Monday, January 31, 2011

Two Speed World Economy

Prior to the great crash the world economy was increasing unbalanced. (see: global imbalances) To give a rough summary.
  • The Western economies (US, UK, to a lesser extent Europe) were growing quickly. This growth was fuelled by high consumer spending and low saving rates. Eastern economies, e.g. China were benefiting by exporting to the US.
  • US had low savings and high current account deficit. China had high savings and current account surplus.
The great financial crisis has hit the West hard, leaving many countries facing a period of negative growth, budget deficits and high unemployment. This is to be expected in the aftermath of an asset bubble bursting and a balance sheet recession (banks struggling to recoup losses on their balance sheets).

However, recovery in the west is being complicated by global inflation. This global inflation is primarily due to the the strength of economic growth in China and the East. China and India's rapid rate of economic expansion is increasing demand for commodities like food and oil. This is causing the rise in cost push inflation that is making life difficult for Western policy makers.

The world has experienced stagflation before, most notably in the 1970s. But, never before has the global economy experienced such a divide in growth. In previous decades, the developing world's share of growth was small, almost to the point of insignificance. But, the rise of the two Eastern giants - China and India has irrevocably changde global economics. This kind of phenomena will become more important in the future. In the post war period, the west, the OECD, was pretty much the global economy, but that will never be the case again. (This is not to bemoan the fact; there was always a sense of injustice that the majority of global wealth was enjoyed by such a small share of the world's population)

This new economic block in the East, will bring both challenges and benefits. The current situation of rising commodity prices and slow recovery is certainly creating difficulties for our recovery. But, also, over time this should resolve itself. If China and India keep booming, they are likely to experience higher inflation; this should slowly reduce their current competitiveness; helping Western economies recover competitiveness. Also with rising incomes in China and India, the Chinese and Indian middle classes start spending more on Western goods and services which will create new markets for our economies. (there is also an increasing risk of a Chinese bubble - boom and bust, but that would be another post)

On the other hand, the size of the new developed economies means that pressure placed on resources will be much quicker than previous estimates. The known reserves of oil are often greater than expected, but, the growth in demand will inevitably place upward pressure on oil prices. It will increase the incentives to find alternatives to oil. If I had to make one prediction for 10 years time, it would be the majority of cars, would be hydrogen or electric powered.

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