Reply #43: The Growth Machine (Roach - capitulating to the "it's different now" crowd?)

[54anickel]

http://www.morganstanley.com/views/gef/archive/2007/20070116-Tue.html

After four years of booming global growth, I have argued that the world is due for a rest -- not a hard landing but a marked slowdown from the strongest surge since the early 1970s. The verdict in the early days of 2007 is that I could well be wrong. For longer than I care to remember, my base case has argued that ever-mounting imbalances will ultimately crimp vigorous growth in global economy. While there can be no mistaking the imbalances of a US-centric world, there can also be no mistaking the extraordinary resilience of the great global growth machine. Is it time for a new approach?

The debate over the sources of growth is as old as the economics profession itself. That debate has great relevance for global rebalancing -- especially since it makes the important distinction between growth that is dependent on external or internal sources. In the end, only the latter strain of growth is self-sustaining. That raises one of the toughest problems of all for an unbalanced world: The demand side of the global economy has been dominated by the American consumer, where growth in recent years has been underpinned less and less by the traditional support of income generation and more and more by the wealth effects of an increasingly asset-dependent economy. As the balance shifts from income- to wealth-dependent growth, the risks of financial vulnerability can mount. That’s certainly been the case in the United States, with record levels of household sector indebtedness, sharply depressed domestic saving, and massive current account deficits.

Similar sustainability concerns pertain to the supply side of the global economy -- increasingly dominated by China. In this case, the growth dynamic has been concentrated in China’s two most outward-looking sectors -- fixed investment and exports, which collectively account for about 80% of Chinese GDP. The sustainability requirements of such an externally-led growth framework are very different from those of the demand-side model. The investment process has to be rational, with capital allocated in the right dosage to the right industries -- avoiding both production bottlenecks and capacity overhangs that might jeopardize ongoing growth. The export process needs to match the needs and aspirations of China trading partners -- without creating undue cross-border frictions.

My problem with sustainability of the current strain of global growth arises mainly out of the internal imbalances of the US and Chinese economies. In recent years, America’s asset-dependent economy has been prone to periodic bubbles -- first equities and now property. Post-bubble shakeouts crimp equity extraction from asset markets -- putting pressure on income-short consumers to rebuild income-based saving rates. By contrast, China’s supply-led model has been funded, in large part, by a relatively undisciplined system of policy-directed bank lending. That underscores the risks of a misallocation of capital that could lead to excess supply and deflation. At the same time, China’s export-led dynamic is now eliciting a mounting protectionist backlash from both the US and Europe. With growth risks tipping to the downside in both the US and China, I have argued that slowing is inevitable for a two-engine global economy; lacking in support from private consumer demand, the rest of the world is not nearly as decisive in shaping the global growth outcome (see my 20 November 2006 dispatch, “Two-Engine Slowdown”).

Globalization has played a dual role in driving the great global growth machine. It has both real and financial dimensions -- with the former reflecting a sharp acceleration in cross-border trade in goods and services and the latter responsible for an even more dramatic increase in cross-border flows of financial capital. Moreover, several of the key implications of globalization have acted to reinforce the interplay between the income and the asset economy -- namely low inflation and low interest rates, as well as the recycling of global saving from surplus to deficit nations. But the implications of globalization also cut the other way. Key in that regard is a global labor arbitrage that has led to an unprecedented divergence between the returns to capital and the rewards to labor in the industrial world. That has triggered an equally worrisome political backlash that could certainly pose serious risks to financial markets and the asset-dependent growth that increasingly underpins the global economy.

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