The crisis hits emerging markets

We are used to hearing that global growth is being driven by emerging markets. In the original Goldman Sachs study that coined the term “the BRICs”, it was estimated that by 2020 the BRICs would account for 49% of global GNP. In 2010, the figure was already 36%. Increasingly responsible for propping up the global economy, many believe that the future lies in emerging economies. When European leaders recently courted China as a possible buyer of troubled government bonds, the idea of emerging economies bailing out their erstwhile masters seemed complete.

The picture is in fact more nuanced for many different reasons. In an excellent recent study, Zaki Laïdi notes that the political demands of the BRICs are ambivalent: they defend national sovereignty in ways that prevents them from developing a shared political project of their own. In economic terms, the notion of a fundamental shift from the North America and Western Europe towards Brazil, China and India also needs to be nuanced.

The dependence of these emerging markets on the state of the economies in North America and in Western Europe is striking. In 2009 the world economy as a whole went through only a minor downturn, largely because of the offsetting growth in emerging markets. In 2010 and 2011, the picture has been rather different. Looking at growth rates across OECD and non-OECD countries, what is striking is how closely matched they are. The latter group consistently post higher growth rates but these rates rise and fall in line with growth in OECD countries.

This correlation in growth trends doesn’t mean the rich world is driving growth in emerging markets. But there are some powerful ways in which the problems in OECD economies have begun to feed through into emerging markets. Two channels in particular stand out. One is a fall in consumption in the US and Western Europe, resulting in a decline in demand for primary and secondary products exported out of emerging economies. On December 1^st, it was reported that China’s manufacturing sector contracted for the first time in almost three years. As the chart below shows, after a sharp downturn then upwards spike in the course of 2008, the rate of expansion of factory output in China has been declining steadily.

The second channel is via the withdrawal of foreign capital because of the pressure on Europe’s financial system. As banks reduce their exposures, those emerging economies dependent upon foreign bank lending are in difficulties. This exit of foreign capital and a declining demand for national currencies such as the Brazilian real or the Turkish lira is having inflationary consequences: as the currencies depreciate, the cost of imports rise, pushing up the general price level. This bites into the competitiveness of these economies as wage demands respond to higher living costs (NB. this is one reason Germany wants to avoid seeing the ECB stoke inflation in the Eurozone – it would undermine its ability to contain wage demands and thus challenge its own competitiveness model). According to the Basel-based Bank for International Settlements, emerging markets owe 3.4 trillion US dollars to European banks; 1.3 trillion US dollars of that is owed by Eastern European countries. According to The Economist, as European banks deleverage downward pressure will be placed on many emerging markets. This is particularly serious for those countries – like Turkey – who run large current account deficits. They are dependent upon foreign capital to manage these deficits.

What the figures imply for the role of the emerging markets in the global economy is far from clear. But the exposure of these economies to the events in North America and Western Europe is obvious. To declare the irrelevance of these two regions in the face of the rise of China or of India is to miss the extent to which growth in emerging markets is dependent upon OECD economies.

Global Imbalances and Financial Crisis: A dimension of the financialization question

We have attempted to argue before that financialization is about more than just the ‘rule of the financial class.’ That, in a way, the idea of an all powerful financial class misses out on some of the other structural problems with current economic organization as a whole. That, for instance, was a point raised in yesterday’s guest post by Daniel Ben-Ami. One dimension of this background, economic structure is the issue of global imbalances. Some argue that the very large current account (ie trade) deficit in the United States, mirrored by the very large current account surpluses in China, lie at the heart of the financial crisis. Over the 2000s, the Chinese bought more and more T-bills, which helped finance American consumption. Seemingly bottomless demand for American debt kept interest rates lower than they otherwise would have been. Low interest rates fueled borrowing at every level of the American economy, it financed American consumption of cheap Chinese goods, and made possible widespread speculation with essentially forced Chinese savings.

A recent paper by Claudio Borio and Piti Disyatat at VOX EU challenges this account on the grounds that “global imbalances reveal little about financing patterns.” One of their key claims is that the global imbalances argument is about net flows – outflows-inflows – rather than gross cross-border flows. When we focus on gross cross-border flows, the story appears not to be about US-Chinese global imbalances, but complex inter-relations between advanced economies: “the bulk of the spectacular expansion of global gross capital flows (inflows plus outflows) since the late 1990s, from around 10% of world GDP in 1998 to over 30% in 2007, has been driven by flows between advanced economies. Flows from, or, between, emerging markets have been much smaller.” Gross capital flows from Europe to the US, especially the UK, massively outstripped Chinese, and it was the seizing up of the former that correlated with the crisis.

We are still digesting the implications of this argument, but it does spur some thoughts about financialization. First, even if global imbalances are part of the puzzle, Borio and Disyatat’s paper suggest a lot had to do with the regulatory apparatus(es) and global financial architecture between and amongst advanced economies. Second, it reminds us that the growth of financial activities in advanced economies is not just larger than can be explained by Chinese savings, but well predates the growth of global imbalances between China and the US. After all, China only became a serious holder of US debt in the 2000s, but the growth in debt-financed consumption, rolling asset-bubbles, and increased financial activity by non-financial companies – to name a few features of financialization – began in the mid-1970s. To supply just one graph illustrating a dimension of the trend, taken from this 2008 article we can see that it was in the early 1980s that dramatic indebtedness began:

It is quite likely that the growth of global imbalances could have dramatically exacerbated a trend, supplying even more funds for the speculative activity of advanced economies, but the underlying financialization of the advanced economies appears to be something more structural than a change in global imbalances would resolve.

Stimulus, jobs and finance

A recent article in Economist Voices by two economist from Santa Cruz, Joshua Aizenman and Gurnain Pasricha, points out that the total fiscal stimulus has been decidedly less than we might think (the EV article is paywalled, an earlier working paper version availablehere). In fact, the results of their study show “that the aggregate fiscal expenditure stimulus in the United States, properly adjusted for the declining fiscal expenditure of the fifty states, was close to zero in 2009” and that the US “ranked at the bottom third in terms of the rate of expansion of the consolidated government consumption and investment of the 28 countries we studied.” The clue is in the first quote – while the national government engaged in a major stimulus, the state governments contracted, leaving overall stimulus just above zero. This should give anyone pause who thinks the fiscal stimulus strategy was tried and failed. And it reminds me of a favorite point from Daniel Lazare’s Frozen Republic, which is that the complexity of the American federal constitution makes national coordination of joint efforts too confusing. This is a democratic problem – if you can’t actually tell what’s going on, and who is responsible for what, power remains obscure, and holding politicians to account is a more difficult task. After all, one could be excused for having thought theUS undertook a major fiscal stimulus – and for the most part, the effect of state and local level contraction has gone under the radar.

But what if there had been a more serious fiscal stimulus? While we have defended some of the virtues of, say, a jobs program against those who think monetary strategies would work better, there are some significant questions to raise about them that speak to the underlying organization of the American economy, and its place in the global economy. In a recent attack on Obama and the Democrats, James Galbraith argues the stimulus failed to restart the economy because of “the complete collapse of the financial sector.” (h/t Art Goldhammer) Now the statistics cited above might suggest that financial collapse isn’t the only reason – there wasn’t nearly the stimulus one might think. But Galbraith points to what is surely an important issue “the for profit job-creation model – the ‘Great American Jobs Machine’ which was predicated on bank credit and venture capital – is moribund.” At the very least, the financial model of the American economy is not just in crisis but in what is increasingly looking like long-term stagnation. Democrats have punted on this issue – sitting around praying that private investors will soon start investing more is just political thumbsucking.

On Galbraith’s account, the only solution would be what is now politically impossible – government jobs programs. Curmudgeon that he is, Galbraith doesn’t go for a classic infrastructure project, crankily suggesting that the “pampered and educated children” of the middle classes “would not take the work and would not do it well if they did.” Instead, Galbraith holds out “state and local government public service” and the “non-profit sector, funded indirectly by the public” as growth areas. If this isn’t a failure to take the bull by the horns I don’t know what is. Having declared the financial model of jobs creation moribund, Galbraith seems to think the US economy could possibly get along without producing anything. If the financial model is indeed in crisis, then that is a deeper structural problem with the American economy than an increase in public service employment could address – how, eventually, would the debt get paid back if all the money were going into activities that produce no foreign exchange? Are we seriously going to soak up ten percent unemployment with more policemen, firemen and health workers?

Put another way, there is no getting around the collapse of American manufacturing, and the problems with the United States having become the world’s banker. Re-orienting the American economy means changing not just its domestic priorities but its international position as well, including addressing the global imbalances that have underwritten the American financial industry. We have no clear idea of what the right answers are to this problem, but it does not help to sweep them under the rug. And it is a further reminder that significant change, nevermind improvement, is more than a technical fix or two away.