Risk & Economy » Regulation » Economics: Take the slack

Dennis Turner

As the UK teeters on the edge of what is expected to be the sharpest economic
slowdown since 1992, the MPC’s room for manoeuvre on interest rates is limited
by some inflationary pressures lurking just below the surface. As if a highly
indebted personal sector, a softening housing market and an over-extended public
sector were not enough, the last quarter of 2007 added problems of credit
pricing and supply into the mix. To cap it all, any hopes we can export our way
to growth are likely to be constrained by weakness in our major overseas

While we are all consumed by what is happening in our own domestic market, it
is easy to lose sight of some important longer-term shifts in global economic
activity. Despite financial turbulence that has spread to most developed
countries, global growth in both 2008 and 2009 is expected to be around 4.5%, a
very robust figure. But there are some significant shifts taking place behind
this figure that are re-shaping the balance of global activity. The fact that
the world’s largest emerging countries are now playing a pivotal role in the
world economy has implications for the UK well beyond current uncertainties. The
international economic landscape is shifting.

The BRICs are making their mark ­ and not just China, which continues to post
double-digit rates of growth. There is also India with its annual GDP increases
now typically exceeding 8%. Rapid expansion is also underway in Russia and the
countries of the Arabian peninsula, helped by booming demand for oil and gas
and, finally, Brazil is ensuring that Latin America is represented among the new
generation of countries spearheading global growth.

All this means that the baton is passing from traditional industrialised
economies, which are now entering a very testing phase. Over half the world’s
growth last year came from the new kids on the block. For the world economy, the
key questions at the moment are about the true robustness of the BRIC economies
and the extent to which their rapid growth is domestically self-sustaining.
While these countries press ahead with impressive rates of growth, they cannot
do it entirely on their own. Global inter-dependence has not gone away. Of all
the links between advanced and emerging countries, the most important is
probably between the US and China.

Not only have the Americans been among the most enthusiastic investors in
Chinese manufacturing, but also the flood of exports going in the opposite
direction has been a principal contributor to North America’s huge current
account deficit. Last year, Chinese exports to the US probably topped $300bn,
almost one-third of all Chinese exports. So, while China tops the world growth
league, its performance has relied heavily on US consumers. The US, like the UK,
is now entering a period of restraint, which may spell trouble for its

The good news, for the Chinese and the world economy, is that while the
outlook for the US is less favourable than at any time since the bursting of the
dotcom bubble, an outright recession looks unlikely. Although the risks from the
‘perfect storm’ ­ the triumvirate of falling property and equity prices, soaring
fuel costs and a credit squeeze ­ have increased, there is nothing in the
current numbers to point to recession itself.

This year, the fundamentals of the US economy are reasonably sound. In the
third quarter last year, GDP growth was a remarkable 1.2%, with the steady
growth of household spending, expansion of business investment, a build-up of
inventories and strong export growth off-setting the slide in residential
construction. Survey data on house prices were, however, ambiguous and the
reported falls may well have been exaggerated. Rising oil prices will certainly
dampen consumer demand, but the weaker US dollar is giving a boost to exports.
Now, policy makers have scope to reduce interest rates and perhaps ease fiscal
policy again, which should keep US growth around 2% this year, and improving
next ­ modest, but hardly disastrous.

The impact of the financial contagion on Asia looks to be limited and the
effects of the US slowdown will be muted in China, India and Singapore, where
domestic demand, especially investment spending, will drive growth. Japan, Korea
and Thailand are a bit more exposed to American spending, but, as a whole, the
region’s dependence on the US has diminished in recent years. There is, though,
a risk that if US interest rates fall, a new clutch of asset price bubbles will
build in Asia unless the authorities implement substantial currency
It seems that now the world economy can move ahead even as the US pauses for

While America, the UK and the EU all face a period of below-trend growth, the
emerging economies are taking up the slack. A new world order is taking shape,
which will change the way policy-makers think about global issues and how
British firms do business. There is a need to think beyond the traditional
markets of the old industrialised countries. While we deal with the short-term
adjustment to years of consumer-led growth, the longer-term picture is changing.