those in the Association of Southeast Asian Nations (ASEAN) region.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 19, 2017
Read article More on this topic More by this author

Blog Post

The US retail crisis

What’s at stake: America is undergoing a retail sector crisis, partly related to the increase of competition from online commerce. We review recent contributions to this debate.

By: Silvia Merler Topic: Innovation & Competition Policy Date: July 17, 2017
Read article More on this topic More by this author

Blog Post

The forward guidance paradox

What’s at stake: the term “forward guidance” is used in economic jargon to describe central bank communications about the likely future path of policy rates. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and recent literature has been trying to reconcile this with reality.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 10, 2017
Read article More on this topic More by this author

Opinion

Engagement in a time of turbulence

The arrival of China as an increasingly significant setter of global standards may be uncomfortable for India but is near-inevitable and needs to be planned for.

By: Suman Bery Topic: Global Economics & Governance Date: July 5, 2017
Read article Download PDF More by this author

Policy Contribution

The challenge of China’s rise as a science and technology powerhouse

China's ambition to be a global leader in science and innovation by 2050 seems well within reach. The creation of US-Chinese science and technology networks is enabling China to catch up and helping the US to keep its position at the science frontier. What steps should be taken by the EU to engage more with China, not to miss out in the future multipolar science and technology world?

By: Reinhilde Veugelers Topic: Global Economics & Governance, Innovation & Competition Policy Date: July 4, 2017
Read about event More on this topic

Upcoming Event

Sep
13
09:00

EU-China Economic Relations: Looking to 2025

This event will see the launch of a report on EU-China relations and discuss issues such as trade and investment, indusstrial cooperation and innovation and global governance

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

The US 100% renewables dispute

What’s at stake: Two years ago, a debate started on whether it would be feasible for the US to achieve 100% renewable energy power. The arguments on both sides have been fierce, and more has been written recently. We review the debate.

By: Silvia Merler Topic: Energy & Climate Date: June 26, 2017
Read article More on this topic More by this author

Blog Post

Raising the inflation target: a question of robustness

In an unexpected move, the Federal Reserve Chair Janet Yellen has recently brought up the issue of raising the inflation target. This blog argues that an increase in inflation targets may prove to be beneficial in achieving price stability in the long run. This would increase the credibility of central banks in achieving inflation goals and stave off the distortionary effects of deflation.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article Download PDF

Policy Contribution

How to handle state-owned enterprises in EU-China investment talks

Chinese state-owned enterprises (SOEs) are one of the main obstacles preventing China and the European Union from agreeing a bilateral investment agreement. Creating barriers to prevent Chinese companies acquiring European assets will not solve the problem, but bringing Chinese corporate governance closer to global market principles will be essential to ensure European and Chinese corporates operate on an equal footing in their cross-border investment decisions.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: June 19, 2017
Read article More on this topic More by this author

Blog Post

The Fed’s problem with inflation

What’s at stake: the Federal Reserve raised the benchmark interest rate by one-quarter of a percentage point. The moved surprised no one, but it still prompted economists to asks themselves questions about the Fed’s relationship with inflation. We review the most recent contributions.

By: Silvia Merler Topic: Global Economics & Governance Date: June 19, 2017
Read about event More on this topic

Past Event

Past Event

CANCELLED - What should be Greece's next growth model?

Due to unforeseen circumstances, we will have to cancel this event.

Speakers: Kuriakos Mitsotakis and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 8, 2017
Read article More on this topic More by this author

Blog Post

Other than climate change, can anything else unite Europe and China against Trump?

Some instant takeaways from the EU-China Summit. A timely show of unity, but little real change in interests.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: June 2, 2017
Load more posts