WASHINGTON – After the disastrous 2008 global financial crisis triggered by crazy speculation in the US, the world has enjoyed several years of steady, if modest, growth. However, If history is any guidance, we are due to have another recession in the near future.
But this time it will not be engineered in the West. According to Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management, and the author of “Breakout Nations: In Pursuit of the Next Economic Miracles” (Norton, 2012), the next crisis will come from China. In a well crafted op-ed piece Sharma explains why. (A Global Recession May Be Brewing in China, The Wall Street Journal, August 17, 2015)
The fact is that China’s growth since the 2008 crisis has been abnormal. It has been fueled by enormous amounts of debt, all of it accumulated at unprecedented speed in just a few years. As Sharma put it:
“The problem is that China’s economic rise of late has been facilitated by a massive and unsustainable stimulus campaign. No emerging nation in recorded history has ever tacked on debt at such a furious pace as China has since 2008, and a rapid increase in debt is the single most reliable predictor of economic slowdowns and financial crisis. China’s debt as a share of its economy increased by 80 percentage points between 2008 and 2013 and currently stands at around 300%, with no sign of abating. [Bold added]. Beijing policy makers have been trying to sustain an unrealistic and randomly selected growth target of 7% by steering cheap loans into one bubble after another—first housing, most recently the stock market—only to see each bubble collapse”.
No easy fix
And there are no easy ways to fix this problem. The recent currency devaluation may help Chinese exporters. But most experts agree that this move looks like yet another attempt to “do something” to support the economy, as opposed to a component of a well crafted strategy.
China’s slow down (Sharma estimates that real GDP growth is about 5%, much lower than the official 7% figure), dragged down all the commodities exporters (including Australia, Brazil and South Africa) which benefited greatly from China’s incredible, debt-funded, infrastructure and construction boom. These countries are now doing poorly, in large part because they have lost their main revenue source.
America is limping along, with 2% growth. Europe is lucky to be in positive territory. Still, many of Germany’s exporters are hurt by China’s slowdown because this means fewer exports.
The next recession
According to Sharma, the outlook for the global economy is not very good. And a further decline in China may trigger another recession.
“This quarter there is little evidence to suggest that the global economy is breaking out of its first-half rut, with growth still stuck in the 2%-2.5% corridor –continues Sharma. “This means that the world is one shock away from recession. A debt-laden China is now the critical link, and another one or two-percentage point decline in its growth rate could provide that shock. The currency devaluation last week, coming after a string of increasingly desperate and ineffective stimulus measures, added to the sense that the critical link is weak indeed”.
Well, Sharma’s prediction may or may not be accurate. But here is the cautionary tale.
Until not too long ago, half the world, including leading Western pundits, extolled the well-crafted and disciplined Chinese investment-driven model. Some argued that may be the smart Chinese technocrats (a blend of re-engineered socialists spiced with updated Confucianism) had really “invented” a new economic model. They had created a new formula that could deliver 10% growth for ever.
Well, it is not so; not by a long shot.
Mostly cheap labor
China did extremely well by managing with skill unique (and almost by definition temporary) advantages. They had tens of millions of newly minted factory workers willing to toil, (for long hours and almost no benefits), for wages that were a fraction of their Western counterparts’.
This inherent labor cost advantage created a massive shift of manufacturing activities to China. But cheap labor is far less significant today. Chinese wages have been going up, while automation is diminishing the relevance of labor costs.
Anyway, having exhausted their real advantages, the Chinese leaders, in a desperate attempt to sustain their economy, created a new fantasy world of debt funded growth. They built everything, everywhere, on a massive scale, triggering absurd levels of over production in all sectors that support the construction industry. And now the bubble has been burst.
Of course, there is another option for China. And this would consist in fostering an innovation friendly economy in which future growth would be the result of proprietary, made in China, inventions.
But innovation requires freedom. And this is why the Chinese leaders are not going to pursue that route. Therefore, with or without a China-triggered global recession, expect China to settle on a 4 to 5% developing country rate of growth.
Not so bad, after all. But hardly inspiring.