Shift in Global Growth Engines Signals Gain After Pain
A revolution in the world economy targeted at revving up new growth engines ultimately will produce gain after pain.
Three years into recovery, with economies lumbered by debt and limited bank credit, policy makers are trying to segue to a more balanced expansion from the drivers and excesses that caused the worst recession in six decades. The U.S. is further along as it spurs manufacturing and exports, while trading giants Germany and China seek to fan domestic demand. Europe’s struggling states want to swap government largess for trade.
While the aim is more-sustainable growth -- and current- account trade data suggest a rebalancing is under way -- the rebirth is leaving the world low on power for now and still could fail if any of the regions don’t pull their weight. The International Monetary Fund will underscore the risks when it revises down its outlook tomorrow.
“As you go through these adjustments, it’s quite painful,” said Jim O’Neill, chairman of Goldman Sachs Asset Management in London. “But coming out the other side with a different structure, we should have a much stronger world economy.”
A more even keel after the last credit-powered expansion would help the stocks of companies biased toward emerging-market consumers and U.S. manufacturing over those tied to commodities and infrastructure, said John Bilton, European investment strategist at Bank of America Merrill Lynch in London.
“There is a changing complexion in global growth,” he said. “It ultimately means a more balanced world economy over the longer haul, but before then it will make it harder for various regions to withstand exogenous shocks and so business cycles are likely to be shorter.”
That chimes with the analysis of Deutsche Bank AG strategists, who say expansions now are more fragile and easily broken. Twenty-one of 25 key economies they monitored have suffered at least one quarter of economic contraction since the global financial crisis hit, and most in the developed world have yet to regain their previous gross domestic product peak.
How soon the global economy can right itself will be debated this week at the annual meeting in Tokyo of the IMF, which serves as the traffic cop for worldwide imbalances. Delegates will be greeted by the news that the lender anticipates even worse growth this year than the 3.5 percent it projected in July.
“The global economy is still fraught with uncertainty, still far from where it needs to be,” IMF Managing Director Christine Lagarde said Sept. 24.
Nobel laureate Paul Krugman said Oct. 3 the U.S. and Europe are “nowhere close to ending” the slump, and German-led austerity efforts may prompt a 1930s-syle depression. Nouriel Roubini, co-founder of Roubini Global Economics LLC, told “Bloomberg Surveillance” with Tom Keene on Oct. 3 that growth is still “anemic,” and major economies are “barely midstream” in deleveraging.
There are nevertheless signs that the downshift may mask a move toward new economic propellers after the last boom proved too reliant on Chinese exports, U.S. consumers and easy borrowing.
U.S. debt has shrunk to a six-year low relative to the size of the economy as homeowners, cities and companies cut borrowing, allowing the government to raise record amounts of money at the lowest interest rates ever.
The IMF estimates the U.S. current-account deficit will shrink to 3.1 percent of GDP next year from 6 percent in 2006, while China’s surplus will contract to 2.6 percent from 10.1 percent in 2007.
“Any evidence that those adjustments are under way is constructive,” O’Neill said.
Less confident is Stephen King, chief global economist at HSBC Holdings Plc in London, who says narrowing trade gaps reflect stagnating global demand. The World Trade Organization last month revised its forecasts to show cross-border commerce expanding 2.5 percent this year, down from its prior 3.7 percent estimate.
Recent rebalancing has “much more to do with economic weakness than strength,” King said.
C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington and a former Treasury Department official, agrees.
“A very large part of the rebalancing is really due to the recession and cyclical factors,” he said. “The IMF shares that view.”
The U.S, once dependent on its own consumers, saw exports rise to a record 13.8 percent of GDP last year, up from 12.7 percent in 2010, according to the International Trade Administration.
Since the 18-month recession ended in June 2009, exports have added an average of one percentage point to annualized growth each quarter. That is almost double the 0.58 point average contribution since 1990 and accounts for about half the 2.2 percent annual expansion of GDP during the recovery, Commerce Department data show.
The rise in exports is “significant” even though “it is from a small base,” said Mohamed El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California.
Behind the improvement is a revival of U.S. manufacturing. Restrained wages and lower energy prices are giving companies a competitive edge over competitors in Europe and Japan, according to a Boston Consulting Group study. It reckons average expenses in the U.S. will be 15 percent less than in Germany by 2015 and 21 percent below Japan.
“The U.S. is becoming one of the lowest-cost producers of the developed world,” wrote Harold L. Sirkin, a senior BCG partner in Chicago.
The chemical industry is a particular winner, as an abundant supply of natural gas from shale formations gives U.S. producers a march over rivals in Europe and Asia, which use mainly higher-priced oil.
Exxon Mobil Corp. (XOM), the largest U.S. oil company, announced June 1 that it plans to build factories producing ethylene and plastics in Texas that will “significantly” increase exports of the latter product, the Irving, Texas-based company said.
Both President Barack Obama and Republican challenger Mitt Romney have pledged to do more to help domestic manufacturers if elected on Nov. 6. Obama backs tax breaks for those that keep jobs in the U.S., while Romney vows a harder line with China over its trade and currency policies.
Such help would come as demand for U.S. products is being blunted by weakness abroad. The trade deficit widened in July for the first time in four months, increasing to $42 billion, as exports fell. The shortfall with China climbed to a record, while the gap with the European Union was the widest in almost five years.
“The U.S. is beginning to do its thing,” said Nariman Behravesh, chief economist for IHS Inc. in Lexington, Massachusetts. “We’ve made some progress toward export-led growth, but stronger domestic demand abroad is crucial.”
Peripheral euro-area countries are suffering what El-Erian calls a “bad rebalancing” as investors force them to ax budget deficits when their economies already are contracting. The IMF predicts general government spending in Greece will slide to 41 percent of GDP in 2015 from 53 percent in 2009. The jobless rate there was 23.6 percent in the second quarter.
As austerity spells recession and drives up unemployment, policy makers are looking abroad for strength. With the 17 euro countries sharing a currency, the focus is on so-called internal devaluation, when labor costs are suppressed and productivity spurred to make goods relatively cheaper.
While painful because the steps risk even higher unemployment at first, Joachim Fels, chief economist at Morgan Stanley in London, said such “previously unthinkable” measures are delivering results, and he’s turning more optimistic about the euro’s long-term viability.
Italy eased rules on firing workers and opened up industries previously closed to competition. Spanish companies can opt out of central wage deals and negotiate directly with unions, as new pension requirements reduce early retirements. Greece cut its minimum wage by 22 percent, and Portugal now has fewer national holidays.
The result is that, excluding Germany, hourly labor-cost growth slowed to 1.4 percent in the second quarter from an annualized 3.9 percent in 2000 to 2008, according to Michel Martinez, an economist at Societe Generale SA in Paris.
“Rebalancing of cost competitiveness in the euro area is proving speedier than generally expected,” he said.
This may be reflected in trade data. In July, Spain recorded its first current-account surplus since the currency began trading in 1999; Greece reported its first since May 2010.
Germany could play a part by diluting its reliance on exports and rallying spending at home, said Neville Hill, head European economist at Credit Suisse Group AG in London. Monthly retail sales have been flat on average since 1999.
While Chancellor Angela Merkel hails her nation’s export might, its budget is almost in balance, unemployment is a two- decade low at 6.8 percent, and the nation has run a current- account surplus every month since January 2003.
Hints of change are emerging, with Volkswagen AG, Europe’s biggest carmaker, agreeing in May to a 4.3 percent pay raise for employees in western Germany. And the Bundesbank has acknowledged it expects German inflation will accelerate.
“One way or another, Germany needs to become less like Germany,” Hill said.
China also is trying to twist toward local spending and away from the infrastructure investment and foreign sales that helped stave off the credit crisis. The government has sought to build a social-safety net, expand public housing and encourage gains in wages.
The result is that China has exported net “growth to the world” in the past five years, having previously subtracted from it, according to Ken Courtis, founding chairman of Next Capital Partners LP in Tokyo.
“Rebalancing is already largely engaged,” he said. “This shift is set to continue.”
Officials’ reluctance to repeat stimulus that inflated a property boom still may come at a cost, given economic growth decelerated to a three-year low of 7.6 percent in the second quarter. Rebalancing also could fade. Capital Economics Ltd. in London estimates the contribution of domestic consumption to GDP fell to about 35 percent this year from 44 percent a decade ago.
“Consumer consumption in China is not increasing at a significant rate, contrary to everybody’s hopes,” Fred Smith, chief executive officer of FedEx Corp., operator of the world’s largest cargo airline, said Sept. 18.
Other emerging markets also need to refocus. A slowing world and increased competitiveness abroad means they no longer can lean on exports, say Morgan Stanley analysts.
India last month cut tax on local companies’ overseas borrowings and allowed more foreign investment in aviation and retailing. Brazil is paring payroll taxes and offering licenses to companies to build and operate roads and railways.
For Pimco’s El-Erian, the mixture of “good rebalancing and bad rebalancing” will dominate the outlook.
“If you ask the question, have we reached a better place, the answer is yes,” he said. “Have we reached a stable place? The answer is no.”