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The post growth West? The debt crisis and the shift to new drivers

    • Florence
    • 18 November 2011

          Three major issues stand out in the list of challenges currently facing the Western world: (1) medium-term trends in the global economy, with special focus on new sources of growth, rebalancing and decoupling; (2) the European debt crisis, its outlook and possible solutions; and (3) green energy as a growth driver.

          Growth – but elsewhere: the era of middle powers. The growth trend of the next decade will depend on three fundamental issues: the new sources of growth and the possibility of fundamental decoupling from the US and EU; the ability of China to escape a middle income trap; and the sustainability of growth models.  The recovery is more troublesome than anticipated.  Fears abound that it potential growth rates may have been adversely affected and that sustained decoupling is unlikely. The G20, via its Mutual Assessment exercise, is trying to achieve a symmetrical, Pareto-improving rebalancing where surplus countries focus on boosting domestic demand and deficit countries focus on structural reform that can boost potential growth and exports. This is consistent with private sector views, as global CEOs are increasingly focusing on middle class consumers in fast-growing emerging economies. Rebalancing is just what economic theory would predict, as it implies capital flowing south. Indeed,the anomaly was before, when capital was flowing north. 

          It is critical to look further than the BRICs. There is a clear differentiation of problems and the capacity to address them, especially as regards the management of capital flows, sudden reversals and currency volatility.  The differentiation in policy space to implement counter-cyclical policies hinges on five elements:  fiscal sustainability (low debt to GDP ratios, averaging around 40%); robust monetary policy frameworks; well-balanced and regulated financial markets that provide good buffers against shocks; floating exchange rates (de-dollarization has allowed floating); and a doubling in a decade of south-south trade.  This is a permanent trend, with terms of trade very favorable to all countries producing raw materials.

          China continues to sustain 8-9% growth.  The second and third year of any five-year plan are typically the high point in investment cycle, but this time things are different, due to heavy expansion last year. Real consumption growth is very strong, even if the share of consumption in GDP remains low.  Still, it can grow faster in the aggregate:  the consumption rate of the urban population is already very strong. The key is therefore to bring more people to urban areas – and the current five-year plan puts heavy emphasis on building more cities. In addition, there needs to be more government consumption on behalf of households – safety nets, environment, etc. Finally, state-owned enterprises have to pay a bigger share in dividends, so that wealth is better distributed. Altogether, this would allow the government share of GDP to increase from the current 15 to 20-25%; furthermore, it would boost domestic demand.

          Europe and the US: between high debt and low growth. The euro area is the epicenter of the global crisis. There are three critical questions in this regard: can the euro area policy-makers manage the crisis? Can the euro area become a better currency area (assuming the policy-makers can manage the crisis)? And what is the outlook (if crisis management fails)?

          The key stumbling block is that, in order to decide on the short term, a clear understanding of the long term is critical. Nothing less than the future shape of European Monetary Union is at stake. It is not about how or whether to bail out Greece: it is about how or whether to bail out the system in a context wherein the nominal convergence that the euro was expected to generate has instead become divergence. 

          In some sense, the decade of the euro has generated the worst of all possible worlds: less competitive economies, governments saddled with debt, countries stuck in a fixed exchange rate.  Add to this that the management of the crisis has generated two “original sins” (the threat of default on public debt, and the threat of exiting the euro), and the result is the disappearance of the European risk-free asset and a large scale liquidation of European assets. The October 26 package has collapsed, as the EFSF can’t raise funds in markets, and therefore there is no firewall.   And the ECB’s resistance to act in a forceful and preemptive manner – grounded on an attempt to prevent fiscal dominance – only creates confusion and further uncertainty.  Markets are running faster than politicians.  It is necessary to find a way to buy time to allow the euro area countries to adjust. Eurobonds have become a necessary condition for the existence of the euro.  Whether Germany will be ready to accept eurobonds, and under what conditions, remains to be seen.  Clearly, we have reached the end of the road. The era of the euro as we know it is coming very quickly to an end.

          Green energy as growth driver: reality or myth. Green energy enjoyed its heyday after 2008, as a new US president and a European 20/20/20 strategy renewed efforts to boost “green energy” investments.  This boom, however, has dimmed in the last year. What was seen as a path to sustainable job creation is now an industry that is capital intensive, creates few jobs and requires abundant public subsidies. In a context of generalized fiscal tightening, the outlook for a subsidy-dependent industry is unclear.   In addition, there has been a revival of dirty energy, as more supplies of oil and – more importantly – natural gas have become available and are likely to be better job generators than renewable energies. Energy investment has been and will continue to be robust; it is a sector driven by demographics, obsolescence, and long lead times. This has been quite uniform across technologies and across regions.  Two patterns can be observed in particular: in mature economies, investments have been targeted at changing the mix of assets towards improving supply security; in the rest of the world, investment has been driven by sheer demand.