Lowy Institute

Back in mid-2010, I wrote a lengthy post looking at the possible link between labour unrest in China and the so-called 'Lewisian turning point'. Last week, we got another critical data point on China's demographic profile when the country's National Bureau of Statistics announced that China's working age population shrank by 3.45 million people in 2012. According to the Bureau, this drop marks the start of a trend that will see annual declines in China's working age population until at least 2030.

These demographic headwinds would be expected to have important consequences for China's sustainable growth rate over the medium term, as well as for the nature of the Chinese growth model. A major complication in making these kinds of assessments, however, is the quality of the available data on population and fertility, as set out in this piece by the ANU's Jane Golley.

Photo by Flickr user triplefivechina


This is part 3 of Mark's thirteen suggestions (in no particular order) of things to look out for in the global economy this year. Part 1 is here, part 2 is here. 


9. Keep an eye on oil prices

Despite some signs that the world is less sensitive to oil price hikes than it used to be, the price of oil continues to be a critical variable for global growth.

Last year's IEA World Energy Outlook emphasised what it described as the emergence of a 'new global energy landscape', one shaped by rising oil and gas production in the US and the expansion of non-conventional supply more generally, changing attitudes to nuclear and renewable energy, and the possibility of a major shift in Iraqi oil production

Combine those factors with continued uncertainties over the global growth outlook, plus the risks of a geo-political shock in the Middle East (traditionally Iran has been the favoured candidate here and with Washington and Tehran still at loggerheads over Iran's nuclear program that theme is still very much alive), and we are left with plenty of scope for both upside and downside surprises in the oil market.

10. Russia (and Australia) and global economic governance

Russia took over the chair of the G20 in December last year and Australia joined the G20's leadership troika at the same time. Russia has now set out its priorities for 2013, and the new presidency faces some significant challenges over the coming year, including the need to deliver on the G20's most important agenda item: strong, sustainable and balanced growth for the world economy.

11. Southeast Asia's recent economic success

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At times over the past decade, Southeast Asia has been in danger of becoming a flyover zone for Australians interested in regional economic dynamism. China has grabbed most of the attention and Japan and Korea have vacuumed up much of the rest. 

But 2012 was a particularly good year for both Indonesia and the Philippines. While many emerging markets struggled to live up to past growth achievements, Indonesia looks to have turned in another solid 6% plus growth rate last year, thanks in part to strong investment growth.  The Philippines too had a good 2012, with this ASEAN economic resurgence prompting The Economist to suggest that the these two 'IPs' could give lessons to the not-so-dynamic BRICs. Of course, both countries still face significant challenges, so the sustainability of their growth stories will merit attention this year.

12. Australia's phenomenal growth run

In 2012, Australia completed its 21st consecutive year of economic growth. It's been a performance that nearly every other developed economy would envy, although for much of the past year Australians seemed to be waiting for it all to go wrong, with a debate over the passing of the resource boom and some foreign observers predicting that it was all going to end in tears.

It would be deeply unfair to attribute all of Australia's success to good luck; you don't survive consecutive stress tests like the Asian Financial Crisis and its global counterpart on luck alone. But it would be equally foolish to believe luck has played no part in this run. So, will our luck hold in 2013?

13. Finally, don't forget to watch out for surprises

I know it's (more than) a bit trite, but still it seems appropriate to dedicate the thirteenth and final spot to the surprise event/black swan/unknown unknown that might end up dominating the coming year. Past examples include the Global Financial Crisis, the Arab Spring, the Fukushima Disaster, and the H5N1 avian influenza. You never know, though, maybe this year's unexpected 'shock' to the global economy will turn out to be a pleasant surprise. It seems like we're overdue one.

Photo by Flickr user nate2b.


This is part 2 of Mark's thirteen suggestions (in no particular order) of things to look out for in the global economy this year. Part 1 is here.

5. China's growth prospects

We spent quite a lot of 2012 on The Interpreter debating China's growth outlook, wondering whether last year's significant slowdown was mainly cyclical, mainly structural, or a combination of the two. After all that analysis, it will be important to peer through the smog to see which theory gets the most support from 2013's growth performance, and hence try to gauge just what the new normal is for Chinese growth.

6. And India's...

Last year was more a case of India tarnished than India shining. The financial press was filled with stories of the failings of Indian infrastructure (including the largest electrical blackout in history), political gridlock and corruption scandals. Growth has disappointed, to the extent that the current fiscal year is now likely to deliver the lowest outcome in a decade. There have also been warnings of sovereign ratings downgrades

Stung by all the criticism, last year did see New Delhi make an effort to reinvigorate the reform process, but with elections due in May 2014, delivering more progress could be tough.

7. Geo-politics and geo-economics in the East and South China Seas

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Tensions remain high in the East China Sea, where in the worst case a miscalculation could have profoundly destabilising consequences. And although it's recently been put in the shade by the Sino-Japanese sabre-rattling over the Senkakus/Diaoyu islands, tensions are also significant in the South China Sea. As I've noted before, these rising geo-political tensions may turn out to have important geo-economic consequences even under much more likely scenarios than the worst-case ones.

8. Keep an eye on food prices

Last year, we were reminded of the world's vulnerability to food price shocks. As experts warned at the time, 'even in a good year, global grain production is barely sufficient to meet growing demands for food, feed and fuel...in a world where there are 80 million extra mouths to be fed every year.'

Although the feared crisis failed to materialise in 2012, there were signs of a 'new norm' of high and volatile prices. Will prices spike again this year? Some good news came with the latest reading from the FAO's food price index, which dropped for a third consecutive month in December 2012. But low stocks are likely to limit price falls, and leave global food balances vulnerable to weather shocks.

Photo by Flickr user Andrew Middleton.


It feels like a long time since we had a boring year in the world economy. Financial crises, debt crises, food crises, natural disasters, geo-economic power shifts, social upheaval and revolution have all shaped and reshaped the economic environment in recent years. 

So will 2013 change the trend and give us a restful year? Or even just one where the downside risks are matched by some nice upside ones? Since Steve Grenville has recently reminded us of economists' failure to forecast, I'm going to do the cowardly but sensible thing and avoid making any predictions. Instead, I've put together thirteen suggestions (in no particular order) of things to look out for in the global economy this year. Here are the first four:

1. Fiscal follies in the US

We sorta, kinda avoided the fiscal cliff, but did so in part by creating a series of other tripwires for the dysfunctional US political process. Prominent among these is a pressing need to raise the debt ceiling, which potentially poses a worse problem than the so-called cliff did. For a while, it seemed like the sheer absurdity of the current US debate was going to get the recognition it deserved in the form of its very own trillion dollar commemorative coin. Sadly, that option has now been ruled out, but there's still scope for more fun and games before the (almost) inevitable compromise.

2. The longevity of eurozone optimism

After spending much of the past couple of years wondering whether the eurozone was doomed, financial markets have turned much more sanguine. Indeed, what was once thought to be a near-extinct species – euro bulls – are now again being found in the wild

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Much of the credit for this turnaround goes to Mario Draghi, president of the ECB and the FT's 2012 Person of the Year. His July 2012 speech, in which he promised 'to do whatever it takes to preserve the euro', is increasingly seen as a turning point, with the subsequent August announcement of Outright Monetary Transactions (OMT) giving force to his pledge. 

By effectively announcing that the ECB was finally ready to take on the role of lender of last resort, the OMT was supposed to reduce the tail risk of a euro collapse. And despite the fact that the ECB has yet to buy its first bond under the program, markets seem convinced, as sovereign yields on eurozone periphery debt have fallen sharply. 

Still, while the ECB has bought the eurozone project some much needed time, the fact remains that the eurozone gamble on the sustainability of a monetary union in the absence of a fiscal and banking union is a failed bet. That means that those fiscal and banking institutions will still need to be delivered if the show is to stay on the road, and while there has been some modest progress, there is still an awful long way to go, not least given the lack of political appetite. On that note, elections in Italy and Germany will be worth watching.

3. From Grexit to Brexit? 

Meanwhile, that push for greater eurozone integration is raising awkward questions for the UK's relationship with the EU. Prime Minister Cameron's speech this Friday will highlight some of the tensions now in play.

4. Japan's latest policy experiment

What happens if you have a massive asset bubble that then bursts? What does a lost decade look like? What happens when policy rates get driven to the zero bound? Does a massive expansion in the monetary base have to lead to inflation? What are the consequences for growth of a rapidly ageing population? And just how big a public debt-to-GDP ratio can a developed country manage if it has its own monetary policy? 

If you wanted to get advance notice of some of the key challenges now facing the world's developed economies, turns out it would have paid to spend some time looking at Japan. Now Japan is experimenting with monetary policy and central bank independence as Prime Minster Shinzo Abe exerts pressure on the Bank of Japan to raise its inflation target in an attempt to jumpstart Japan's long-moribund economy. The break from orthodoxy has been widely noted, with some arguing that Japan may now be a leading indicator for the end of the era of central bank independence.

Photo by Flickr user lrargerich.


Greece is not the only economy suffering from the absence of an effective international framework for dealing with sovereign debt problems. Over the past few months, the financial press has been tracking Argentina's travails as Buenos Aires struggles to deal with the legacy of its own December 2001 default. It was the largest sovereign default in history, at least up until this year's Greek record, and many observers have noted the parallels between the Greek and Argentine experiences.

In the aftermath of that 2001 default, Argentina restructured its debt through two debt exchanges, in 2005 and 2010, switching the defaulted bonds into new paper with lower face value and longer terms. Despite the punitive nature of the terms on offer, creditors owning about 93% of outstanding private external debt eventually accepted the deal. But a group of holdouts, led by hedge funds that specialise in chasing defaulting governments (so-called vulture funds), have pursued Argentina in the courts.

In October, the holdouts won a legal victory that has thrown the details of Argentina's debt restructuring into doubt. If upheld, this ruling will raise the possibility of another (technical) Argentine default and have potentially significant implications for other sovereign debtors.

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It's true that many observers don't find Argentina a particularly sympathetic case right now: Buenos Aires is still in default to a bunch of foreign governments at the Paris Club, which undermines the willingness of other governments to intervene in the current situation. And actions such as the nationalisation of YPF have also ticked off foreign investors and officials.

Still, the current ruling threatens to disrupt long-standing precedents and make orderly debt restructurings even more difficult than they already are, although the legal manoeuvrings are still continuing.

The Greek and Argentine cases highlight the continuing absence of an international sovereign bankruptcy regime. 

Back in the early 2000s, the IMF's Anne Krueger set out the case for a  Sovereign Debt Restructuring Mechanism or SDRM, and the Fund did a lot of work on the idea. In the end, the SDRM proposal failed to get traction in the face of much opposition, particularly from Wall Street. But given the ongoing lessons from Greece and Argentina, not to mention the debt problems afflicting a range of other developed economies, maybe it's time to revisit the debate on whether our current framework is up to the task of dealing with sovereign debt distress.


Back in 2009, I wondered whether Brazil's adoption of capital controls was a portent of a shift in international attitudes towards regulating capital movements. Later posts by Stephen Grenville tracked the way in which the IMF was changing its own views. That rethink has continued; the latest paper setting out the Fund's view is here. The IMF is now adopting the institutional position that controls have a potentially useful role to play in managing volatile capital movements. Another sign that the times, they are a changin'.

Steve Grenville covered the problems of volatile capital flows at greater length in a recent article in the ANU's policy-focused journal Agenda. He noted that the IMF had shifted a long way but still had a fair distance to go before they had operational answers.

Photo by Flickr user .Martin


Back in the heady days before the GFC, we got used to a world economy marked by strong annual growth rates plus a rising trend rate of growth.

A key driver of both developments was the growing share in world output of faster-growing emerging markets. Between 2003 and 2007, for example, world real GDP growth averaged an impressive 4.8% when output is measured on a PPP basis (which gives a relatively greater weight to fast growing emerging markets), and a more-than-respectable 3.6% when market exchange rates are used.

In contrast, according to the latest IMF World Economic Outlook, growth this year will perhaps be 3.3% on a PPP basis and 2.6% on a market exchange rate basis. The Fund judges that 'prospects are for sluggish and bumpy growth', with a significant risk that 'global activity could deteriorate very sharply.' More recently, the OECD's latest forecast update reckons that the global economy faces 'a hesitant and uneven recovery' over the next two years. Like the Fund, the OECD is warning of the threat of renewed recession.

Of course, this gloomy outlook for the world economy is largely a legacy of the GFC and the eurozone crisis that followed. And there are more than enough short-term risks, from the looming US fiscal cliff through to continuing eurozone fragility, to keep expectations subdued. Not surprisingly, the subdued growth performance of the developed world has helped drag down activity in emerging markets. 

But is there anything more going on?

Take a really simple model of world growth, where the pace of global activity is a combination of growth at the frontier in the world's advanced economies (driven mainly by productivity growth and innovation) and growth behind the frontier in the world's emerging markets and developing economies (driven mainly by a process of catch-up or convergence). Now think about what's happening in each of those groups.

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At the frontier, some analysts are looking beyond the present troubles and worrying that structural or potential growth is now lower than it used to be. Economists like Tyler Cowen and Robert Gordon have highlighted trends in variables such as innovation and demographics to suggest that we should no longer expect the kind of growth at the (US) frontier as we've seen in the past. Other economists worry that the impact of the current crisis – higher public debt stocks, more unemployed workers, a large and perhaps still growing list of shelved investment projects – will all have trimmed potential growth rates in the affected economies.

The pessimists may turn out to be too gloomy in the long run; there's always a tendency to conflate current cyclical conditions with long term trends and there's almost certainly some of that going on now. Still, there's no denying that many advanced economies are likely to face some strong demographic, fiscal and socio-economic headwinds over the medium-term when it comes to raising their growth performance.

Even a slow (or stalled) frontier should in theory be consistent with robust global growth thanks to the process of convergence towards that frontier. After all, sizeable gaps in GDP per head between developed and developing economies indicate that there's plenty of scope for more catch-up growth.

Yet here too, the earlier optimism on sustained emerging market growth performance (part of what I have described in the past as our Consensus Future) has faded somewhat. In part, this is just a case of facts changing opinions; annual growth in India slowed to 5.3% in the latest quarter, with analysts now expecting this year to deliver the weakest growth performance for a decade. Likewise, Brazil's economy is barely growing at all, and even the powerhouse that is China has seen growth dip markedly this year, although here at least there some signs of a turnaround.

As already noted, a significant share of this growth slowdown has been driven by spillovers from the economic mess in the developed world. But there is also a growing debate as to whether there are other, structural factors in play. Two in particular stand out.

First, there is the risk that some of the big emerging economies will find themselves stuck in the so-called middle income trap. There is growing agreement that China has now shifted down onto a lower growth path, leaving the days of double digit growth behind it. Since this slower growth is now operating on a much larger economy, the implications of this change could be modest. But what if the slowdown is not just the side effects of transition to a new growth model and a narrowing of the convergence gap, but rather an indication that the middle income trap is now biting? 

Moreover, China is now a major growth driver for a range of other emerging economies, so the answer to this question would have implications for its key trading partners too. And similar questions can be raised about some of the other emerging powers. For a pessimistic take on the future of growth in the BRICs, see this piece by Ruchir Sharma in Foreign Affairs.

Second, there is the possibility that changes at the frontier (and in the global economy more generally) have had big, adverse implications for the pace of catch-up growth. In other words, maybe the 2003-2007 period represented a short, golden age for convergence, and while the convergence process may well continue, from now on it will do so at a much reduced rate.

For now, I don't think we have anywhere near enough evidence to ditch the Great Convergence story altogether, although I do think that the case for modifying that story to include a slowdown in the pace of catchup growth is becoming more compelling.

Photo by Flickr user Martha de Jong-Lantink


As the IMF has recently pointed out, these are tough times for the global economy, with a range of international economic risks including the ongoing crisis in the eurozone, the looming US fiscal cliff, the deterioration in sovereign creditworthiness across much of the developed world, and questions over the future growth trajectory of some of the big emerging markets all combining to cloud the world economic outlook.

Meanwhile, the recent Asian Century White Paper has arrived with a lengthy list of the economic policy challenges Australia will have to meet to prepare for what the Government thinks is the likely shape of our economic future. Then there is the debate over whether we in the lucky country might be in the process of seeing some of our luck run out

All of which makes it a good timing for Cameron Clyne to deliver this year's Lowy Lecture on funding Australia's future tomorrow evening. The National Australia Bank's chief executive will take a look at the fallout from the Global Financial Crisis and ask what we need to do to better insulate the Australian economy from future international shocks. Stay tuned for a link to his speech and video recording.

Photo by Flickr user darkmatter


Last week, Japan's finance minister expressed concerns over reported customs delays for Japanese companies in China. Some observers have described disruption to Japanese trade as a form of economic sanctions imposed by Beijing to signal its displeasure with Tokyo over the Senkaku/Diaoyou Islands dispute. With world trade already slowing – the WTO recently cut its forecast for world trade growth this year to 2.5% from 3.7% – this is a particularly bad time for a trade dispute between East Asia's two economy heavyweights.

If the sanctions diagnosis is correct, it wouldn't be the first time China has chosen to use international trade to pressure Japan. In 2010, there were claims that China had blocked the export of rare earths as part of a dispute over Tokyo's detention of a Chinese fishing boat captain. 

And it's not the first time that China has wielded the trade weapon this year: a few months ago there were claims China was imposing restrictions on banana imports from the Philippines in retaliation over a dispute relating to contested waters around the Scarborough Shoal in the South China sea. The Philippines tourism industry also suffered fallout in the form of canceled visits. Last year, when the Nobel Peace Prize committee announced it was going to honour a prominent Chinese dissident, exports of Norwegian salmon to China were targeted in response. Likewise, researchers have found empirical evidence that Beijing has punished countries that officially received the Dalai Lama with a reduction in their exports to China.

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To be fair, China is far from unusual in using international trade to send messages to other economies. There's a long history of trade sanctions and trade embargoes to attest to that. But, as I noted in a previous post, the potential vulnerability of 'Factory Asia' to politicised trade disputes means that, if used too frequently in the region, this particular weapon could quite quickly become a two-edged sword.

Still, looking ahead, if the much-anticipated rebalancing of the Chinese economy finally does arrive, it will have significant implications not only for regional trade patterns but also for the effectiveness of the trade weapon at Beijing's disposal. 

That's because a China that is less reliant on external demand and a bigger source of domestic demand is going to be simultaneously less vulnerable to trade disruptions at home while becoming an even more important market for other trading partners. Controlling access to China's large domestic market already gives Beijing substantial geo-economic heft. If China's growth difficulties can be overcome, that weight will continue to grow.

Photo by Flickr user lensfodder.


As my colleague Linda Jakobson has written, the recent burst of anti-Japan protests in China tells us some interesting things about sovereign sensitivities, Chinese domestic politics and resource security. I wonder whether they might also have some implications for the dense and complex network of regional supply chains that are sometimes described as 'Factory Asia'?

One of the defining features of our current era of globalisation has been the emergence of global supply chains or global value chains. In a process that economists have variously described as the disintegration or fragmentation of production, the rise of vertical specialisation, or the second great unbundling, production has been 'sliced and diced' into different stages of production distributed across a range of economies.  

Source: Asian Development Bank.

Several factors have driven this trend, including policy-led declines in tariffs and other trade barriers (in part through specific agreements like the ITA and regional arrangements like ASEAN), technological innovations in transport and communications which have reduced coordination costs by increasing the speed and quality of communications, and a combination of strong demand growth in the developed world with a strong supply response from emerging economies.

East Asia in general (and China in particular) has been at the heart of this process, with supply chains in the region more integrated, and national export structures more closely intertwined, than is the case in North America or Europe.

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While global supply chains have proven to be a very successful manifestation of globalisation, they are not without their vulnerabilities. A swing to protectionism would be very disruptive, for example, although it's also true that their country-spanning nature may have served as an important barrier to protectionist impulses in recent years. Big increases in transportation costs (due to increases in the oil price, for example) would likewise threaten the current model of globalisation. And natural disasters such as the 2010 volcanic eruption in Iceland and the 2011 earthquake and tsunami in Japan have also demonstrated some of the fragilities of these complex international networks.

Now, however, two additional factors look to be threatening the longer term viability of the Factory Asia model.

First, the aftermath of the global financial crisis has seen a sharp decline in growth across much of the developed world, prompted in large part by a major retrenchment by European and American consumers. If the years of credit-fueled consumer binges that were the counterpoint to East Asia's high investment, high export growth model are to become nothing more than a fading memory, then economic and business models predicated on that version of the world will be at risk.

Second, the expansion of global and regional supply chains took place against a very particular geo-political and geo-economic environment. Specifically, it was a product of the period following the end of the Cold War when cross-border trade and investment were facilitated not only by a more friendly trade policy environment and by technological innovation but by a period of relative geo-political tranquility (at least in East Asia). 

If this week's developments prove to be a sign of things to come, a region which is going to be marked by the kind of nationalistic tensions and business disruptions we have just seen would be a region that looks much less welcoming to the kind of deep economic integration that has hitherto helped power East Asian growth.


In the (almost) three weeks since it was announced that we are establishing a G20 Studies Centre here at the Lowy Institute, I reckon the most common reaction from interested observers (following on from some initial wishes of good luck) has been some variation on the statement, 'but the G20 is in trouble, isn't it?' 

While I think some of the G-pessimism is overdone, there's also no doubt that, for example, the FT's warning that the G20 risks irrelevance is pretty representative of widespread concerns that the grouping has lost a degree of credibility and momentum. I still remember last year's Cannes Summit being described as 'comically irrelevant' in the same newspaper.

In fact, as I noted in my first post on the announcement of the Centre, observers have been warning that the G20 was struggling since at least the Seoul Summit. In my view, a big part of the G20's perception problem is that, by getting off to such a good start, the grouping raised unrealistic expectations about how it was likely to function. Forged in crisis, the G20 benefited from the 'hang together or hang separately' environment that surrounded its initial meetings at leaders' level. Given the diversity of its membership, however, it was inevitable that this consensus would evaporate and be replaced with disagreements and conflicting national interests.

After talking to some participants, it seems clear that there is a sense of disenchantment about how some G20 meetings are run: too much process and too little substance; too many agenda items and too little action; too many pre-prepared positions and too little meaningful discussion. There are a range of explanations for this, including the apparently still growing number of those involved (the G20 is in reality a G20+) and the ever-present pressure to come up with new 'deliverables' or 'announceables'.

It follows that a critical objective for future G20 chairs, including Australia, is to make sure that participants continue to value their attendance at G20 meetings, rather than viewing them as an unfortunate imposition on their time.

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One way to approach this problem is to think again about the G20's role. To date, this has often been couched in terms of whether the group can or should transition from its initial role as global economic and financial crisis committee to the grander, post-Pittsburgh role of global economic and financial steering committee – the One G to rule them all.

If it turns out that the G20 is fit to be the world's crisis committee but nothing more, then expectations of future G20 meetings change. Instead of the focus being on managing international economic cooperation and delivering improved economic coordination, the central function of most G20 meetings is going to be much more modest. It will be to provide a regular opportunity for leaders, finance ministers and central bank governors to build working relationships in order to make sure that, when a crisis response is required (like at the peak of the GFC), it will be quicker and easier to deliver. 

In this model, the key thing would be to make sure that the summits continue and hence that participants basically enjoy attending them. In this sense, Steve Grenville's comparison to a 'children's birthday party, where the main objective is to make sure that no one feels excluded, every participant wins a prize and everyone goes home happy', would actually make for a reasonable, if somewhat tongue in cheek, description.

On the other hand, if the G20 is to meet the rather higher expectations after the Pittsburgh declaration, then future meetings are going to need to deliver much more than happy attendees. In particular, they will have to demonstrate that the group is capable of producing effective international economic cooperation in an environment where some believe this is almost impossible

That means either making demonstrable progress on the items already on the G20's agenda or recognising that no more can be done on a given item and removing it before new commitments get added. An effective global steering committee will be measured by successful initiatives, not by an ever-expanding list of to-do items, working parties and outsourced reports. This steering committee model requires much more work than the birthday party model, but the rewards would likewise be much greater, and the promise of Pittsburgh would be closer to being fulfilled.

Photo by Flickr user jasoneppink.


Back in 2009 I wrote a post for The Interpreter suggesting that, in the aftermath of the GFC, big was beautiful when it came to Asia's growth prospects, citing in particular optimism about China, India and Indonesia. For the next couple of years, that looked like a good call, but now two of those three are experiencing growth problems.

I discussed the ongoing debate over China's growth performance in two earlier posts, but China is not the only Asian giant with growth worries. India's recent growth record – accompanied by, and in no small part a product of, a truly depressing political situation – has turned hopeful Indians into worried ones.

India's first quarter 2012 GDP reading (also the final quarter of India's 2011-12 fiscal year), which saw growth dip to just 5.3% over the previous year, was the lowest result in almost a decade. Only a couple of years ago, some observers were daring to wonder whether India could reach double-digit growth for the first time. With 5% now looking the more likely alternative, some observers have started to pen their obituaries for 'Incredible India' and wonder whether India could be the 'first BRIC Fallen Angel'. 

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Granted, the second quarter 2012 reading (the first quarter of India’s 2012-13 fiscal year) did come in higher than expected, at 5.5% on the previous year. That has prompted some hopes that the worst could be over. But it hasn't stopped a range of economists slashing their growth forecasts. Then there are the concerns about the quality of the data...

What of Indonesia, the third member of my original trio? Here at least the story is rather different, with more talk of boom than gloom. Indeed, instead of worrying about faltering growth, analysts have been debating whether or not Indonesia's economy is overheating.

Overall, it still seems likely that in an international environment overshadowed by the continued risk of a worsening of the eurozone crisis, Asia's more open and trade exposed economies are going to be at greater risk of growth volatility than the bigger, more closed economies, and hence that size will continue to matter. But it's also fair to say that big isn't looking quite as beautiful as it used to.

Photo by Flickr user Mr TGT.


Part 1 of this post, which asked 'What's the story with China's growth?' and 'Why has growth slowed?', is here.

Q3. OK, but does all that mean that China's high growth days are over?

A. The honest answer is: we don't know yet. The mix of factors at work means that we can't really be sure what proportion of the current slowdown is cyclical, and what part is structural. Given that uncertainty, the China bulls and bears will both be eager to stick with their own stories, not least since there is a very human tendency to place a lot of weight on not only our priors but also on the most recent data point.

For the optimists, the story is one about a cyclical downturn prompted by the combination of tough global conditions and a perhaps too-slow shift by Chinese authorities from a restrictive to a stimulative stance. In the longer term, they can fairly point out that there is still plenty of scope for more catch-up growth given the persistent and sizeable gap in output and capital per head between China and the countries of the developed world.

For the China (über) bears, on the other hand, this is a chance to emerge from the cave they retreated to after repeated past predictions of disaster failed to materialise, and predict that the crash they have been waiting for has finally arrived.

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For the more cautious pessimists, the current downturn is likely to prompt worries that China may be falling into the so-called middle income trap, and face a future of substantially lower growth even once the current cyclical downturn has passed.

Two points to finish with.

First, while we won't know for a while exactly what the current slowdown is telling us, hardly any forecasters have assumed that China would maintain the kind of double-digit growth rates we have seen for the past three decades over the coming ones. As China moves from enjoying demographic tailwinds to pushing against demographic headwinds, as the growth mix shifts, and as the convergence gap with the developed world narrows, the assumption has always been that China's growth rates would decline. 

See for example the recent major study on China by the World Bank, which among other things projected that, even on a best case scenario, Chinese growth could ease to below 6% within the next decade. Slower growth was always on the cards: it's the size and the timing of that shift that's uncertain. And that matters: there's a big difference between a gradual slide to a slower growth rate and an abrupt deceleration.

Second, it's important to remember that lower growth rates will still be operating on a Chinese economy that is much, much bigger than it was even a decade ago. That means that China's global economic footprint – absent the sort of complete meltdown that the über-bears worry about – will remain incredibly important for the world economy.

Photo by Flickr user toehk.


Q1. What's the story with Chinese growth?

A. Something interesting does seem to be happening. Back in March, Wen Jiabao said China's growth target for 2012 was just 7.5%. That implied a sizeable change for an economy that had averaged roughly 10% growth for the past three decades and 11% growth for the past ten years. It also meant a drop below the almost magical 8% number that many analysts have seen in the past as providing a floor for Chinese growth.

As a result, many China watchers chose not to buy in to the new projection and kept their forecasts above the old 8% floor. Now, they are scrambling to revise their numbers downwards. In fact, China's economy has been slowing since early 2011. In the first quarter of 2011 the economy grew by almost 10% on the previous year. By the second quarter of 2012 the headline growth rate had slipped to 7.6% from a year earlier, its slowest pace in three years and a fall of more than two percentage points. 

Since then, below-consensus economic readings for July and August suggested that activity has continued to ease into the third quarter as well, to the extent that even the official 7.5% growth target is now at risk. As a result, many analysts have started downgrading their forecasts for this year to accept the likelihood of sub-8% growth.

Q2. So, why has growth slowed?

A. At least three distinct factors are at work.

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First, until quite recently, Beijing was actively seeking to take the heat out of some key sectors of the economy. In the aftermath of the GFC, Chinese authorities responded with a massive fiscal and monetary stimulus. This was very successful in restoring strong economic growth to an economy that had come close to stalling in the final quarter of 2008 and first quarter of 2009, but it also produced a range of unpleasant side effects, including concerns about overheating and fears about bad loans and an inflating property bubble

The authorities responded with measures designed to cool the property market in particular. With that sector accounting for around 13% of GDP last year and playing an important role in supporting activity since the GFC, its not a surprise that this tougher policy stance has taken a toll on activity.

Second, China (like the rest of us) is facing a tough external economic environment right now, one where the prospects for global economic growth continue to be depressed not only by the aftermath of the GFC but also by the mess in Europe. The EU is China's largest trading partner and accounts for about 18% of total Chinese exports. In August, Chinese exports to the EU fell sharply compared to the previous year. This deterioration in external conditions has reinforced domestic policy tightening and further depress growth.

Third, China's economy may also be transitioning to a lower pace of potential growth, firstly due to demographic factors through the possible arrival of the so-called Lewisian turning point, but also as a consequence of trying to rebalance the economy away from the investment- and export-led growth model (hitherto extremely successful but now possibly running into diminishing returns) towards a more consumption-based model. 

Remember, back in 2007, Wen Jiabao famously warned about the 'Four U's', saying that China's economy was Unsteady, Unbalanced, Uncoordinated and Unsustainable. Correcting those 'U's' was always likely to have implications for the sustainable pace of Chinese growth.

In addition, China's policy response to the downturn has been milder than many forecasters had predicted. In part, this presumably reflects the fact that the authorities meant what they said when they forecast lower growth this year. It also reflects some lingering concerns about the adverse side-effects from the previous stimulus package

But there is also the role of this year's political transition to take into account. The old consensus view seemed to be that, in such a politically sensitive year, the authorities would be extra-keen to avoid any growth mishaps. The new view seems to be that the upcoming transition has in fact delayed the policy response and seen Beijing get behind the curve. Recent announcements of new infrastructure spending plus some strong readings on bank lending in August suggests that they are now trying to catch up.

Q3. OK, but does all that mean that China's high growth days are over?

A. More on that in a follow-up post.

Photo by Flickr user Sharon Drummond.


Yesterday, the UN's Food and Agriculture Organization (FAO) released its food price index for August, which showed the overall index of prices unchanged from July's reading. That offers some comfort to those who were worried about a looming food crisis following a 6% jump in the index in July. In real (inflation-adjusted) terms, food prices remain below the highs reached in previous peaks in early 2011 and in mid-2008. But that still leaves them at high levels by the standards of the past two decades:

Just a few days ago, the FAO, IFAD and the World Food Program issued a joint statement warning of the dangers posed by the situation in world food markets. The three bodies have emphasised that the world is now dangerously vulnerable to adverse supply shocks like the drought and heatwave now punishing the US corn belt. That's because 'even in a good year, global grain production is barely sufficient to meet growing demands for food, feed and fuel – this, in a world where there are 80 million extra mouths to be fed every year.' See this infographic from the WFP describing the food price roller coaster since 2008.

Meanwhile, commentators such as David Frum warn that rising prices could turn 2013 into a year of crisis and social unrest.

This is the third major international food price spike in the past five years, with prices rising sharply over 2010-2011 to reach a record high in early 2011. Many commentators have suggested that the high prices of that year played an important role in helping to trigger the Arab Spring.

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The first crisis came in 2008, when the world economy was faced with a serious problem: by June that year, more than 30 countries had experienced some form of social unrest or domestic protest triggered by high prices, and by the start of July 2008 the Managing Director of the IMF was warning that 'some countries really are at a tipping point. If food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people and at the same time maintain stability in their economies.'

While the global food crisis grabbed headlines for much of the first half of 2008, however, it was replaced in the news by another GFC – the global financial crisis – and the subsequent slump in economic activity was associated with a sharp fall in commodity prices.

In a Lowy Institute working paper published in early 2009, I took a look at some of the lessons from the 2007-08 experience, arguing that it told us some important things about life in a resource-constrained world economy, including the likelihood of higher and more volatile commodity prices and a growing vulnerability to supply shocks. In a subsequent essay for the journal Survival, Alan Dupont and I warned that the world might be facing a new era of food insecurity.

For now, at least, the experts don't seem to think that we are in immediate danger of repeating the 2008 crisis in 2012. The WFP has highlighted what it sees as some key differences between then and now, including higher global stocks of wheat and rice than was the case in 2008, the absence (so far) of export bans, and a backdrop of weaker global growth which means demand is more subdued. Likewise, in its latest Food Price Watch, the World Bank says that its experts 'do not currently foresee a repeat of 2008'.

But we shouldn't downplay the risks. For a start, there is no doubt that countries which are heavily dependent on food imports (measured as a high share of net cereal imports as a proportion of total consumption) and where food consumption itself is a high share of household expenditure are vulnerable to current price conditions:

Moreover, the same Bank report goes on to warn that if certain risk factors did materialise – a return of export bans, a severe el Nino, a sharp increase in energy prices – then 2008-style price increases would again be likely.

Lastly, even if we manage to avoid these pitfalls this year, trends in supply and demand suggest that global food markets are set to remain tight over the longer term. That means the world – and especially the poor – will remain vulnerable to food shocks.