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A profound, yet little commented upon, change is occurring in the global economy. It is the relative strengthening of the public finances of the major emerging market economies with respect to the crumbling public finances of the industrialized countries. This change is likely to accelerate the tendency already very much in evidence in recent years for the emerging market countries to gain relative importance in the global economy. It is also likely to carry with it profound political implications for international relations between those countries and those in the G-7.
Earlier this year, Bill Gross, the head of PIMCO the world’s largest bond fund, published a highly disturbing chart that he labeled “The Ring of Fire”. The chart vividly encapsulated how dramatically compromised the public finances of all too many major industrialized countries had become. It did so by highlighting the toxic combination of high public debt and of high budget deficit levels across a wide array of major industrialized countries. The most striking feature of the chart was that it underlined that not only were the public finances of Japan, Greece, and Italy all on unsustainable paths, but so too were the public finances of France, Spain, the United Kingdom, and the United States.
Sadly, “The Ring of Fire” chart is highly suggestive of lackluster economic growth performance in the industrialized countries in the years ahead. Since one has to expect that, over the course of the economic cycle, high budget deficit levels will be associated with higher interest rates as industrialized country governments compete with their private sectors for a limited pool of available financing. One would also expect that high public debt levels will undermine private sector confidence as both households and companies will come to fear the prospect of future distortive taxes to deal with compromised public finances.
Yet a further reason for concern that compromised industrialized country public finances will lead to lackluster growth in these countries is that these poor finances are occurring across a wide array of countries. As such, as Martin Wolf keeps reminding us, a synchronized attempt by these countries to address those poor public finances by higher taxes and by deep public spending cuts could result in an insufficiency of global aggregate demand. This would be particularly problematic at a time when the industrialized countries’ economic recovery remains so feeble and at a time when these economies are still burdened with troubled banking systems.
At the same time that poor public finances are clouding the economic prospects for the industrialized economies, a very different picture characterizes the major emerging market economies. Indeed, an extension of “The Ring of Fire” chart to the emerging market economies reveals that growth in these economies is likely to be supported by relatively sound public finances. It is striking in this respect that whereas public debt levels in many major industrialized countries are headed to soon exceed 100 percent of GDP, those in the major emerging market economies, with the notable exception of India, are generally in the range of 40 to 50 percent of GDP. And, with relatively small budget deficits in those countries, there is every reason to expect that their public debt levels will remain at healthy levels.
Already in the decade prior to the 2008-2009 economic crisis, a number of factors favored considerably faster economic growth in the emerging market economies than in the industrialized countries. In contrast to the slow growing and aging populations in the industrialized countries, emerging market economies are characterized by younger and faster growing populations. At the same time, savings rates in non-Japan Asia have considerably exceeded those in the G-7, while the emerging market economies are taking full advantage of the potential to grow rapidly through simply catching up technologically to the industrialized countries.
In the years immediately ahead, one must expect that the emerging market economies will retain many of the advantages that have favored their rapid growth in the recent past. There is now every reason to expect that these advantages will be amplified by the relatively very much sounder public finances that characterize the emerging market economies than characterize the industrial countries. And there is also every reason to expect that, as they become even more important in the global economy, the emerging markets will become increasingly more vocal in pressing their case for their representation in international economic organizations like the IMF to more fairly reflect their relative importance.
Desmond Lachman is a resident fellow at AEI.
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