The First Decade: Boom, bust and beyond

The West has seen 10 years of unbridled consumption and two major recessions. In the third part of our essay series, Hamish McRae looks at how the economic cycle unspooled – and why the smart money is on the booming East

Wednesday 09 December 2009 01:00 GMT

There were two huge economic stories – stories that when historians look back at this decade they will recognise determined the shape of the world economy for the first half of this century. One is cyclical, the other structural.

The cyclical story is blazingly obvious: we have come through two recessions, the second an extremely serious one, the costs of which will be evident for a generation. The structural story is less so, at least to those of us in the established developed world, but on balance is even more important. It is the shift of economic power from West to East, from North America and Europe to Asia, from the Group of Seven developed economies to what are dubbed the "emerging" countries and most particularly to China and India. If you want one fact that captures the seismic scale of what has happened, it is that China started the decade as the world's sixth or seventh largest economy and has ended it, in all probability, as second only to the United States.

There are other stories of course, some of which are encouraging, such as the reasonable progress made by the world's poorest continent, Africa. Sadly, some are less so; for example, though inequality has in general fallen between countries, it has continued to rise within them. More of this in a moment; first the two great tales, cyclical first.

It is impossible to get any perspective on the current economic downturn. We are slap-bang in the middle of it and cannot know how speedy or secure the recovery will be. What we do know is that the first decade of the century has been framed by two "busts" with – for the developed world at least – a fragile boom in between. The beginning of 2000 saw the peak of the 1990s "dotcom" boom, what we now recognise was unsustainable growth fuelled by enthusiasm for, and over-investment in, the new communications technologies. The world has been transformed by those technologies, but for a lot of the participants – and investors – it was a commercial and financial disaster. The world recession of the early 2000s was not particularly serious and some countries, including the UK, escaped altogether. But for investors it was a catastrophe; though the world economy bottomed out in 2001, share prices had peaked at the beginning of 2000 and continued to fall until 2003. Even now, at the end of 2009, the major world markets have yet to regain their levels of early 2000. Retired people through most of the developed world have lower pensions as a result.

If share prices slumped, house prices boomed. With a couple of exceptions, most notably Germany and Japan, the developed world saw rises in the price of residential property on a greater scale than at any time in recorded history. Obviously the experience varies from country to country, but in very broad terms between 2000 and 2008 house prices in most countries doubled relative to people's incomes. Since incomes were rising, the actual increases were higher. Then the bubble burst, with consequences that we are still grappling with right now.

The house price boom was enormously important, for two main reasons. It supported a boom in consumption, as people felt richer and borrowed more against the value of their homes. That in turn drove the long boom through most of the decade. But it also was associated with excesses in the banking industry, as banks scrambled to lend more and more to home-buyers and created all sorts of complicated financial instruments that they thought would spread the risks they were taking on. Everything was fine while prices continued to climb. But when US house prices started to plateau two things became clear. One was that many of the loans would never be repaid; the other was that these loans had been parcelled up and sold all over the world and that investors buying them had no idea how little these loans might really be worth. What became known as the "sub-prime crisis" undermined the global banking system and helped plunge the world into what has become, in many countries, the most serious recession since the Second World War.

There is still no clear consensus on the balance between the significance of the various things that went wrong. We are still in the blame game. We can see there were several elements to the failure, including:

– Excessively low interest rates in the US and some other developed countries;

– China's willingness to lend the US money to support the consumer boom;

– Poor management decisions in many large banks, fuelled in part by the way they paid their staff;

– Weak, or at least misdirected, financial regulation in several countries;

– Rating agencies that gave prime or AAA ratings to what were really junk debts;

– The familiar human response that when things seem to be going well we expect this to continue forever.

It will be for the economic historians to grade those factors, and doubtless some others, into a league table of shame. It will be for the politicians, central bankers and financial regulators to reconstruct a system to try to prevent anything like this happening again. Meanwhile we have to live with the consequences.

What we do know is that in autumn 2008 the world banking system came closer to collapse than at any time since the 1930s. Britain had had its own banking tremors more than a year earlier, starting with the failure of Northern Rock. But what seemed at first to be a difficult, but containable, weakness in the banking system spiralled out of control through 2008, with the crucial element being the bankruptcy of Lehman Brothers in New York. That led to a loss of confidence in banks everywhere and in the UK, the near-collapse of Royal Bank of Scotland and HBOS one weekend in early October 2008.

The full facts have yet to emerge but a couple of lessons are already clear. One is that the weakness of the world financial system was a central cause of the plunge in world trade towards the end of 2008 and during the early part of 2009. Another is that there is an inherent financial and economic cycle from which it is very hard to escape. We seem to be prisoners of this cycle and one of the great challenges of the next few years will be how to curb the booms as well as supporting people during its slumps. And leading on from that, we have learnt that when things go seriously wrong, only governments are big enough to be able to pick up the pieces.

But there is a long-term price for such support. That price will be a doubling of the National Debt. By the time government deficits get back under control, most developed countries will find they have a debt equivalent to their Gross National Product. The position varies from country to country, but the similarities are greater than the differences. This is the first time that there has been such a surge of debt in peacetime. Previously debt has risen to this extent during war. After a major war there has always been a period of relative austerity as debts have been brought under control.

This does not mean that the UK is facing something like the latter 1940s. We are not going back to rationing. But it does mean that there will be a period of adjustment throughout the developed world and one that will be more serious in some countries than others. The shift in the UK will be particularly sharp. So the Teens of this century will feel very different from the Noughties: a time to save rather than a time to spend, a time to ponder about our excesses and perhaps a time to reflect on our values – on what really matters to us.

But that is to see the world economy through a developed-country prism. From the perspective of China or India, the Noughties were quite different. They were a period of continuous, unbridled, sustained success. If you want to catch a feeling for the progress made, consider that in 2000 China built some 600,000 cars. (Britain built 1.6 million). In October China announced it had built 10 million cars so far this year, which means it has passed the US to become the world's largest motor manufacturer. Or take India. It has now become the second-largest investor in the UK after the US, a position that would have been unthinkable 10 years earlier.

The downturn, far from holding back the growth of these new giants, seems almost to have sped it up. It has certainly sped up the transfer of economic might from the "old" world to the "new".

This transition, this shift of power, has been reflected in the change of governance of world economic matters. Until 2009 the main body co-ordinating economic policy was the Group of Seven, the seven largest economies of the developed world. But at the London Economic Summit earlier this year, the attendees were the Group of 20, as the large developed countries were joined by the largest of the emerging ones. If you want to choose a single moment when the baton of leadership came, if not to be handed over, at least to be shared, the London summit is as good a time as any. If you want to take a decade when the shift of power really took hold, it is indeed the Noughties.

The scale of the shift has been best described in some work by the investment bank, Goldman Sachs. Back in November 2001 it coined the acronym BRIC, to pull together the three largest (and very different) emerging economies of Brazil, Russia, India and China. The expression caught on, and now the Brics are contrasted with the G7 as a way of capturing the transition from old to new. Goldman at the same time developed a computer model that sought to identify the characteristics driving growth in these countries and to see how that might demonstrate how the Brics would grow vis-à-vis the G7. The model took into account various inputs, including the size of the working population, and made various assumptions about the pace of technology transfer and so on. It is only a model, but the results so far have been spectacularly accurate. Actually the growth of the Brics has been somewhat faster even than the model predicted. If the present pace of development were to continue, China would pass the US to become the world's second largest economy some time around 2027 and India would pass it some time in the 2040s.

Goldman also looked the next tier of emerging economies, noting the rapid growth potential of such countries as Indonesia, Mexico and South Africa – countries now all represented in the G20. So the shift of power is not just to the Brics themselves; it is a wider shift to the emerging world as a whole, a global rebalancing of power, in effect reversing the shift that took place as a result of the Industrial Revolution during the 19th century.

As with all revolutions, there are places that are left behind and people that are disadvantaged by the change. Parts of Africa have been untouched by the tide of rising prosperity, though sub-Saharan Africa as a whole has achieved reasonable growth of close to 6 per cent during this decade, compared with growth of an average of little more than 1 per cent between 1960 and 2000. Latin America has in general had a successful decade, Brazil particularly so. The idea that Latin America was a region of embedded hyperinflation has been knocked down. The region does, however, retain some of the largest income differentials in the world.

There are also broader concerns about the sustainability of the present industrial model, in particular with the burden it places on natural resources. Quite aside from increased pollution and other regional effects, China's boom has pushed up commodity and energy prices for the entire world. While there have been beneficiaries among the raw material and energy producers, the net effect of growth in China has been to put a brake on growth in other places. Meanwhile some measures intended to reduce the environmental burden of growth, such as the development of biofuels, have had perverse results. A rise in global food prices has been one, for land used for growing biofuel crops is land not available for growing food. So the Noughties have not been a decade of universal progress, even for the Brics and the other emerging nations that have on the face of things done very well.

I think that in another century's time, this decade will be seen as important in three main regards. The most obvious now is that it will be seen to have demonstrated the weaknesses in the developed world's financial and economic system. The markets and the financial institutions have proved pretty inadequate, but so too have western governments – both as regulators and as managers of their own finances. That collective failure will hang over the world for many years to come. Look how the failures of the 1930s have shaped government policies 75 years later. So will we, and other countries in the developed world, look back on the Noughties as a period of economic failure? Not necessarily. Notwithstanding the disaster of 2008-09, every single developed country will have ended up the decade richer than it began. It is just that we, and other countries, need to learn from our mistakes.

The second area of importance is the shift of economic power. Put crudely, you could say that just as the 19th century was Europe's century and the 20th was America's, this decade has set the 21st century on the path to be Asia's. That is a vast oversimplification, but it is not a bad place to start. It leads into a whole set of separate debates about the nature of power: soft power versus hard power, the importance of cultural factors such as creativity and so on. What is indubitably true is that the shift of economic weight to the emerging nations will be associated with some shift in political weight. And what is extremely likely is that we are living through the very early stage of a shift that will continue for half a century or more.

That leads to a third aspect of the Noughties that will come to be seen as hugely important. It is that the values of the West are no longer so dominant as they were a decade ago. Back then, the technologies developed in Europe and America – in particular the internet and the mobile phone – seemed likely to extend the ideas of Western societies to the rest of the world. Now, a decade later, that is not clear at all. Everyone has access to these technologies. There are more internet connections in Asia than in Europe or America. The world's fastest-growing mobile phone markets (and some of the most innovative applications) are in Africa.

The present developed world may retain some competitive advantages – great universities, for example – but these are being eroded. Over the past decade the world economy has become pretty much a level playing field. That is new, challenging, exciting – and just a bit scary too.

Tomorrow: Michael McCarthy on the climate crisis

The decade digested

* In February 2002, Will Young was crowned the country's first "Pop Idol". The following month, his debut single "Evergreen" sold 403,027 copies on its day of release. It went on to shift 1.7 million, the biggest-selling single of the decade.

* A search for the appearance of the words 'David Simon' and 'The Wire' in British newspapers over the last 10 years yields over 3,000 hits. In July 2008, the show's fifth series started on cable channel FX. It had just 38,000 viewers.

* Beijing spent $40bn on 2008's Olympic Games, making it the costliest in history. The previous Summer Games, held in Athens in 2004, cost a relatively modest $15bn.

* Scientists switched on Switzerland's Large Hadron Collider (LHC) on 10 September 2008. It broke down nine days later. They hope it will help isolate the fundamental particle the Higgs boson by firing protons into lead nuclei.

* With almost 140 million views, "Charlie bit my finger – again" is the Noughties' most popular clip on YouTube. It shows Harry Davies-Carr, five, and his brother Charlie, two, fooling around on a sofa. In April Susan Boyle's debut on Britain's Got Talent soared into second place, with over 80 million hits.

* Fans ordered over 250,000 replica jerseys in advance of David Beckham's arrival at LA Galaxy in 2007. Beckham's contract is worth $6.5m a year, the highest ever in Major League Soccer, the US equivalent of the Premier League.

* "I don't give shitty jobs," were the first words said by David Brent when The Office made its debut on BBC Two on 9 July 2001. It has since been sold to broadcasters in over 80 countries. The series has won 21 international awards including two Golden Globes.

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