By Simon Johnson
The G20 communiqué, released after the Toronto summit on Sunday, made it quite clear that most industrialized countries now have budget deficit reduction fever (see this version, with line-by-line comments by me, Marc Chandler and Arvind Subramanian). The US resisted the pressure to cut government spending and/or raise taxes in a precipitate manner, but the sense of the meeting was clear – cut now to some extent and cut more tomorrow.
This makes some sense if you think that the global economy is in robust health and likely to grow at a rapid clip – say close to 5 percent per annum – for the foreseeable future. With high global growth, it will matter less that governments are cutting back and unemployment will come down regardless. Taking this into account, the IMF is actually predicting (as cited prominently by the G20) that budget “consolidation” actually raise growth over a five-year horizon.
There is no question that some weaker European countries, such as Greece, Portugal, and Ireland, had budget deficits that were out of control. Particularly if they are to pay back all their foreign borrowing – a controversial idea that remains the conventional wisdom – these countries need some austerity. But what about those larger countries, which remain creditworthy, such as Germany, France, the UK, and the US? If these economies all decide to reduce their budget deficits, what will drive global growth?The answer in Toronto was obvious: China. China is only about 6 percent of the world economy, measured using prevailing exchange rates, but it has a disproportionate influence on other emerging markets due to its seemingly insatiable demand for commodities. It also has a relatively health fiscal balance – and its fiscal stimulus, working mostly through infrastructure investment, did a great job in terms of buffering the real economy in the face of declining world trade in 2008-09.
Now, however, the Chinese government is trying to slow the economy down – there is fear of “overheating”, which could mean inflation or rising real wages (depending on who you talk to). Chinese economic statistics are notoriously unreliable, so reading the tea leaves is harder than for some other economies, but most of the leading indicators suggest that some sort of slowdown is now underway.
The G20 knows this, so the bet is that China will pull off a “soft-landing”, with growth staying in the region of 8-9 percent. China’s recent exchange rate appreciation against the dollar does not help in this regard, and this is one reason why pressure for further appreciation from other governments is likely to remain muted. Even the United States, above all, wants a robust China.
Talking to Chinese experts – I was in Beijing over the weekend – there are three major worries.
1) There is already a great deal of wasteful investment in infrastructure. At some level, there is a desire to clean this up and make it more sensible. This implies slower growth.
2) There is much discussion of “overcapacity” in the state sector. Again, there is interest in addressing this – although it is not an easy problem. In any case, this further lowers the incentive for state investment both directly and through various forms of subsidies to government-backed enterprises.
3) The incentives for local government officials have been heavily weighted towards boosting GDP growth; they move up (and presumably down) the government and party hierarchy based on how they do in this dimension. There is now a great deal of thinking that it would be better to also include other objectives, such as impact on the environment. This makes sense – air and water quality are hot issues – but it would also imply slower growth.
China’s reported GDP numbers are likely remain robust – the reported statistics are very much part of the broader government management process. But the economy could still slowdown in ways that would impact commodity prices – these are the key variables to watch, including for energy and metals used in industrial production (e.g., for the link to Latin America, see the NYT today).
The irony, of course, is that China is also a leading candidate to be at the epicenter of the next boom. In a sense this is what the G20 would like, unless the boom becomes debt-based and unsustainable, as in emerging markets during the 1970s or Japan in the late 1980s.
The G20 is betting that China can keep its growth high enough to sustain the global economy while also not getting drawn into some sort of bubble – particularly one that would involve big Western banks. Given the nature of China and the volatility of global capital flows – international investors love you without limit, until the moment they leave you – this is quite a bet.
We should also not overestimate the ability of the Chinese government to fine tune its economy. To be sure, the authorities have done well both in terms of high average growth and in terms of managing the impact of regional and global cycles over the past 20 years. Can they really do so well indefinitely?
An edited version of this post appeared this morning on the NYT’s Economix; it is used here with permission. If you would like to reproduce the entire article, please contact the New York Times.