The year is still young but even in the first few weeks of 2016 strains are being felt by the global economy. What do they tell us about the future structure of the world economy? By far the most important feature in the emerging shape of the global economy is the reaction to the turmoil in emerging economies. Most of the larger ones saw a sharp reduction in their rate of economic expansion in the last quarter of 2014. What is at work is a change in relations among developed and developing countries.
Links among nations at different levels of development or those with different economic sizes work in both ways. They can pull as well as push. For a couple of decades — in the 1980s and the 1990s — economic strength of the developed world pulled emerging nations along with them. The latter expanded because of the growing markets for their products in the former. It was this link that was behind what is generally called the East Asian miracle. Rapid expansion of the economies of the Western world lifted the incomes of all segments. Those at the lower end of the income distribution scale saw significant increases in their disposable incomes. This led to an increase in the demand for basic consumption goods. They were mostly produced by the East Asians using their cheap labour. The result was the economic expansion the world had never seen before in its history. China, for instance, saw the size of its economy increase 32 times in the three decades between 1980 and 2010.
These links were not expected to last for long and they didn’t. The delinking started with the Great Recession of 2008-09 that saw very sharp drops in rates of economic growth in rich countries. This affected emerging markets as well. However, one part of the impact was the result of the way emerging nations had financed their initial expansion. As developing nations responded to the increased opportunities in developed markets, they attracted investment capital from the world’s financial markets. The positive signals from rich emerging nations were translated by both trade and capital flows. The overall result for emerging nations was positive. In the 1980s, emerging markets along with poor developing countries accounted for 36 per cent of the world product. In 2016,their share is 56 per cent, a massive gain of 20 percentage points.
A significant increase in the rate of growth that led to the increase in emerging nations’ global share was financed from debt. It was borrowing from domestic banks that helped them to initially escape the worst of the Great Recession. From 2008 to 2015, corporate debt in these countries including the bonds they floated expanded from $8.9 trillion to $ 24.5 trillion. China accounted for a significant part of this. In some smaller East Asian nations, consumers also borrowed heavily. Such debt burdens could have been sustained and serviced had personal and corporate incomes continued to increase. That did not happen because of the sharp contraction in China’s expansion. From 1999 to 2011, commodity price increases amounted to 80 per cent. This was fuelled by what was seen as China’s insatiable demand. That demand collapsed leading to a 50 per cent decline in the commodity price index from its 2011 peak. Most of this reduction occurred in 2015 as China slowed down.
OPEC’s approach to managing its oil resources didn’t help either. The oil exporters led by Saudi Arabia decided not to reduce their output in order to maintain their market share. Riyadh wanted to push out the high-cost producers in the United States who were able to exploit new technologies such as fracking and horizontal drilling to significantly increase the country’s oil and gas output. The OPEC policy succeeded up to a point but there was a cost associated with it. The drop in the price of oil reached the point at which Saudi Arabia was faced with a large and growing fiscal deficit. The Kingdom announced that it was contemplating putting Aramco, the national oil company, on the market. If Riyadh follows through, Aramco could be capitalised at more than a trillion dollars, making it the world’s largest company. Its market value could be a multiple of that of ExxonMobil; its stated oil reserves are 261 billion barrels, or more than 10 times that of the American oil company. However, even a semi-privatised Aramco will not fully follow the dictates of the Saudi administration. An entirely new dynamic would thus be introduced into the decision-making process.
Saudi Arabia was not the only commodity producer that was deeply affected by the collapse of the commodity markets. For Brazil, commodities represent 45 per cent of exports (iron ore, soybeans, sugar) and about as much for Malaysia (oil and copper). The Great Recession had many ripple effects. Demand contracted sharply for developed countries leading to a significant slowdown in emerging markets’ exports. This in turn brought down commodity prices, which slowed down the rate of economic growth in the developing world. In both the developed and developing countries, the non-rich segments of their respective populations suffered more. This had political as well as economic consequences. All sharp economic slowdowns leave long-lasting consequences. The one in 2008-09 will not be any different.
Published in The Express Tribune, January 25th, 2016.