Think globally like Jimmy Rogers, or Stephen Roach, Morgan Stanleys #1 economist.
>>Growth could well be in short supply in the world economy over the next decade. The United States -- the unquestioned engine of global growth since the mid-1990s -- could be facing stiff headwinds for years to come. Nor do Europe and especially Japan seem particularly capable of filling the void. That puts the onus on the developing world -- heretofore heavily dependent on exports to the industrial world as a major source of growth. With that impetus likely to be on the wane, the developing world will have no choice other than to discover a new recipe for growth. For a world in search of growth, that could well be the only way out.
The US-centric global growth dynamic has overstayed its welcome. That’s the unmistakable message of America’s massive current-account deficit -- the broadest measure of international balance between the United States and the rest of the world. The world economy is now attempting another transition from recession to recovery. But it commences that shift with the US current-account deficit at 4.1% of GDP in 4Q01. By way of contrast, the current-account deficit was 2.7% in late 1998, when the United States was about to lead an important transition in the world economy from financial crisis to global healing. Back then, there was considerable scope for a further widening in the US external imbalance. Today there is not. Another spurt of US-led global growth could well take America’s current-account deficit up to 6% of GDP in 2003, requiring foreign capital inflows of nearly $2 billion per day in order to finance it. History demonstrates that current-account adjustments usually commence when deficits hit 5% (see my 4 April dispatch, "On Current-Account Adjustments"). I doubt if the United States will be an exception to that rule.
Our "global decoupling" thesis stresses the likelihood of three new attributes to the character of the global economy in the years ahead -- slower growth in the US, faster growth elsewhere in the world, and a weaker dollar. Only by some combination of these outcomes would America’s massive current-account deficit begin to move back toward balance. But the coming realignment in the mix of global growth will be driven by more than just an adjustment in the US current-account deficit, I believe. Also at work is a confluence of powerful structural forces likely to impede potential growth in the United States and Japan, and to limit progress in Europe.
Two sets of forces are at work in the US -- a likely downshift in trend productivity growth and a purging of the excesses that built up during the bubble. The productivity story rests on three likely developments -- a sharp slowing in IT spending after the binge of the 1990s, a shift in the mix of aggregate output toward nonproductive expenses on homeland and national defense, and higher business operating expenses associated with the added logistical costs in the post-9/11 era. The excesses that need to be purged include record debt loads of consumers and businesses alike, anemic household saving, and a lingering overhang of business capacity. Reflecting these likely depressants, I look for the US economy’s potential growth rate to slow into the 2.5% range over the next 3-5 years, a significant moderation from the 4% trend of the late 1990s. If such a downshift comes to pass, it would all but neutralize the "excess growth contribution" the US has been making to the world economy since 1995. The world’s growth engine would, as a result, be chugging along at a much slower speed.
The outlook in Japan is, unfortunately, more of the same. Robert Feldman’s CRIC cycle says it all -- Japan is locked into the political economy of a most vicious circle. The nation has now moved into the "I" phase of this paradigm -- a modest degree of Improvement. But that’s what then sets the stage for the next phase, a sense of Complacency that, in turn, sows the seeds of next Crisis. While each crisis evokes a Response, in the CRIC cycle it falls far short of the legitimate reforms that are required to break a pattern that is now into its second decade. The lack of financial sector reforms is particularly disturbing in this regard, as the authorities continue to drag their feet on the cleanup of nonperforming bank loans. Prime Minister Koizumi’s disappointing failure as a reformer makes a political resolution of this dilemma highly unlikely. As a result, it seems improbable that the Japanese economy will stage a meaningful breakout from the 1% growth path it has been on since the early 1990s. That would keep Japan’s contribution to global growth very close to "zero."
The outlook in Europe is more upbeat than in either the United States or Japan. That’s in part because Europe did not succumb to the excesses of the late 1990s -- especially the seemingly open-ended business spending binge on information technology. If anything, Corporate Europe remains IT-starved. Moreover, debt and saving imbalances are nowhere near those of the US. At the same time, Europe has been making a good deal more progress on the reform and restructuring front than a weak euro might lead one to believe. Tax, cost, and price harmonization within the EMU has led to improved efficiencies for the region, as have surprising improvements in labor market flexibility (i.e., Germany), together with the eventual improvement in the shareholder-value culture. While there can be no denying Europe will benefit from several of these developments, our euro team believes that it will still take at least three years to realize the ultimate productivity benefit of around 2% per annum. Even if that were to occur, it would result in an add-on of only about one percentage point to the gains of the 1990s. That’s not enough to offset the emerging weakness in the US and the ongoing malaise in Japan.
That brings us to the developing world. For global economic growth to stay the course of the last 30 years, I believe that the developing world will finally have no choice but to unshackle its domestic demand. Needless to say, that won’t be easy, nor will it occur quickly. Two candidates seem best positioned to lead the charge -- China and India. Collectively, in 2001, these countries accounted for 45% of total developing-world GDP, according to the purchasing power parity metric of the IMF. By way of comparison, the combined output weight of China and India is double the 22% share of Latin America.
China and India have already demonstrated encouraging progress in taking more of a leadership role in today’s global economy. In 2001, these two nations kept the world from tumbling into a severe global recession -- they accounted for fully 44% of world economic growth that the IMF now places at 2.5% (see my 19 April dispatch, "The World’s New Growth Cushion"). China and India are both extremely focused on the first stage of their economic development -- drawing sustenance from external demand. That underscores the huge potential both nations have both as exporters and as the world’s outsourcers of preference. China has the opportunity to become the dominant force in world manufacturing, whereas India has to the potential to do the same with respect to IT-enabled services. Yet exports and outsourcing are but a means toward the end -- the job creation and income generation that eventually unshackles domestic demand. For China and India, which collectively comprise 38% of the world’s population, the impacts of that potential can hardly be minimized. But at this point, that’s all it is really is -- potential. Sadly, the long history of economic development is littered with the carcasses of false promises. It remains to be seen whether China and India will break the mold in that regard.
China and India could well be the answer for a world in search of growth in the first decade of the 21st century. The world has lost its engine, and there are no obvious candidates to take its place. That’s especially true in the industrial world, where a possible downshift of trend growth in the US economy seems unlikely to be offset by a pickup in underlying growth elsewhere in the developed world. Nor is this likely to be a transitory development -- especially in the United States and Japan. That puts the onus on the developing world, especially on its two gorillas, China and India. I am hopeful that both nations can pull it off over the next three years or so. But barring that critical transition, a seemingly chronic global slowdown could become the new norm in the first decade of the 21st century. Just as China and India collectively saved the world from recession in 2001, they have the opportunity to underwrite recovery and expansion in the immediate future. Companies domiciled in mature markets have no choice other than to look to China and India for new sources of growth, in my view, and investors need to do the same. The search for growth is on.
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