A Decoupling World?
The recent print edition of the Economist features a story about how the global economy will be able to weather the storm of a US slowdown. The narrative is that Asian consumption growth can take over as the US consumer slows their pace and as such the world will not automatically follow the cycle of the US economy as it has been before or at least the transmission effect will be less marked. This is not news in the sense that it has been a standing topic of dicussion for some time now amongst international economists. In fact The Economist themselves has already implicitly argued this in their latest survey on the global economy (walled for non-subscribers). So in terms of editorial continuity, The Economist's story does not surprise me. As always when presenting a cover story The Economist has a leader and a special report, this time consisting of two articles - one main and one secondary.
Before we get all nitty-gritty on this let us make some things clear ... the idea that the world can totally decouple from a US slowdown is obviously nonsense. Yes, sorry I don't mince my words but the US is still the world largest market and when it slows we will feel it. However, for the sake of argument The Economist is absolutely right in the sense that the effect of a US slowdown probably will be less severe than many pundits have argued. Furthermore global imbalances need to be unwound and this has a US slowdown as one of the main ingredients so the point here is to tune in to the new dynamics of the global economy not to write off the influence and effect of the US economy. So should we take a look at what The Economist is saying ...
(from the leader)
First off we have the ongoing discussion of a hard or soft landing in the US; the housing market is indeed tumbling but consumer spending continues to be on the up-side largely thanks to downward pressure in headline inflation (i.e. oil prices). Remember though that there is a clear floor for falling oil prices but in the end The Economist sums up leading to the main question.
The strength of consumer spending has led many economists to argue that America is headed for a soft landing. Perhaps, but as the housing bust deepens, even the most spendthrift Americans will keep a tighter grip on their wallets. America may avoid recession, but it won't avoid a slow-down. Will it drag the world economy with it?
The bulk of The Economist's argument resides in the hypothesis of the rise of the Asian consumer and to some extent also the European ditto.
Asia is the world's fastest-growing consumer market. The IMF forecasts that total household spending there will rise by almost 7% in real terms this year. In comparison, the 3% growth in American consumption looks almost parsimonious. (...) Still, however bouncy Asian consumers are feeling, slowing growth means that America will buy fewer goods from the rest of the world. So the big question is how much the rest of the world depends on exporting to America. And the answer is: less than is generally thought.
Buoyant Asian demand should help keep Europe afloat, too, for European exporters are a lot more dependent on Asia, and a lot less dependent on America, than they used to be.
European demand should also do its bit for the world economy. Europe's recovery is not, as is widely held, purely export-driven. Most of the euro area's current growth comes from domestic demand, as spending by firms and households has perked up'
In essence the small quote copy-pasting excercise above pretty well sums up The Economist's discourse on this one. But hold on for a minute ... are you seriously going to tell me that the growth of China recently has been driven by internal consumption demand and not investment (and here) and exports? In fact the special report by The Economist takes on primarily China and who do we know to be a regular observer of China and the relationship with the US? Right on ... Brad Setser. Brad also covers the Economist story in a recent post and he is also puzzled. Invoking a piece by Nick Lardy from Institute of International Economics he sets out to differentiate the narrative of Chinese growth driven by internal consumption.
The facts in the Economist story are right. Chinese consumer spending is growing faster than US consumer spending, even if Chinese consumption spending isn't growing as fast as the Chinese economy. Household savings in Asia are not rising, contrary to the popular view. Consumption is falling relative to GDP in places like China largely because labor income is falling relative to GDP.
However, the spin in Economist's stroy -- and this resulting cover -- still seemed somewhat off. Net exports rarely contribute more than a percent or two to GDP growth. If a country’s trade surplus jumps from 3% of GDP to 7% of GDP in a two year period, that is a big deal even if net exports still only adds 2% to growth a year. The fact that net exports have added nearly a percent point a year to Asian growth over a five year period – i.e. the overall trade surplus has jumped by almost 5% -- actually is rather strong evidence that exports have been a big part of Asia’s recent growth. They certainly have been a big part of China's recent growth.
Brad also raises the real pertinent question here about the overall growth dynamics of Asian countries ...
The real question in some sense isn’t whether Asia can decouple from the US. It is whether Asian consumption and investment growth can decouple from Asian export growth. If net exports don’t contribute positive to Asian growth, but domestic demand – consumption and investment – is unchanged, Asia will grow rapidly no matter what.
So what do we have here? As Brad I am not in this one to throw mud at The Economist; I think the articles are good and that they touch upon an important and changing aspect of the global economy. That only goes for the China and Asian story though. I am still deeply critical of any assured claim that Europe is going to pull forward the global economy through domestic demand (i.e. imports) until we see how 2007 plays out. I also think The Economist mentioned Japan in some faint sentence but since this was not elaborated I won't rant about that here.