Domestic Demand in a Multi-Speed Global Economy

This article is contributed by The Insight Bureau. Called the 'GEMS Close-Up Report', these reports take a succinct but penetrating look at the current state of the global economy and the emerging markets. This particular report was written by Dr Yuwa Hedrick-Wong. Dr Yuwa Hedrick-Wong is a member of The Insight Bureau network of economics speakers.

By Yuwa Hedrick-Wong via The Insight Bureau


A Multi-Speed Global Economic Future


The recovery cycle is now over five years old. Even though it has been longer than the post-war average of 4.8 years, the global economy remains fragile with uncertain outlook. Many have voiced concerns that the major economies of the world have yet to close the so-called output gap, meaning their economies are expanding at a rate below their capacity. In a more typical business cycle, the usual challenge would have been overheating at this stage, not under-performance.


We don’t even need to believe in the concept of the output gap, or that it can be precisely measured, to see that there is no dynamism in the global economy. Global economic growth in the past five years has been uneven, intermittent and generally weak; with different parts of the world diverging rapidly in prospects. This is in sharp contrast to the decade prior to the 2008/09 global financial crisis when a super abundance of liquidity and credit created the classic rising tide lifting all boats phenomenon, when any Tom, Dick and Harry could have half decent economic growth by doing the minimal or nothing at all. But that rising tide has vanished, and the bubble has burst. Now every country has to chart its own way forward. And the economic fundamentals governing their prospects turn out to be very different between them, and that is why the global economy is facing a multi-speed future in the coming decade, with all the complexity that it entails.


Firstly, there is a major difference today between the advanced economies and emerging markets in terms of debts (and we are talking about the sum total of government, corporate, and household debts). In the past, problems of high and unsustainable debts were exclusive to poor and developing countries. It was seen basically as a poor country problem. But in a very dramatic departure from historical experiences, today we are confronted with high and increasingly unsustainable debt levels in advanced economies. Emerging markets, in contrast, are doing much better. For example, total debt load is an astonishing 460% of GDP in Japan, close to 400% in Spain, over 300% in Greece, Portugal, Italy, and France. The US debt level, on the other hand, is a more manageable 250% GDP. In contrast, total debt in China is just over 200% of GDP, and it is only 125% in India, 105% in Turkey and around 75% in Mexico.


Such high debt loads in the advanced economies means that low inflation is a problem and deflation positively dangerous. This is because the best way for a country to get out of debt is through strong economic growth coupled with moderate inflation. Deflation creates the worst possible situation whereby the debt load automatically increases as time goes on. Even if a highly indebted country manages some economic growth and avoids deflation, its fiscal policy remains necessarily constrained, reducing its ability to invest in physical and social infrastructure that is critical to raising productivity and long term growth, as well as narrowing its policy options for responding to external shocks or domestic social needs.


For many emerging markets, even with relatively low and manageable debt loads, they now have to cope with stagnant demand for their exports in the advanced economies, which are their traditional markets. In the decades before the 2008/09 global financial crisis, world trade grew twice as fast as world GDP. However, in the last five years, alarmingly, world trade grew slower than world GDP. It is now much more difficult for any country to export its way out of economic difficulties. The slowdown in China has also seriously affected global demand for commodities and related resources, hurting commodity exporters. The dramatic collapse of the world price oil last year further undermines the balance of payment position of many oil exporters, especially those with higher costs of production like Russia and Iran.