Wednesday, November 26, 2014

The Global Economy’s New Path

WASHINGTON, DC – Whether we like it or not, the world around us is in a state of constant change. But recent economic trends suggest that this change may be shifting its direction in a fundamental way.

Consider the advanced economies. During the last two decades, economic growth in these countries was led by consumption – so much so that economic activity in these economies swung from investment to consumption by a total of 10 percentage points of GDP. As a result, in 2010 the share of consumption in their GDP had reached 81.6%.



(In percent of GDP)

Advanced economies







Emerging and developing economies







Meanwhile, emerging markets and developing economies provided almost a mirror image of this trend, raising their investment and boosting the supply of goods to the rest of the world at the cost of consumption in their own economies. By 2010, the share of consumption in their GDP had declined, from 73.4% to 67.1%.

Looking forward, it is unlikely that the consumption share of GDP can increase further in advanced economies. The main drivers of this increase were primarily financial engineering and wealth effects from strong asset prices. Neither of these factors currently is at play to push consumption’s share of GDP higher.

But can the advanced economies’ consumption even be sustained at the current level? Perhaps not. Current levels of consumption are associated with over-extended governments and households, whose debt levels remain high, implying that more savings are required. Banks also need to raise capital. In general, many economic agents need an extended period of deleveraging.

However, current policies in the major advanced economies are aimed at maintaining current consumption levels in order to support growth and employment. If the consumption share of GDP nonetheless declines, simple arithmetic tells us that investment and exports need to be higher to maintain total demand.

Should we expect emerging markets and developing economies to pick up the slack? To sustain strong growth in these economies as external demand weakens, domestic demand needs to become the major engine of growth. This means stronger domestic consumption and appropriate levels of investment to support such consumption growth. In economies where investment levels are leading to excess capacity, resources could shift from investment to consumption, provided that these countries’ external accounts remain sustainable.

These are major tectonic shifts in the structure of the global economy, and are fraught with potential dangers. The pace of change will vary between sectors and across economies, leading to mismatches of demand and supply worldwide.

Moreover, with globalization, an economic problem in one part of the world can be transmitted to the rest of the world more strongly, substantially complicating policy responses in both advanced and developing economies. A study of such spillover effects by the International Monetary Fund suggests that, before the global financial crisis, external factors explained 36% of change in output in the five systemically important economies (the eurozone, the United States, China, Japan, and the United Kingdom); after the crisis, however, this share reached close to 60%. In the rest of the world, including emerging markets, the share of external factors in output change increased from about 43% to more than 60%.

In this environment, we must diligently pursue policy coordination at the global level. To achieve an orderly realignment of consumption and investment worldwide, policies that boost investment in one part of the world should match policies that boost consumption in other parts.

In particular, advanced economies should implement fundamental productivity-enhancing reforms, the eurozone should strengthen the currency union, and emerging market and developing economies should boost their domestic sources of growth. And these policies should be consistent with fiscal and external stability. Moreover, financial-sector policies and regulatory frameworks should be coordinated at the global level, in order to design and implement consensus-based rules – thereby addressing the problems posed by very large, global institutions that are considered too big or too complex to fail.

Only with such global coordination can we reduce, and possibly eliminate, economic instability and disorderly adjustments both at home and abroad, even as we seek to maximize the benefits of the inevitable changes in the global economy.

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    1. CommentedVincas Andriusis

      Process of Globalization has no option to stop, because it is natural progress of the Humanity development. But it will be not enough just to unite the economic and political structures into the Global structures. In order to solve the problems of the economy we will need to change direction, and not a little bit – we’ll need to change it 180-degree angle. This means that the consumereconomy, which is generally opposite to the concept of the economy will have to change their economy, focused on the natural and common humanity needs. Thus, in particular, will need to change the thinking of mankind.

    2. CommentedEdward Ponderer

      The nations of this planet must indeed be proactive in adjusting the global economy into homeostasis, and this will require a watershed breakthrough -- the realization that the dominant concern of every nation must be directed beyond ones own borders -- just as a loose colony has evolved into a single body when the dominant concern of the limbs and organs is the body as a whole. And this happens because it must as the interactive conditions of the whole have become greater than the sum of the parts, and the cohesiveness of the parts must follow suite in order to thrive -- or even survive.

      Difficult as this transition sounds, the consequences of not doing so are far more difficult to deal. Consider Zhu Min's observation that: "These are major tectonic shifts in the structure of the global economy, and are fraught with potential dangers. The pace of change will vary between sectors and across economies, leading to mismatches of demand and supply worldwide." Indeed -- but not merely that. Are there simply two monoliths: "emerging market and developing economies" and "the advanced economies," or is there really a distribution that might be better modeled by three or more?

      Even at three, there appears to open up a "fractal basin," which in the basis of a chaotic pendulum. That is, a metal pendulum swinging between three magnets below, placed at the vertices of an equilateral triangle. Near the border of any two magnets, the third more distant magnet provides the weakest field. However, because the two closer magnets largely cancel each other, that third magnet paradoxically becomes dominant. This is the simplest construction of an effect that proves a fractal pattern throughout.

      Anyone who has ever toyed around with a chaotic pendulum know how wildly unpredictable the thing can swing in every which way -- and how long. Its a fun toy dynamic, but it would not prove a very fun global economic dynamic.

    3. CommentedZsolt Hermann

      The article is spot on with its recommendation of global coordination and policy making.
      Today the world has evolved into a completely closed and interdependent integral network, thus even the greatest, stronger countries could be imbalanced, even in a fundamental change by changes in seemingly unconnected regions or small countries.
      We already saw this through the example of Greece last year and that was only a scare (so far) and Greece is not really a dominant country.
      But global coordination is not enough until we accept the other, even greater problem the article touches upon, the unsustainable nature of the present consumer society, the illusion of infinite growth and endless profit in a closed and finite natural system.
      Using this article's first line, "whether we like it or not" we exist in a natural system regulated by strict natural laws, thus we also have to adapt to those laws of general balance and homeostasis in order to survive and have a future.
      Thus mutual global coordination, cooperation, and living by the fundamental natural laws governing our reality is the path towards a predictable future.

    4. CommentedJoshua Ioji Konov

      Mr. Min, under the currently used economics the probability for substantial economic growth by most developed economies is very low, indeed; however, if the market effectiveness is improved to boost business activities that could not be succeeded just by using monetary or fiscal approaches, these economic growth (i.e. market development) could be empowered...

    5. CommentedFrank O'Callaghan

      One of the core issues in the global change is constantly neglected. Inequality in wealth distribution causes insecurity. A redistribution will stimulate the whole world. The greac concentration of wealth in few hands it the root cause of the crisis.

    6. CommentedRobert Pringle

      Zhu Min makes a fundamental point that is often neglected: the need both for coordination of macro policies and a simultaneous implementation of financial sector policies with rules to address the inbuilt instability of present arrangements including the too-big-fail problem. At present, these are discussed in separate fora with distinct groups of experts - in fact the first is hardly discussed at all since the failure of the G20. It is the function of a proper international monetary system to provide a benchmark for good monetary policies together with an overarching framework of rules to ensure a sustainable market-based banking and financal system. Creditor countries such as China should go on pressing for both sets of reforms; a variety of options is analysed in Until we reestablish a proper international monetary system that promotes such coordination, the world will remain ensnared in the money trap. The tragedy is that the US is under the illusion that it can get out of the trap all by itself. The US must rediscover multilateralism.

    7. Portrait of Pingfan Hong

      CommentedPingfan Hong

      According to the table, for advanced economies, the share of investment plus the share of consumption equals exactly 100%, for both 1990 and 2010, implying a balanced current account for this group. This is in contradiction to the fact that there has been a constant net transfer of financial resourses every year for the past decade from the developing countries to the developed countries as a whole, in the form of foreign exchange reserves accumulation of the former.

    8. Portrait of Pingfan Hong

      CommentedPingfan Hong

      It sounds like you are advocating for a central planning for consumption and investment in the world economies at the global level: turn the IMF into a global planning commission?