Wednesday, November 26, 2014

The Global Economy Without Steroids

WASHINGTON, DC – Economic growth is back. Not only are the United States, Europe, and Japan finally expanding at the same time, but developing countries are also regaining strength. As a result, world GDP will rise by 3.2% this year, up from 2.4% in 2013 – meaning that 2014 may well be the year when the global economy turns the corner.

The fact that the advanced economies are bouncing back is good news for everyone. But, for the emerging and developing economies that dominated global growth over the last five years, it raises an important question: Now, with high-income countries joining them, is business as usual good enough to compete?

The simple answer is no. Just as an athlete might use steroids to get quick results, while avoiding the tough workouts that are needed to develop endurance and ensure long-term health, some emerging economies have relied on short-term capital inflows (so-called “hot money”) to support growth, while delaying or even avoiding difficult but necessary economic and financial reforms. With the US Federal Reserve set to tighten the exceptionally generous monetary conditions that have driven this “easy growth,” such emerging economies will have to change their approach, despite much tighter room for maneuver, or risk losing the ground that they have gained in recent years.

As the Fed’s monetary-policy tightening becomes a reality, the World Bank predicts that capital flows to developing countries will fall from 4.6% of their GDP in 2013 to around 4% in 2016. But, if long-term US interest rates rise too fast, or policy shifts are not communicated well enough, or markets become volatile, capital flows could quickly plummet – possibly by more than 50% for a few months.

This scenario has the potential to disrupt growth in those emerging economies that have failed to take advantage of the recent capital inflows by pursuing reforms. The likely rise in interest rates will put considerable pressure on countries with large current-account deficits and high levels of foreign debt – a result of five years of credit expansion.

Indeed, last summer, when speculation that the Fed would soon begin to taper its purchases of long-term assets (so-called quantitative easing), financial-market pressures were strongest in markets suspected of having weak fundamentals. Turkey, Brazil, Indonesia, India, and South Africa – dubbed the “Fragile Five” – were hit particularly hard.

Similarly, some emerging-market currencies have come under renewed pressure in recent days, triggered in part by the devaluation of the Argentine peso and signs of a slowdown in Chinese growth, as well as doubts about these economies’ real strengths amid generally skittish market sentiment. Like the turbulence last summer, the current bout of market pressure is mainly affecting economies characterized by either domestic political tensions or economic imbalances.

But, for most developing countries, the story has not been so bleak. Financial markets in many developing countries have not come under significant pressure – either in the summer or now. Indeed, more than three-fifths of developing countries – many of which are strong economic performers that benefited from pre-crisis reforms (and thus attracted more stable capital inflows like foreign-direct investment) – actually appreciated last spring and summer.

Furthermore, returning to the athletic metaphor, some have continued to exercise their muscles and improve their stamina – even under pressure. Mexico, for example, opened its energy sector to foreign partnerships last year – a politically difficult reform that is likely to bring significant long-term benefits. Indeed, it arguably helped Mexico avoid joining the Fragile Five.

Stronger growth in high-income economies will also create opportunities for developing countries – for example, through increased import demand and new sources of investment. While these opportunities will be more difficult to capture than the easy capital inflows of the quantitative-easing era, the payoffs will be far more durable. But, in order to take advantage of them, countries, like athletes, must put in the work needed to compete successfully – through sound domestic policies that foster a business-friendly pro-competition environment, an attractive foreign-trade regime, and a healthy financial sector.

Part of the challenge in many countries will be to rebuild macroeconomic buffers that have been depleted during years of fiscal and monetary stimulus. Reducing fiscal deficits and bringing monetary policy to a more neutral plane will be particularly difficult in countries like the Fragile Five, where growth has been lagging.

As is true of an exhausted athlete who needs to rebuild strength, it is never easy for a political leader to take tough reform steps under pressure. But, for emerging economies, doing so is critical to restoring growth and enhancing citizens’ wellbeing. Surviving the crisis is one thing; emerging as a winner is something else entirely.

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    1. CommentedZsolt Hermann

      I am not sure the solutions suggested in the article will be enough, neither for developing nor developed countries.
      The whole world economy is "on steroids", meaning that it is based on the excessive, overproduction and over consumption paradigm, bubble humanity created, presuming we are outside of the closed and finite natural system we are actually part of.
      We still think everything is in our hands and we can do whatever we want with this very sensitively balanced system without consequences.
      This is why we are in a crisis which crisis is ongoing and deepening despite the overly optimistic starting sentence.
      Moreover since humanity evolved into a totally interconnected and interdependent global human network, the ruthless, and mostly exploitative competition, our present lifestyle, economy and society is based on is self-destructive as cancer.
      Thus it is not enough that we all stop using "steroids", the unnatural economy and lifestyle based on excessive artificial demand, and return to available resources and natural necessities, but we also have to switch to a global, mutually complementing and cooperating human system, fully adapting to the evolutionary conditions surrounding us.
      We exist in a natural system with strict, unbending laws and principles we cannot simply invent a "sub-system" without any natural foundations and then hope for the best, ignoring all the very real warning signs around us.

        CommentedEdward Ponderer

        If I might take the liberty of adding to Mr. Hermann's thoughts here:

        Globalization sews us into a patchwork crises extending from the socioeconomic to the ecological-climatic. There are scholarly articles and presentations aplenty on the varying aspects of this, and I would think one such as Simon Michaux’s “Peak mining & implications for natural resource management,” (see: should provide economists with some pause. Simply put, there are complex material realities outside the purview of standard economic theories which are, with all due respect, marching us like lemmings into the sea.

        Economists have the ability to reformulate from bottom-up—and they have the understanding of the assumptions of present economic theory that are clearly obsolete, in order to do this—but are not doing so for fear of admitting the obsolescence of too much of their own knowledge base, potentially themselves. I’m an engineer by trade, and I understand this fear all too well. It is the fear—if something brilliantly new and defendable doesn’t come out of the effort, and something not threatening to where one’s bread is buttered at that—of appearing obsolete oneself. That our various professions must operate under such a competitive fear instead of a collaborative, supportive integration, is truly a large part of the problem in the world today—or at least what stymies realistic solution.

        Economists can be part of the integrated, global team that helps to lead us through the wormhole of this crisis into a new, better world. However, this will not happen if they insist on studying this black hole with the geometry of Euclid by insisting on the physics of Newton.

        We are well past the event horizon, we have entered into deterministic chaos and unbalanced, acceleration as we foolishly destroy resources in production for media-generated “necessities.” Natural systems often have analogous chaotic phenomena threatening a community. By entering a behaviorally altruistic phase, the parts interact with this chaos to form a sensory and action communication across different organizational levels from the individual member up into the whole. The result is homeostasis, and may well represent THE successful evolutionary path to more complex forms of life.

        If bacteria colonies of 70 billion can “figure out” what to do here (See for example: Learning from Bacteria about Social Networks,, a human “colony” of 7 billion ought to be able to. There is the key fact, however, that there is no centralized decision-making authority (there couldn’t be in these round-table like communal organizations), although subgroups of these “equals” come to flexibly take on different specialized tasks—naturally in a “right time, right place” manner, and these may be changed depending upon circumstances.

        The round-table, mutually responsible economics here may sound very alien to any classical human-made system, capitalist or socialist. But this is due to the fact that no such system ever dealt with the fundamentals of human relationship before, directly addressing the reality of human ego that destroys both types of systems. Our unstoppable globalization with it Internet/wireless brain and nervous system is also something totally alien to human history—all evolution is new.

        What we lack in the disciplined self-control that the biochemically-controlled automata of nature can instinctively muster, we can make up for in our genius at forming virtual environments to influence us. This is just what self-help groups do on small-scale today. If human ingenuity allies itself with Nature in this way instead of doing battle with it, the very consumerist mass media that is driving us into a black hole, can transform to pull us out the wormhole at the other end.

    2. CommentedRavindra Muley

      Madam, Your Article appropriately sums up the zeitgeist in the economy, the way Emerging Markets were growing for the while was certainly commendable, however suddenly we now see slow growth gripping in and now we speak of the emerging markets in new trendy terms such as “Fragile Five” etc.

      There are concerns on exchange rate volatility in Turkey and India, similarly the Central Bank in India is not able to tame inflation and is using old remedies of tightening policy. For India that goes to elect new government in May, there has been slew of populist measures being thrown to garner votes, there are no structural or long term reforms happening, corruption is another big factor in Emerging economies.

      The latest data on Industrial Production, the engine that churns growth numbers, is but weak for countries such as India, Indonesia, Thailand, Brazil and Mexico. Even current account numbers are negative for many of them. In wake of tapering the markets will see capital flight risks a factor of worry and loss on stock valuation and dampening investor sentiment.