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Cover Story: Where in the World is Growth?

Financial Executive...April 2013

The global race for growth is changing as small countries have powered their way up the charts while the United States, China and other industrialized nations are performing below their normal levels. Where can growth and profitability be found now and in the future?

By Stephen Barlas

Small countries with idiosyncratic economic advantages — such as Mongolia and Macau — have powered their way to the top of world growth charts these days as traditional leaders, such as the United States and China, are bouncing well below normal levels. Sure, Mongolia and Macau (formally an administrative region of China) are tiny, and their outsized increases in gross domestic product (GDP) benefit from computations based on Lilliputian bases. Mongolia is building its economy atop vast mineral wealth and Macau is gambling — and winning big — that its proliferating gaming tables are a good bet to carry its economy.

Still, their contrast with wheezing neighbor China highlights worldwide trends. The powers that be have, at least for the moment, and maybe in some cases for the future, been. Many developing world economies are ascendant.

The Chinese economic engine that could suddenly can’t. Though it may hit 7 percent growth in 2013, economists such as Colin Moore, chief investment officer at Columbia Management, believe the rate will be closer to 5 percent, meaning China is in the throes of a relative recession.

The United States is hiccupping along, slowly clearing away bad mortgages and even more slowly dealing with serious fiscal problems, which threaten to restrict GDP growth to 1 percent in 2013, and maybe beyond. Germany is spinning its wheels in the eurozone muck. The rest of the BRICs — Brazil, Russia and India — have become bric-a-brac, at least at the moment.

Meanwhile, the prospects for healthy, long-term growth seem brightest for developing countries with burgeoning, young working age populations and plenty of room for productivity growth. Going forward, forget about the BRICs; here come the MITS (Malaysia, Indonesia, Thailand and Singapore). Global Trends 2030: Alternative Worlds, a study released in December by the U.S. National Intelligence Council, reported: “The health of the global economy increasingly will be linked to how well the developing world does — more so than the traditional West.”

Though it didn’t exactly write an epitaph for China, India and Brazil, it did predict the ascendancy of countries such as Colombia, Indonesia, Nigeria, South Africa and Turkey.

Global Economy for a Global Generation

So is there a changing of the economic guard? The International Monetary Fund’s (IMF) Managing Director Christine Lagarde’s address to the annual Davos conference in Switzerland on Jan. 23, 2013 was titled A New Global Economy for a New Generation. In her statement, Legarde said: “I believe we are standing in the antechamber of a new global economy, marked by rapidly shifting circumstances and new modes of thinking. This new economy will be geographically different, driven more by the dynamic emerging markets and developing countries. But it will also be generationally different, shaped by different values and principles.”

Keith Hembre, chief economist for Nuveen Asset Management, agrees that emerging market economies will grow fastest going forward, in part because they are starting from a low level. But he is not ready to relegate the U.S. and other developed economies to the status of also-rans. “It is not historically the role of emerging market economies to replicate productivity gains,” he adds. “The U.S., China and Europe will shrink in relative size but their economies will not be eclipsed by those in the developing world.”

Certainly, near-term prospects are not good for traditional economic locomotives. The World Bank’s Global Economic Prospects (GEP) report, issued in January 2013, contained reductions in forecasts for international economic growth in 2013 compared to the estimates the bank published in June 2012. The bank said it expects the world economy to expand 2.4 percent this year, compared with 3 percent growth it had forecast as of June.

“The economic recovery remains fragile and uncertain, clouding the prospect for rapid improvement and a return to more robust economic growth,” said World Bank Group President Jim Yong Kim.

All countries face the same challenge: how to grow their economies on the backs of younger, more productive work forces. Some countries with more potential than Mongolia and Macau to carry economies outside their borders are having some success. Mauro F. Guillen, director, Lauder Institute, and Felix Zandman, professor of International Management, both at The Wharton School of the University of Pennsylvania, say Indonesia and Malaysia are good prospects. They are considerably larger than Mongolia and Macau, and if they continue to grow at six or so percent a year, they may be able to do some of the heavy lifting — especially in Asia — that China has been doing, but won’t be able to do at a growth rate of 7 percent instead of 10-12 percent.

Joseph Davis, chief economist, The Vanguard Group, points to Australia and Canada, whose banking systems never faltered. “They continue to turn in impressive performances,” he says.

If the world economy is to be pulled out of the ditch, the U.S., China and Europe will have to gain some traction. But at the moment, the first two are spinning their wheels and the third is moving in reverse. European Union growth in 2013 may be negative, even though banks in Italy, Spain, Portugal and Ireland have healed considerably.

U.S. growth, forecast at around 1 percent for 2013, is not very dynamic. And in what must be a maddening reversal of fortune, Chinese manufacturers are moving to lower-cost labor countries such as Thailand and Vietnam.

Here is part of the problem, according to Wharton’s Guillen: “The big three haven’t found common ground,” he says, referring to the U.S., Germany and China. He argues that those three, maybe plus Japan and Great Britain, should be meeting as a G-5 instead of the G-20 group, which includes nations that have no hope of contributing to the healthy growth of the world economy.

Even within the big three, there are anti-growth policies being pursued, for example, the widespread changes of manipulation of currency, and not only by the Chinese.

The U.S. is printing dollars at a drunken rate. China is awash in cash, since the government has expanded the broadly measured money supply over the past five years much more rapidly than the U.S., even though the Federal Reserve’s moves have attracted con­­siderably more international attention. China’s money supply is now larger than that of the United States, even though China’s economy is half as large. There is no safe haven, given doubts about the dollar, yen and euro.
The sad thing, according to Moore, is that the currency wars are a zero sum game, or, as he calls them, a race to the bottom, and says, “I have never seen a race to the bottom work.”

Fiscal Trends Not Encouraging
Nor are fiscal trends any more encouraging, at least short term. The U.S. is a good example. Democrats and Republicans can’t seem to agree on a long-term fix for the looming federal deficit.

“The policy uncertainty remains extremely pointed, hence the recovery here is not as strong as it could be,” says Davis. “The precondition for a strong U.S. recovery going forward is that fiscal policymakers convey to the markets that they have adopted comprehensive deficit reform. That doesn’t have to mean a balanced budget, nor austerity starting right away. Needed are meaningful steps, which assure we don’t have a structural deficit even when we get to full employment.”

Asked what factors are important if a nation wants to assure strong growth, Davis ticks off things such as access to capital, prudent government regulation, protection of property rights, ease of doing business and openness to skilled labor and immigration. “The U.S. measures highly on many of these, but we have slipped a little,” he adds.

Moore agrees that we need more immigration given the aging of the U.S. population. Increasing the productivity of the current workforce may be possible, but given the current high level of productivity, that is not likely. Nor is adding “leverage,” another important component to growth, most characterized by consumer spending. In fact, U.S. consumers are deleveraging after the recession, cutting back on credit card spending and increasing saving.

So from where can growth come? Moore says one way is to alleviate income inequality by adjusting the tax code. He had no problem with Obama’s push to raise taxes on earners over $400,000.

But the U.S. retains some advantages, technological innovation among them. Hembre points to the explosion of the U.S. energy natural gas and oil sectors because of fracking, an extraction technology developed by a small Texas company. Domestic companies are pioneering advancements in mobile communications, too.

China also retains some structural advantages. But though it is not deleveraging like the U.S., Chinese consumers are not spending either. Part of the reason is that the country has almost no safety net, meaning a social security-like system, and people are saving 30 percent of what they earn for a rainy day.

Moreover, three developments in particular are now undercutting demand for Chinese exports and its domestic growth: higher labor costs, lower worldwide demand and sometimes careless capital spending. Boston Consulting Group (BCG) says that in 2000, Chinese factory wages averaged 52 cents an hour. But annual double-digit percentage increases will bring that to $6 an hour in high-skilled industries by 2015.
Moore says, “There are a lot of poor people trying to make it up that ladder, and that is not going to happen if the country keeps building bridges to nowhere.”

Mark Williams, chief Asia economist at Capital Economics, agrees. Quoted in the Economist magazine, he says, market optimism over China’s prospects risks being disappointed if in 2013 “the recovery remains centered on infrastructure and real-estate investment rather than consumption.”

The 27-country European Union (and the smaller 17-country eurozone) appears to face even deeper challenges than either the U.S. or China. Lingering banking problems, pretty much eliminated in the U.S., continue to cripple major economies in Europe, with the European Central Bank (ECB) continuing bailouts in Portugal, Spain and Italy.

In Europe, Issues Abound
Germany, Europe’s biggest economy, is doing “okay,” nothing more. The German government itself has cut its growth forecast from 1 percent to 0.4 percent in 2013 after a shaky 2012 where the rate was 0.7 percent, well off the 2 percent of the previous two years.

But France, Europe’s second largest economy, faces a flagging economy. The socialist government of Francois Hollande has in some ways discouraged foreign investment and failed to temper the power of labor unions and the rich packages they obtain for French workers. So unit labor costs are not decreasing there, as they are in Ireland, for example, which is in the midst of a turnaround.
Moreover, Hollande has raised taxes, whereas Irish Prime Minister Enda Kenny has cut them.

Then there is Great Britain. U.K. Prime Minister David Cameron sent tremors through the EU when he announced in late January that he would allow Great Britain to vote in 2015 on continued participation in the EU, should his Conservative Party win the election. Cameron is a bit schizophrenic. He doesn’t like the EU rules in the area of business and government regulation, but he likes the privileged access to European markets that comes from the integration begun in early 1993 when the EU was formed.

Robin Bew, editorial director and chief economist, Economist Intelligence Unit, wrote last year: “The truth is there are no good options left for Europe. Opportunities to get ahead of the problem have been squandered. Leaders face an unpalatable choice between a eurozone break-up — which risks plunging the region into depression — and a deeper union, which would make core countries such as Germany liable for the periphery’s problems.”

Which brings us to the third largest economy in the world: Japan — number three after the U.S. and China. Japan has been climbing out of an economic abyss for what seems like 30 years. Shinzo Abe, its new prime minister, has undertaken a somewhat radical approach to powering up the economy by initiating a major infrastructure spending program despite the fact Japan has the highest debt burden in the developed world, at 220 percent of gross domestic product.

That is being paired with a devaluation of the yen — there is that race to the bottom again — meant to help Japanese exporters.
At a press conference in Washington in January, the IMF’s Lagarde said the Japanese measures may not be the right way to go unless Japan also shows a “determination to change the debt trajectory and reduce the deficit.”

Though Asia does have pockets of potential economic promise, large and small, from Mongolia to Indonesia, India does not appear to be one of them. Moore says that while the country has a well-educated workforce, it is the “most bureaucratic country” he has ever experienced. “If a project can be delayed, it will be delayed,” he says.

Moore is more excited about another BRIC, Brazil, as well as South America generally. He is not alone. Michael Reid, the Americas editor for the Economist, writing at the end of last year, noted that economic growth in Latin America will be solid rather than spectacular, at between 3.5 percent and 4 percent, barely up on the 3.1 percent of 2012.

The uptick will come mainly from recovery in Brazil, where growth should return to around 4 percent, thanks to a combination of lower interest rates and cuts in business and consumer taxes. Peru, Chile and Colombia will once again grow above the regional average.

Brazil, the world’s sixth largest ec­onomy, has been the big dog in South America. But it has had its tail between its legs of late. The problem has been somewhat declining prices for commodities and a consumer base, which after running up purchases of most everything, has started to pay off its television and auto loans, and subsequently slowing spending. Some stimulus is needed there, and it needs to come from productivity growth, since it cannot rely on consumption.

Trade Agreements to the Rescue?
Brazil can’t do it alone, given the need to sell its commodities to some buyers. Which brings up the question of international trade agreements, which can spur economic growth in a nation by allowing for increased exports and imports. The latter, however, is a double-edged sword since consumers buy cheaper foreign products and disadvantage domestic manufacturers, although some domestic manufacturers benefit from lower-priced industrial inputs.

The U.S. is already negotiating one such broad agreement, the Trans-Pacific Partnership (TPP), and getting serious about another one, a trade pact with the EU (as announced in President Barack Obama’s State of the Union address on Feb. 12). In fact, the U.S. and EU have launched negotiations, as reported in The Wall Street Journal two days following the president’s address, “to pursue one of the most complex trade packs ever, aiming to reshape global standards by uniting two international economic powers.”

The Journal article further noted that “officials from both sides of the Atlantic said it could take two years to work through thorny regulatory divisions, but that ultimately the talks could lead to a far-reaching agreement that serves as a model for international trade deals.”
Finishing such agreements isn’t easy. Canada’s efforts to conclude a free trade agreement (FTA) with the EU is a case in point. Those negotiations have been ongoing for years, and lately the Conservative government of Prime Minister Stephen Harper has been “spooked” by the specter of the U.S. signing its own FTA with Europe, which could leave Canada on the outside looking in.

Canada and the U.S. are both involved in the TPP negotiations, along with Malaysia, Australia, Vietnam and Chile, among others. The current thinking is to conclude an agreement in time for the APEC [Asia-Pacific Economic Cooperation] summit in Bali, which begins Oct. 5. The Philippines, South Korea and Japan are thinking about joining, and there’s even talk of asking China to sign on.

In the end, though, a resurgence of the international economy depends on individual governments adopting three basic economic policies: non-manipulation of currency, reduction of wasteful government spending and stimulation of consumer spending.

Supportive political initiatives — such as refreshing older workforces through immigration, reducing regulatory burdens and supporting technological innovation — would supercharge growth. But doing all those things in concert requires dexterity, which seems to be in short supply at this point in time, in country after country.

Stephen Barlas (sbarlas@verizon.net) is a freelance writer in Arlington, Va., who has been covering Washington, D.C., and government since 1981.