Hamish McRae: Tackling deficits could cripple growth
Sunday 07 October 2012
It is the international meetings season this week, with the International Monetary Fund (IMF) and World Bank annual meetings in Tokyo running from Tuesday to Saturday. This year the tone will be sombre, not just because of the continuing anguish in Europe, but more generally because of a sense that conventional economic policy does not work very well any more.
So the finance ministers and central bankers gathering in Tokyo still enjoy the panoply of power – people still hold open limousine doors for them – but they are no longer very powerful. Print billions more money? Sure, you can do it, but nothing much happens.
So what should we expect? Well, we at least will get some information. The IMF's World Economic Outlook is published on Tuesday. It always gives a cool, if conventional, assessment of what is happening to the world economy and this year is expected to revise down its expectations for both this year and the coming one. The world economy as a whole is expected to grow by about 3.3 per cent this year and 3.6 per cent next, with the eurozone contracting by 0.4 per cent this year and only growing by 0.2 per cent next. Indeed, the eurozone has become the principal drag on global performance. Forecasts have been cut for next year for China (now expected to grow by 8.2 per cent), India (6 per cent) and Brazil (4 per cent).
But you have only to think about those numbers – 8 per cent, 6 per cent and 4 per cent – to appreciate how swiftly economic power is shifting away from the old, developed world to the new emerging one.
Within our world, the two great running stories, the fate of the eurozone and the weakness of the US recovery, will continue to run. Right now there is not much new to be said about the former. At some stage in the next few weeks, Greece runs out of money, or it gets another loan. At some stage Spain asks for a formal bailout, or it juggles around its national finances and manages to hang on a bit longer. In both cases, the outcome is completely predictable, but the timing quite uncertain.
The weakness of the US economy, by contrast, has become extremely interesting. It is politically interesting because in a tight, presidential election, any further recovery would be most helpful to the president, while one really bad number might tip it towards the challenger. This is monstrously unfair, because the lags in economics are very long and the pain being felt across America now is the result of policies under the previous administration. There is a recovery but an exceptionally weak one. There are many explanations for its weakness, but it seems to me that the largest single story is the boom-bust cycle in the US housing market. Housing debt is holding back consumer demand and hence job creation. And it was the burden of dodgy, mortgage-backed securities that scuppered the banking system.
And so to what, if the world were fairer, might be some good news for the president. On Friday, we had unemployment fall to 7.8 per cent, still horribly high, but at least it is below 8 per cent. As you can see from the left-hand graph, the US has just experienced the longest period of unemployment above 8 per cent since 1950. The peak of this cycle was not as high as it was in the early 1980s, but the duration was much longer. The US is creating jobs, albeit slowly.
Will that continue? I accept that part of the problem in the US job market is structural rather than cyclical, in that the new jobs need a different skill-set from the jobs that have been lost. But I don't see why job growth should not continue, given something else that seems to be happening: a modest recovery in house prices. That is shown in the right-hand graph. Between the beginning of 2007 and the end of 2009 US house prices fell on average by 30 per cent, almost double the fall in the UK. Since then they have been essentially flat. But in the first half of this year there have been a number of small signs of a turn in the market and in past few weeks that is starting to show in prices. The US is a huge and diverse market so you have to be careful about generalisations: top-end New York is going great guns and parts of Detroit remain dire. But the flip from stagnant house prices to modestly-rising ones, if it has happened, has huge consequences. Couple it with the decline in unemployment and you can begin to paint a more optimistic picture of the US over the coming four years.
There is, however, two huge and looming problems: the so-called fiscal cliff, when at the end of this year the Bush-era tax cuts automatically expire; and the longer-term correction of the US deficit.
In theory, fiscal policy is tightened by the equivalent of a couple of percentage points of GDP. That is huge. Even those of us who feel that US fiscal policy has been disgracefully lax would not want to see it tightened in such an arbitrary way. The tacit assumption in the US is that something will be done whoever wins the election. The financial markets have taken it all in their stride, with share prices remaining close to their highs, but markets are notoriously bad at coping with political upsets.
That leads to the election and what the next administration will do about the deficit. The race may have tightened in the past few days, and there is always a temptation to see the political choice as crucial. Well maybe. But the fiscal arithmetic remains the same. We know the deficit has to be tackled. So I suppose the key question will be whether a tightening of fiscal policy will be a serious drag on growth.
That leads to what seems to be the most interesting question of all, one that applies here as well as in the US. We know that very high deficits of up to 10 per cent of GDP have not done much to boost the economy. So might the correction of those deficits not do as much damage to growth as many fear?
Will the West become more like the new rich in China and India?
Another way of looking at that 8 per cent growth in China and 6 per cent in India is to see how it affects the burgeoning middle class of both countries.
There have been several studies on the two countries as mass consumer markets – the likely number of cars sold in China for example – as well as top end ones. Will the new rich behave in the same way as the old rich?
Now a new study by the Boston Consulting Group called The $10 Trillion Prize has attempted to put some numbers on this, the $10tn being the estimated size of the two countries' markets for consumer goods and services in 2020. To put this in perspective, if you say half our GDP is accounted for by private consumption, that would be about $1tn.
The authors' thesis runs like this: By 2020 there will be a billion middle-class consumers in China and India, spending $6.2tn and $3.6tn respectively. There are already 115 billionaires in China and 55 in India, and – I like this one – seven of the 13 richest self-made women are from China. By 2020, China will be the largest luxury market in the world.
These consumers are much more optimistic than we in the West. Most have started from a modest base and so have achieved a lot already. This pushes them into a virtuous circle, where rising income leads to rising savings and hence, more wealth. To sell to them, people have to tap into that optimism, helping them "live big on less".
By contrast, most people in the developed world expect to have to trade down. One strong characteristic in both China and India is the importance of brand names. In Europe, which paradoxically creates most of the top brands, this is least important.
The book is aimed at the US market, so there is a great deal about how American businesses should try to get a share of the goodies. I find the more interesting thought is the extent to which we will be shaped by what is happening on the other side of the world. How will our tastes and social attitudes change? If the new rich become more like the old rich, will we old rich become more like the new?
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