What do the financial and economic crises of the high-income countries mean for emerging and developing countries? I addressed this in New Delhi last week, at a discussion sponsored by the Federation of Indian Chambers of Commerce and Industry (FICCI), the Consumer Unity & Trust Society (CUTS) and the Financial Times.
The conclusion I drew was that the crisis is dangerous. But this is not so much because of its direct effects. It is far more because of the lessons that might be drawn. The right lessons have to be drawn, not the wrong ones.
In the years since the financial crisis broke upon the high-income countries, the economic performance of the biggest emerging countries has been remarkable. Even allowing for the slowdown forecast for 2012 in the International Monetary Fund’s recent World Economic Outlook update, India’s gross domestic product is set to rise by 43 per cent between 2007 and 2012. This is below China’s rise of 56 per cent. But it is far superior to the high-income countries’ 2 per cent.
This is a revolution. It also shows a large measure of decoupling. We learnt in late 2008 that a big shock in high-income countries would adversely affect developing economies. But the Asian giants were relatively unaffected. They found ways of offsetting the shock.
Would that be the case again? The worst likely shock might be a combination of an oil-price jump - perhaps following conflict in the Gulf - with the collapse of the euro zone. The latter would temporarily disable, if not destroy, the euro zone’s financial system. That would generate large global shocks, via trade, remittances, finance and pervasive uncertainty.
One can also identify risks inside big emerging economies. China, in particular, might be unable to offset another deep recession in the high-income countries with a huge rise in credit-financed investment, as it did three years ago. According to the economist Andy Xie, fixed asset investment has reached 65 per cent of GDP. It is almost impossible to imagine the investment rate could be raised further, without risking a huge overhang of unneeded capital and a subsequent investment bust.
Another global “bust”, possibly worse than that of 2008 would also damage the Indian economy. In its January Global Economic Prospects, the World Bank noted that “conditions today are less propitious for developing countries than in 2008”. India has high fiscal deficits and a high rollover rate for public debts. With a current-account deficit of close to 4 per cent of GDP in 2010, it would be vulnerable to another big global shock.
Yet such direct threats should not be exaggerated, for two reasons. First, the scenarios are possible, but far from probable. Downside risks are large, as the IMF notes, but they are just that: risks. The euro zone may do the right thing, in the end. Similarly, conflict with Iran may be avoided. Second, a vast and relatively poor country, such as India (with GDP per head, at purchasing power parity, only a 12th of U.S. levels), can still generate rapid growth by catching up on the world’s richest countries, almost regardless of the global environment.
Thoughtful Indian observers are well aware that the principal obstacles to rapid economic development are internal, not external. Among obvious constraints are failures of governance, including wasteful spending on subsidies at all levels of government, a dire record on the provision of education and health to the bulk of the population, rigid labour laws, inadequate infrastructure and costly restrictions on efficient use of land. Much of this is laid out in an excellent collection of essays by Shankar Acharya, former chief economic adviser to the government of India. Yet such failings are also opportunities. Given how well India has performed despite these disadvantages, consider how well it might do without them.
