Key Trends in Globalisation

Investment's failure to recover is the key problem in developed economies

Gavyn Davies Financial Times blog is one of the world's most important because its focus is not only individual issues but on constantly seeking to assess the overall state of the global economy. The title of his latest piece 'Great Recession and Not-So-Great Recovery' is self-explanatory.

The focus of this article is on: 'a dangerous schism between the improvements in financial confidence and the marked lack of improvement in global GDP growth.' It notes: 'An abnormally deep recession in 2008/09 has been followed by an abnormally weak recovery, so real GDP per capita is now 10 per cent below the levels indicated by previous cycles.'

The article goes on to pose the following question: 'if global fiscal policy is tightening and the European banking sector is still in deep trouble, can a continuation of balance sheet expansion by the central banks produce a stronger recovery? The IMF and its economists seem to be answering “yes” to this question, since they are forecasting much stronger global growth in 2014 and 2015.'

The answer given is that: 'But there must surely be severe doubts about this conclusion. Both the IMF and the major central banks are becoming concerned that quantitative easing is causing excessive risk taking in some financial assets, and it is doubtful whether the beneficial effect on the wider economy, via price expectations and aggregate demand, is as powerful as it was at the start.'

These points are indeed correct but they can be focused further by analyzing what remains the core of the problem of depressed recovery in the developed economies, the severe fall and continued weak state of fixed investment. This is illustrated clearly in Figure 1, which shows the changes in components of GDP in the OECD (i.e. advanced) economies as a whole since the peak of the last business cycle in the 1st quarter of 2008.

In constant price dollar PPPs, the form in which the OECD publishes the statistics, OECD GDP in the 4th quarter of 2012, the latest available data, was $625bn above its level in the 1st quarter of 2008. Government expenditure was $326bn above its 4th quarter 2008 level, net exports $482bn above, and personal consumption $659bn above. However fixed investment was $700bn below its 4th quarter 2008 level.

It is therefore clearly the depression of fixed investment that remains the key weakness in the advanced economies.

Figure 1

 

The trend can also be seen clearly in Figure 2, which shows the quarterly percentage change in the domestic components of GDP in each quarter between the 1st quarter of 2008 and the 4th quarter of 2012. Personal consumption  continues to recover - being 2.8% above its 1st quarter 2008 level. Government consumption is 5.0% above its 1st quarter 2008 level – although this has essentially remained static since 2010, and is now mildly falling, reflecting various austerity policies. The key problem is that fixed investment remains –8.8% down.

Figure 2

 

A necessary consequence, of course, is that fixed investment has fallen as a percentage of GDP continuing a long term trend in advanced economies. Fixed investment, which in the 1970s was slightly under 25% of OECD GDP, by the eve of the financial crisis had slipped to slightly above 21% – i.e by approximately 3% of GDP. On the latest data it had declined by approximately a further 3% of GDP to 18.4%.

Since the 1970s fixed investment has therefore fallen by around 6% of GDP, with half of this fall occurring prior to the international financial crisis and half since it commenced – Figure 3.

Figure 3

 

It is, therefore, clear that it is the fall in fixed investment which primarily accounts for the ‘Not So-Great Recovery’. As fixed investment is also the primary source of GDP growth in advanced economies, in growth accounting terms constituting around 50% of economic growth, this sharp decline also therefore underlies the long term growth deceleration in the developed economies.

The superior response to the financial crisis of China, which has focussed on an investment side stimulus programmes, thereby preventing any decline in fixed investment, is evident from such data.

China is winning the new global industrial contest

The international financial crisis brought about a radical change in the structure of international industrial competition, and China is winning this new contest. That is the only conclusion that can be drawn from the pattern of industrial expansion and contraction in the major industrial centres in the five years since the beginning of the international financial crisis in 2008.

As taking comparisons only for single years can obscure this fundamental trend, Figure 1 shows the changes in industrial output during the entire last five year period in the world’s four major industrial centres – China, the U.S., the European Union (EU) and Japan. The pattern is clear and striking.

• U.S. industrial production on the latest data, for February 2013, remained 1.3% below its level five years previously – essentially stagnating over the five year period taken as a whole.
• Industrial output in the EU remains at 12.2%, i.e., significantly below its level five years ago. EU industrial production has fallen since February 2011.
• Japan’s industrial production remains at 19.2%, i.e., substantially below its levelof five years ago and has also fallen since February 2011.
• China’s industrial output is 76.1% above the level five years previously.

Figure 1

 

China’s industrial production therefore increased by over three quarters during a period when U.S. industrial production stagnated and EU and Japanese industrial production significantly declined. That is a conclusive victory by China in this competitive struggle.

Extending the comparison to other developing economies, there is no individual industrial centre matching the four major global ones. Figure 2 therefore shows aggregated data for developing economic regions. As statistics for all developing economies are not available for February 2013, the period January 2008 to January 2013 is considered. Data for China is also shown. As no separate China data was published for January, due to the Spring Festival holiday, China’s January data is taken as the mid-point between December and the combined January-February statistics.

Again the pattern is clear over the five year period.

• China’s industrial production grew by 77.9%.
• Total developing Asian industrial production expanded by 53.9% – China accounting for the largest part of this.
• Latin American industrial production increased by 3.0%.
• Eastern Europe and the former USSR’s industrial production increased by 2.0%.
• Industrial output in Africa and Middle East fell by -0.2%.

Figure 2

 

China was therefore successful in industrial competition not only with developed but with developing economies. As the increase in China’s industrial production was over 75%, and it was already one of the world’s main industrial centres, this constitutes a major shift in the balance of world industrial production in China’s favour.

What conclusions follow from these developments?

First, the claim of some Chinese commentators that there is a great revival of U.S. industry and China is lagging behind is factual nonsense. Not only has China’s industrial growth far outperformed that of the U.S., but U.S. industrial production has not even yet recovered to pre-financial crisis levels. Their arguments, based on citing purely individual examples such as that Apple will manufacture a few Macs in the U.S., are based on one of the most elementary and worst forms of statistical distortion – citing individual anecdotes and not overall trends.

Second, these differences in development have long-term consequences spreading to outside industries. Productivity increases in the industrial sector are much greater than in non-industrial sectors. Therefore China’s success in industrial competition raises its overall rate of productivity growth relative to less successful competitors.

These factual trends do not mean China will not face major future challenges within the industrial sector. China has already successfully shifted the centre of gravity of industrial production from low technology products (textiles, toys etc.) into medium technology (construction equipment, smartphones, personal computers, ships etc.). But China’s transition to very high technology industrial production still lies ahead – outside non-market sectors such as military and space production.

But it is not abnormal that China’s industry is currently dominated by medium, not yet high, technology production. China’s GDP per capita is approximately that of Japan in 1966 or South Korea in 1988. At those times Japan and South Korea had successfully made the transition from agricultural and low value added industrial economies to dominance through medium technology sectors – ship building, steel etc. Today China globally dominates the same industries. But at that time the period of domination of Japan and South Korea by high technology product innovation – Sony’s PlayStation and Walkman, Samsung’s high-end televisions and mobile phones – lay 10-15 years ahead.

As Lin Yifu, former chief economist and senior vice president of the World Bank rightly stresses, it is impossible for an economy to develop market sectors greatly out of line with its overall level of development. The full transition of China’s industry to dominance by high technology production lies a decade ahead. The key fact at present is that comparison of trends in the major industrial centers shows that in the intensified global competition created by the international financial crisis China is clearly winning.

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This article was originally published in Chinese at Sina Finance and in English at China.org.cn.