Friday, December 21, 2012

The West's pre-2008 economic world will not return; No plain sailing for emerging economies

In the first part of "The Party's Over" (above), first broadcast in December 2011, Robert Peston, the BBC business editor, visits Shanghai, the fastest growing city in China and home to 23m people. Here, he meets some of the city's workers prepared to earn less than their UK counterparts to help fuel the Chinese economic boom.

However, the woes of the West struggling with high debt, ageing populations and the end of the American Dream and its equivalent for other developed nations, will not mean that emerging economies face a long period of plain sailings. Headwinds are evident everywhere.

The United States has an unexpected silver lining compared with just a short time ago.

The United States will become increasingly energy independent in the next three decades as it boosts its production of oil, natural gas and renewable power such as solar and wind. Meanwhile, US crude oil production averaged almost 6.5m barrels per day in September 2012, the highest volume in nearly 15 years. The last time the United States produced 6.5m barrels per day or more of crude oil was in January 1998. Since September 2011, US production has increased by more than 900,000 barrels per day. Most of that increase is due to production from oil-bearing rocks with very low permeability through the use of horizontal drilling combined with hydraulic fracturing (fracking). The states with the largest increases are Texas and North Dakota.

The US Energy Information Administration this month issued its Annual Energy Outlook 2013 (AEO2013), which highlights growth in total US energy production that exceeds growth in total US energy consumption through 2040. 

The BBC says that in the teeth of the worst financial crisis in living memory, Robert Peston examines how the world got to this point and how the colossal imbalances in the global economy have left the UK in need of a radical economic overhaul.

In this first of two programmes Peston examines how, thirty years ago, momentous decisions were taken which shaped the world we live in today. In China, Deng Xiao Ping opened up the country to foreign capitalists; in Britain and America, the free market revolution was unleashed by Margaret Thatcher and Ronald Reagan. "The Party's Over" compares the lives of workers in a Chinese company with their co-workers in Britain.

Robert Peston interviews bankers, politicians and economists, and concludes that the boom we enjoyed before the crash was based on an illusion, and that the world's economy is now so unbalanced that in the West we face a sobering wake-up call.

Part 2

Not all plain sailing

The demographic outlook for the BRICs (Brazil, Russia, India and China) varies greatly. The differences in the projected change in the working-age population are very significant in both absolute and relative terms. This will impact not only economic growth prospects, but also savings and investment behaviour and potentially financial market growth prospects. Brazil and India are demographically in a substantially more favourable position than China and Russia. With the exception of India, demographic developments in the BRICs are becoming, or will soon become, a net negative in terms of per-capita growth. The working-age population in India will increase by a stunning 240m (equivalent to four times the total population of the UK) over the next 20 years, compared with 10m in China. However in the big country league, only in Brazil, India, the UK and the US will the potential labour force be tangibly larger in 2030 than today.

China should double its GDP (gross domestic product) by 2020 President Hu said in a speech at the opening of the Communist Party’s 18th congress last month. Hu who handed over the position of party general secretary to Vice President Xi Jinping a week later, also called for “deepened reform of the financial system” and more local-level democracy. China was ranked 121st in gross national per capita income for 2010 by the World Bank, at $4,260, close to Jordan and Thailand and less than 1/10 of the US’s $47,140. However, on a purchasing power parity (PPP - - The rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country) basis during Hu's presidency, GDP per capita more than tripled from $2,800 in 2002 to a forecast $9,100 in 2012 according to the International Monetary Fund.

ChinaRealTime, a Wall Street Journal blog, says that rising incomes pushed China into the middle-income bracket of emerging nations. With few signs of democratisation, China also defied expectations that rising wealth would lead to political reform.

Ten years of rapid growth is an impressive record. But much of the credit must go to Hu’s predecessor Jiang Zemin, who shepherded far reaching reforms that laid the foundations of the decade’s growth. The boost from those reforms is now running its course.

China’s entry into the World Trade Organisation in 2001 ushered in an export boom, with exports averaging nearly 30% annual growth from 2002-07. But as China has grown to be the world’s largest exporter, with more than 10% of the global market, the room for further expansion is limited. Rising wages, and a stronger yuan, have also taken a toll on export competitiveness.

Ruchir Sharma, head of emerging market equities and global macro at Morgan Stanley Investment Management, which has about $25bn in emerging market assets, and is the biggest investment rival of Goldman Sach's, says in a recent issue of 'Foreign Affairs,' that the recent slowdown in growth in emerging economies should not be surprising, because it is hard to sustain rapid growth for more than a decade. The unusual circumstances of the last decade made it look easy: coming off the crisis-ridden 1990s and fueled by a global flood of easy money, the emerging markets took off in a mass upward swing that made virtually every economy a winner. By 2007, when only three countries in the world suffered negative growth, recessions had all but disappeared from the international scene. But now, there is a lot less foreign money flowing into emerging markets. The global economy is returning to its normal state of churn, with many laggards and just a few winners rising in unexpected places. The implications of this shift are striking, because economic momentum is power, and thus the flow of money to rising stars will reshape the global balance of power.

Sharma who is the author of the book, 'Breakout Nations: In Pursuit of the Next Economic Miracles,' says that the notion of wide-ranging convergence between the developing and the developed worlds is a myth. Of the roughly 180 countries in the world tracked by the International Monetary Fund, only 35 are developed. The markets of the rest are emerging-and most of them have been emerging for many decades and will continue to do so for many more. He says that Dani Rodrik, the Harvard economist  captures this reality well. He has shown that before 2000, the performance of the emerging markets as a whole did not converge with that of the developed world at all. In fact, the per capita income gap between the advanced and the developing economies steadily widened from 1950 until 2000. There were a few pockets of countries that did catch up with the West, but they were limited to oil states in the Gulf, the nations of southern Europe after World War II, and the economic "tigers" of East Asia. It was only after 2000 that the emerging markets as a whole started to catch up; nevertheless, as of 2011, the difference in per capita incomes between the rich and the developing nations was back to where it was in the 1950s.

Excerpt from 'Breakout Nations':

As playwright Arthur Miller once observed, "An era can be said to end when its basic illusions are exhausted." Most of the illusions that defined the last decade -- the notion that global growth had moved to a permanently higher plane, the hope that the Fed (or any central bank) could iron out the highs and lows of the business cycle -- are indeed spent. Yet one idea still has the power to capture the imagination of the markets: that the inexorable rise of China and other big developing economies will continue to drive a "commodity supercycle," a prolonged upward rise in the prices of commodities ranging from oil to copper and silver, to textiles, to corn and soybeans. This conviction is the main reason for the optimism about the prospects of the many countries that live off commodity exports, from Brazil to Argentina, and Australia to Canada.

I call this illusion, for it is strikingly similar in some ways to the mania for technology stocks that gripped the world in the late 1990s. At the height of the dotcom era, tech stocks comprised 30% of all the money invested in global markets. When the bubble finally burst, commodity stocks -- energy and materials -- rose to replace tech stocks as the investment of choice, and by early 2011 they accounted for 30% of the global stock markets. No bubble is a good bubble, and all leave some level of misery in their wakes. But the era has had a larger and more negative impact on the global economy than the tech boom did.

The hype has created a new industry that turns commodities into financial products that can be traded like stocks. Oil, wheat, and platinum used to be sold primarily as raw materials, and now they are sold largely as speculative investments. Copper is piling up in bonded warehouses not because the owners plan to use it to make wire, but because speculators are sitting on it, like gold, figuring that they can sell it one day for a huge profit. Daily trading in oil now dwarfs daily consumption of oil, running up prices. While rising prices for stocks--tech ones included--generally boost the economy, high prices for staples like oil impose unavoidable costs on businesses and consumers and act as a profound drag on the economy.

That is how average citizens experience, as an anchor weighing down their every move, not the exciting froth of the hot new thing. The dotcom sensation broke the bounds of the financial world and seized the popular imagination, attracting thrilled media hype around the world and enticing cubicle jockeys to become day traders. There was the dream of great riches, yes, but also a boundless optimism and faith in human progress, a sense that the innovations flowing out of Silicon Valley would soon reshape the world for the better.

Tech CEOs became rock stars because they promised a life of rising productivity, falling prices, and high salaries for generating ideas in the hip office pods of the knowledge economy, or for trading tech stocks from a laptop in the living room. It was impossible in those days to get investors interested in anything that did not involve technology and the United States, so some of us started talking up emerging markets as "e-merging markets," while analysts spent a lot of time searching for the new Silicon Valley, which they dutifully but often implausibly discovered hiding in loft offices everywhere from Prague to Kuala Lumpur.

A decade later the chatter was all about the big emerging markets and oil, but with a darker mood. is driven by fear and a total lack of faith in human progress: fear of a rising phalanx of emerging nations with an insatiable demand led by China, of predictions that the world is running out of oil and farmland, coupled with a lack of faith in the human capacity to devise answers, to find alternatives to oil or ways to make agricultural land more productive. It's a Malthusian vision of struggle and scarcity: of prices driven up by failing supplies and wages pushed down by foreign competition.

Excitement about rising commodity prices exists only among the investors, financiers, and speculators who can gain from it. has inspired many an Indian and Chinese entrepreneur to go trekking across Africa in search of coal mines, yet it has no positive manifestation in the public mind at all. At the height of the tech bubble millions of American high school students aspired to become Stanford MBAs bound for Silicon Valley; today the growing number of oil, gas, and energy-management programs represents a small niche inside the MBA world. The only popular manifestations of are complaints about rising gasoline prices and outbreaks of unrest over rising food prices in emerging markets.

It is well-justified unrest. If anything, the negative impact of sky-high commodity prices on the larger economy is underestimated. The price of oil rose sharply before ten of the eleven postwar recessions in the United States, including a spike of nearly 60% in the twelve months before the Great Recession of 2008 and more than 60% before the economy lost momentum in mid-2011. When the price of oil trips up the United States, it takes emerging markets down with it. In 2008 and 2009 the average economic growth rate dropped by 8%age points in both the developed and the emerging world, from its peak pace to the recession trough.

The strongest common thread connecting the dotcom and eras is the fundamental driver of all manias: the invention of "new paradigms" to justify irrationally high prices. We heard all sorts of exotic rationales at the height of the dotcom boom, when analysts offered gushy explanations for why a company with no profits, a sketchy business plan, and a cute name should trade at astronomical prices. It was all about the future, about understanding why prices in a digitally networked economy "want to be free," while the "monetization" problem (how to make money on the Internet) would solve itself down the line. The dotcom mania, while it lasted, was powerful enough to make Bill Clinton -- who campaigned as the first U.S. president to fully embrace the "new economy" -- a living emblem of American revival, just as the commodity price boom played a role in making Vladimir Putin a symbol of Russian resurgence and InĂ¡cio Lula da Silva the face of a Brazilian recovery. When the rapture is over, the nations and companies that have been living high off commodities will also share the sinking feeling that followed the dotcom boom.

Excerpted from Breakout Nations: In Pursuit of the Next Economic Miracles, W.W. Norton & Company. Copyright © 2012 by Ruchir Sharma.