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By Andy Xie
BEIJING ( Caixin Online) — The global economy is unlikely to accelerate in 2014. The hope that the U.S. economy is reaching escape velocity won’t pan out. Abenomics is likely to fizzle out in 2014. Emerging economies will likely remain in low gear. The chances are that the global economy, as weighted by nominal GDP at current exchange rates, will grow at 2%.
Globalization, turbo-powered by information technology, has cut short the feedback loop between demand stimulus and supply response. Any growth response to demand stimulus is short-lived, as past five years has demonstrated.
Holding down costs of non-tradeables like housing, health care and education is the key to economic competitiveness and sustainable growth. Any economy that grows on inflating such non-tradeables through stimulus will pay back with low growth later.
The year began with much hope that the U.S. economy would be strong enough to carry the global economy forward, just like in the old days. The United States has been gaining momentum with a strong third-quarter growth rate and a string of good employment data. The euphoria was broken by a very poor non-farm payrolls report last week. Some blamed it on cold weather. There may be some truth to this. Nevertheless, the idea that U.S. economic momentum is snowballing is in doubt.
I have argued for many years that this round of globalization has fundamentally changed how an economy works, even for a large one like the United States. While demand is and always has been local, the supply side has become genuinely global. Both manufacturing blue-collar jobs and most white-collar jobs have become global. Today’s information technology allows a multinational company to position research, marketing, finance and managerial jobs anywhere. Hence, when a country stimulates demand, it’s met by supply from anywhere.
The concept of “escape velocity” has gained popularity in the United States. It is a fancy way of saying that the economy can accelerate without stimulus. As the Fed is taking the first step to unwind its quantitative easing, investors and speculators need some psychological support to stay in the game. The term “escape velocity” has emerged in that context.
While the jury is still out, I believe that the U.S. economy is likely to grow at a similar pace in 2014 as in 2013, say, between 2% and 2.5%. The dream of economic momentum snowballing as in the 1990s will remain just a dream.
Abenomics fizzles
Japan had two quarters of high growth, so many became convinced that Abenomics was the real deal. The data tailed off toward the usual Japan level of 1% in the third quarter and likely in the fourth quarter, too. Financial markets have become wobbly lately as growth momentum cools off. But the Nikkei Average /quotes/zigman/5986735/realtimeJP:NIK+0.16% is still at a lofty level. Too many have a vested interest in believing in Abenomics to jump ship now. When bad numbers continue for another two quarters, they will.
The Abe government has been asking Japanese companies to raise salaries to sustain the economic momentum. Even if the salary increase comes through, as people know it was forced and not likely sustainable, why would they spend it?
I’m surprised by how many investors are taken in by Abenomics. Most international funds that invest in Japan have been going all-out to market it to retail investors. This is the main reason that the Nikkei Average has stayed so lofty. I suspect that self-interest is the main driver. Such funds have been withering for a long time. They are latching on to Abenomics for a good time. Even if it doesn’t last, it is better than nothing. Most important, the people who sell Abenomics may not have their own money on the line.
Abenomics is just the same old construction stimulus that the ruling party has been doing for 20 years. The Bank of Japan’s QE isn’t new. It is just bigger than before. Its achievement is to get the yen /quotes/zigman/4868099/realtime/sampledUSDJPY+0.09% down 20% against the dollar, which has happened before. Even the structural-reform talk isn’t new. It happened before and mostly remained talk. So far, structural reform in Abenomics is still talk. This glaring failure has not scared away the investor community. I guess they really don’t want to stop the party and are willing to ignore anything.
Japan has a low unemployment rate. Macro stimulus is the wrong recipe. Japan’s deflation just reflects the yen level. It is not causing a downward spiral. Curing deflation is just devaluing yen. It won’t cure growth weakness.
The Abenomics bubble is likely to burst in 2014. The manifestation is for the Nikkei to come down by 30%. Japan’s fundamental problem is the rigidity of its corporate sector. Unprofitable industries keep going with cheap debt and not caring about shareholders. Its electronics industry is a good example. Globalization is making more of Japan’s industries uncompetitive. The petrochemical industry is next.
Japan’s solution is to shut down uncompetitive industries and shift resources to competitive ones, as Germany has done in the past decade. Characterizing Japan’s problem as a macro one is just misleading.
Shaky ground
High commodity prices led to a frenzy in the sector’s investment. The 2008 crisis prompted a pause. It continued in the following three years. Huge amounts of capital were poured into high-risk projects. The risk to commodity economies is the bursting of this investment bubble, not reduced income due to lower commodity prices per se.
I have been talking about the Australian economy heading down due to the bursting of its mining-investment bubble. This story remains intact. The worst will pass only when the financial system is cleared of related non-performing assets.
Many African economies could suffer quite badly this year. There has been a gold rush in Africa. Big mining companies have been pouring in money. As the money stops, there could be severe consequences. Many African economies have built up their cost base on the back of new capital inflow. It would be difficult to cut it back.
The African story may be hard to watch in 2014. It is not a major economic force yet and won’t impact the global economy much. But it is a big human story. The past decade has been very good for Africa. However, it may have spent money too fast, causing inflation and fiscal stress. As the money inflow tightens up, a crisis could break out.
The global economy is roughly two-thirds developed and one-third developing at market exchange rates. Developed economies are likely to see a growth rate of 1.5% in 2014. The United States could grow at 2.5%, while Europe and Japan are likely to expand at 1%. Emerging economies may see 4% growth, which is not so different from last year. The global economy as a whole may see a 2% growth rate.
Global trade probably grew at 4% in dollar terms last year, roughly in line with the nominal GDP growth rate. The chances are that the same would happen in 2014. Anyone who pins recovery hopes on trade will likely be disappointed again.
Is global trade the driver or consequence of growth? Now it is probably the latter. In the decade before the 2008 financial crisis, trade was driving growth. Multinational companies were fanning out to diversify their production bases and markets. Their activities led to trade growing much higher than GDP. The golden decade of trade growth was probably a one-off event.
When structural impediments are the main issue for growth, then stimulus, even when effective, can provide only temporary relief. After the 2008 crisis, all big economies, mainly China and the United States, pursued serious stimulus. The global nature of the stimulus produced good growth for two years. It should have been the opportunity for serious structural reforms. Unfortunately, when the going is good, no one wants to take bitter medicine.
Stimulus fatigue is setting in around the world. China and the United States are likely to scale back stimulus some. The euro zone will not do anything significant. The European Central Bank may cut its interest rate from 25 basis points to zero. It will not have any meaningful effect. Japan’s new stimulus is unlikely to offset the impact of the consumption-tax increase. Brazil, India, Indonesia and other major emerging economies may continue to increase interest rates against receding hot money.
Another major deal on global trade could rejuvenate the global economy. Unfortunately, the latest World Trade Organization agreement is very weak. It shows that the WTO system is stuck. It is no longer the platform for moving trade forward. The U.S.-led Trans-Pacific Partnership is also stuck. Washington’s free-trade negotiations with the European Union are stuck too. It seems that no significant deal on trade is coming to rescue growth this year or beyond.
Any country that wants to prosper must do so within a poor global economy. One way is to devalue. Of course, competitive devaluation will eventually make everyone worse off. For emerging economies, devaluation is usually followed quickly by inflation. It doesn’t bring benefits.
The only sustainable way out is to increase competitiveness through structural reforms. It increases growth potential through higher efficiency. Most major economies could identify a few key issues impeding economic growth: health-care costs in the United States, labor-market rigidity in Europe, zombie industries in Japan, insufficient infrastructure in India and overinvestment in China. Imagine that these big issues are all tackled. What could the global economy grow at? Four-percent growth could return.
Of course, coordinated structural reforms are a pipe dream. Structural reforms are painful. Everyone is waiting for others to act first. When others are growing fast, one gets a free ride. Hence, the incentive is not to reform. Waiting for others to move first produces the stagnation equilibrium that we are in now.
China is the largest trading economy with a low per-capita income. The waiting game hurts China more than others. The Organization for Economic Cooperation and Development (OECD) countries enjoy per-capita income six times China’s. Getting stuck may not be so bad for them. They just need to find the redistribution policy to help the unemployed.
China’s debt is growing much faster than GDP, while OECD economies are the opposite. If the world is stuck in this equilibrium for long, China is likely to experience a debt crisis before the others. This should be the incentive for China to seek a solution first at home and abroad.
I have proposed that China should push an FTA with the EU. It is the only viable trade deal that could add significantly to the global economy. The EU collectively is a larger trader than China. Combining the two in a free-trade area may force other major trading nations to join the block. It could lead to what the WTO wanted but failed to accomplish.
Cutting investment to 30% of GDP by 2020 is a viable domestic target that could start a consumption-led growth cycle. The current 50% level is so far beyond what is needed that waste on a large scale is inevitable. Hence, cutting investment will not weaken the supply side. It just transforms waste into household income and demand. China could bring back a double-digit growth rate with such a strategy.
While we always hope for the best, reality can be cruel. As long as muddling through is possible, real reform is hard to come by. After the 2008 crisis broke out, I predicted widespread government stimulus, its eventual failure and the world heading to stagflation. Unfortunately, this path is still the likeliest.
See this commentary at Caixin Online. Follow Caixin on Twitter @caixin.
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