Key Trends in the World Economy

India and China

The international financial crisis is shaking up and reshaping many economic relationships. One at the top of that list should certainly be economic relations between India and China.

The complementarity of the two countries in the present international financial situation is evident. India has naturally been affected by the international financial crisis but its economy is still continuing to perform strongly compared to almost all other countries - while GDP growth is almost certain to have decelerated from the 7.6% year on year year increase recorded in the third quarter, India will continue to be one of the few major economies experiencing economic growth this year and India's industrial production in December was down only 2.0% year on year, which is far superior to current performance in most countries. India's macro-economic fundamentals, particularly its high savings and investment rates, continue to be strong. China continues to register economic growth and its savings and investment rates are the highest in the world.

In short, India and China will be the world's two best performing major economies in 2009 and therefore able to offer more favourable markets for each other than almost any other combination of countries.

The Indian government, however, is quite open about the fact that India cannot finance alone all the infrastructure investment it requires to sustain its rapid economic growth at present – short term and medium term project requirements by themselves amount to over $250 billion. Meanwhile India's budget deficit of 6% of GDP limits the room for manoeuvre of the government in publicly funded infrastructure development.

China, however, is not only very strong financially but also has highly experienced companies capable of leading infrastructure projects. Simultaneously India has areas of great strengths where it has achieved leads over China – in a number of service sectors led, of course, by software in which China can benefit from Indian expertise. The two economies, in short, have developed significant complementarities. Discussions between India and China governments on economic issues would therefore seem to be a high priority.

The main obstacle to this at present would seem to be circles in the US which are seeking to create tensions between India and China for political purposes and some short sighted figures in India who are prepared to go along with such an agenda. The US is, however, in no position to aid India economically or to undertake the scale of infrastructure and other economic development which India requires to sustain its growth rate. Tension between India and China therefore damages India even more than China.

Economic relations between the world's two most rapidly growing major economies will therefore be a matter of great interest during the current financial turmoil.

US 4th quarter GDP - a classic investment led downturn

The 4^th quarter US GDP figures confirm that the economic downturn, in its domestic aspect, is taking the classic form of an investment led decline.

As seen in Figure 1 US fixed investment already started to fall from the 1^st quarter of 2006 onwards - US consumer expenditure and GDP, in contrast, continued to rise until the 2^nd quarter of 2008. US government consumption is still rising.

Figure 1

US GDP has so far declined by 1.1 per cent since its peak. Consumer expenditure has fallen by 1.8 per cent - also since its peak. However US fixed investment has already declined by 8.8 per cent since the first quarter of 2006.

In order to illustrate the 'classic' form of the current downturn Figure 2 shows the decline in US GDP after 1929.

Figure 2

As may be seen the pattern of the current decline is almost identical to that after 1929 - with, of course, the dimensions of the latter case being much greater than those during this downturn.

US GNP (Gross National Product) fell by 29.7 per cent between 1929 and 1933. Personal consumption fell by 19.7 per cent in the same period. US government expenditure continued to rise throughout the depression. But US private domestic fixed investment fell by 73.9 per cent from its 1929 level.

Given the classic form of the present recession the key issue is therefore whether the decline in investment can be halted by indirect means - in particular, as this embodies most governments current thinking, whether it can be halted by 'Keynesian' methods.

Keynes believed that a decline in investment, driving a recession, could be halted by indirect means such as reduction in interest rates, government spending etc. It was not necessary for the state to directly control investment.

As Keynesian writers such as Graham Turner have consistently stressed, based on analysis of the economic crisis in Japan during the 1990s, neither the US nor Britain is as yet applying real Keynesian methods. The most crucial issue in a Keynesian perspective is not primarily large budgetary deficits but driving down borrowing costs - pushing interest rates below the anticipated return on capital and therefore making investment profitable.

In the present situation driving down interest rates requires central bank purchase of government bonds and debt - that is 'quantitative easing'. An increasing number of governments, including the US, are, slowly being forced to consider this, although none has as yet implemented it.

China, however, is pursuing an alternative path. Its large state company sector means that it does not have to use only indirect methods to control investment - state owned companies can be directly instructed to increase their investment programmes. Simultaneously the state owned banking system means financial institutions can be directly instructed to increase lending not simply to the state but to the private sector. A rapid expansion of credit is taking place in China with the money supply, as measured by M2, rising at 18 per cent year.

China is therefore relying on a combination of direct (via state companies) and indirect (budget deficits, increase in bank lending) means to counter the economic downturn.

Neo-liberal or monetarist economic solutions are currently not being pursued by the government of any economically developed country. The US, Japan and Western Europe are all attempting to meet the economic downturn by  'Keynesian' methods - starting with large scale budget deficits and moving towards quantitative easing. While some small countries are being urged to undertake deflationary measures the major ones are pursuing a quite different path.

To see what will be the difference in outcome between the Keynesian methods which governments in the US, Japan and Europe, conceive they are using, compared to Keynesianism accompanied by more direct methods of state intervention being used in China, is not only a test of their different economic theories but also will be of great importance for the world economy.