Globalized road to recovery will be bumpy, U.K. economist warns

by Takashi Kitazume

Even though many economies appear to be emerging from recession, the road to recovery is going to be pocked with setbacks and slippages in the coming year, with prospects for future growth clouded by the long-term effects of the global financial crisis, a British expert said at a recent seminar in Tokyo.

And while the postcrisis world is looking increasingly to emerging economies to drive global growth, turbulence could potentially erupt in those markets as well, and with greater impact than before, warned Vanessa Rossi, a research fellow in international economics at the Royal Institute of International Affairs, popularly known as Chatham House.

At a Nov. 19 seminar organized by Keizai Koho Center, Rossi noted how analysts and economists incorrectly assessed the situation and their forecasts of what was to come after Lehman Brothers collapsed in September 2008. Unless they learn from their mistakes and improve their analyses, the world will not be able to form policies capable of preventing future crises, she said.

Some of the mistakes were caused by a lack of understanding of how problems originating in the financial sector can create rapid and severe shocks in world trade, Rossi said.

“In the event of such turbulence in finance, companies reacted as you might expect them to — they had to cut back on investments and operations and secure their finances,” she said. “So it was inevitable that demand for investment goods would fall rapidly, and consumers did the same thing, cutting discretionary spending, particularly in areas like car purchases.”

Initial views that the financial sector would be the hardest hit — and therefore that the United States and Britain would be the worst countries affected — were wrong because they failed to take account of the impact on world trade, which turned out to be far larger and caused severe damage to economies that rely more on trade and manufacturing, like Japan and Germany, she said.

Given the trillions of dollars lost in world trade and the even larger erosion in global wealth caused by the crisis, “I doubt very much that we can expect a very rapid, steady, strong upturn in the developed economies,” Rossi said.

The recovery that’s emerging and is forecast for the coming months in the industrialized economies “is actually not so strong,” she said.

“We’ve had an extremely deep recession, and typically in the past from recessions of that scale, we would have expected a much bigger rebound than the one we’re seeing,” she said.

What’s more convincingly V-shaped, she noted, are the projections for emerging markets.

“This is where we seem to have the utmost confidence now — in the ability of the (emerging) economies to regenerate wealth and surge forward, and it’s leading many of the developed economies to look for their salvation in export growth into these markets,” she said.

However, Rossi said that such a strategy by the advanced economies is already posing questions for the future because you can’t rely on exports alone.

And the cause of future turbulence in the global economy, she warned, could come from the emerging markets.

“(The latest) shock originated from developed countries — not just the U.S. but Europe as well — but it’s highly likely that (the next shock) could come from another country and in another form,” she said.

The emerging markets could potentially be the source “because they are now such a large part of the world economy,” she said. And the impact of that turbulence could be much larger than the 1997-98 Asian financial crisis, which had very little effect on the rest of the world, she said.

Given that many analysts made errors of judgment in their postcrisis forecasts, “we should be extremely careful about the rosy assumption for the emerging markets,” Rossi said.

“It relies heavily on the influence of countries like China, in particular, to drive those numbers forward, and the background picture for emerging markets is much more mixed than these averages suggest. So I think we should be careful — not about the coming year where figures seem quite secure on the back of the policies of China, but we should be more careful about the following years — whether we can truly follow on with such high growth rates with stability in areas of the world that could actually see greater pressures emerging as well,” she said.

The performances of the emerging economies during the crisis revealed big gaps among them, with Russia badly hit and showing the most volatility in the BRICs group, she said.

China and India — the two major pillars of Asia’s growth story — faced the crisis in different ways. The impact on India was limited because it has a service-oriented economy that relies little on world trade, giving it stability in the face of the global turbulence, Rossi said.

“China, in contrast, had a very big impact,” with exports down by around 25 percent for much of this year, she said. “But it was able to offset a massive shock of this kind because of its ability to push forward fiscal and monetary policies in order to restimulate the economy and achieve growth of 8 to 9 percent.”

Rossi said the world has relied “very heavily” on China’s ability to offset global problems. “In the past China has managed to fight global recession in similar ways, but we have to begin to question (that ability) if we’re looking five to ten years ahead — whether even China will be able to perform this kind of policy maneuver every time there is a global downturn.

“It becomes more difficult. This time it was more difficult than previous times. The losses on exports were bigger, and the needs for policy changes were larger. But at least at the moment those policy changes can be effective, but we can’t assume that goes on being the salvation of global downturns,” she noted.

Yoichi Takita, a senior writer for the Nikkei business daily and moderator of the discussion, said that economic bubbles do not emerge twice in the same market in the same form. Although bubbles are inevitably created in a market economy, what’s important is to recognize where the bubble is, he said.

Japan’s post-bubble experience shows that an economy that has undergone a financial system crisis can enter a prolonged period of stagnation, Takita said. Japan’s nominal GDP, which continued to rise for several years after its asset-inflated bubble collapsed in 1990, turned mostly flat after the nation experienced its own financial-sector woes in 1997 and 98, including the collapse of Yamaichi Securities Co. and Long-term Credit Bank of Japan, he said.

And if that lesson is any guide, the U.S. economy could enter a prolonged period of low growth for years to come, he said.

While recession in the U.S. and British economies was relatively shallow compared with those in Japan and Germany, it has to be noted that their recoveries have been supported by massive public aid to their financial sectors — with the amount of that help reaching 70 to 80 percent of their GDPs, Takita said.