As the global economy enters the seventh year of a sluggish recovery, it’s time to start asking when the world will face its next downturn — and what will drive it.
In the past 50 years there has been a global recession once every eight years, on average, so the next one may be brewing. When it will come is hard to call. But the policy panic in Beijing over its currency and the fall of its stockmarket suggest the next global recession likely will be “made in China”. This would represent a significant break from the past. Historically, the US has been the single largest contributor to global growth, and a contraction in its economy the catalyst that tipped the world into recession.
The global economy hardly ever contracts as a whole — in part because even 3 per cent growth feels like a recession in many large developing countries — so the definition of a global recession is different from a national recession. The International Monetary Fund has used per capita income and a complex set of other factors to identify four global recessions in 50 years: in the mid-1970s, the early 80s and 90s, and during the global financial crisis of 2008-09. In all four cases global gross domestic product growth in market-determined exchange rate terms fell below 2 per cent, compared with its long-term growth rate of 3.5 per cent.
Global growth also dropped under 2 per cent following the bursting of the US tech bubble in 2001. For practical purposes, then, there have been five global recessions since 1970.
For most of that period, the US has been the world’s premier economy, and its downturns often have had global ramifications. When Americans spent less, the world slowed down. But since the global recession of 2008-09, for the first time in recent history another economy emerged as the largest contributor to global growth. This decade China has accounted for a third of the expansion in the global economy, compared with 17 per cent from the US. The contribution from the other giant economies — Europe’s and Japan’s — has fallen to less than 10 per cent. So the key to global growth is now in Beijing’s hands.
The problem is that China’s economic rise of late has been facilitated by a huge and unsustainable stimulus campaign. No emerging nation in recorded history has tacked on debt at such a furious pace as China has since 2008, and a rapid increase in debt is the most reliable predictor of economic slowdowns and financial crisis. China’s debt as a share of its economy increased by 80 percentage points between 2008 and 2013, and stands at about 300 per cent with no sign of abating. Beijing policymakers have been trying to sustain an unrealistic and randomly selected growth target of 7 per cent by steering cheap loans into one bubble after another — first housing, most recently the stockmarket — only to see each bubble collapse.
These setbacks set the stage for Beijing’s surprise devaluation of the yuan. Foreign-exchange reserves have fallen from $US4 trillion ($5.4 trillion) to $US3.65 trillion over five quarters, and about half of that $US350 billion decline represented hot-money outflows, which is largely money being taken out by Chinese companies and residents. This vote of no confidence put downward pressure on the economy and, along with falling export growth, forced the surprise devaluation.
Chinese policymakers seem unwilling to accept that downturns are perfectly normal even for economic superpowers, as the US has often demonstrated. During the past century the US economy experienced a dozen recessions and a Great Depression even as it remained the world’s leading economy. But Beijing has little tolerance for business cycles and is reviving efforts to stimulate sectors that it had otherwise wanted to see fade in importance, from property to infrastructure to exports. Given the over-investment in these areas and the cloud of debt that still hangs over the Chinese economy, these efforts are unlikely to lead to a sustained upturn. While China reported that its GDP grew exactly in line with its growth target of 7 per cent in the first and second quarters this year, all other independent data, from electricity production to car sales, indicate the economy is growing closer to 5 per cent.
That leaves the global economy perilously close to recession territory. In the first half of this year, global economic output expanded by barely 2 per cent, making it the weakest two-quarter period since the expansion began in mid-2009. Industrial production and world trade growth were flat, developments that in the past have corresponded with global recessions.
Developing countries are hardest hit by the China slowdown. Many are suppliers to China’s manufacturing industries, where growth has virtually stalled. Outside of China, overall growth in the emerging world has fallen below 2 per cent, implying that for the first time since the crises of the late 90s and early 2000s the developing countries are growing more slowly than the developed world. One of the least affected is the US because its trade and financial links to China are limited compared with most other countries.
The best hope for the global economy would be for China to avoid a deeper slowdown and for some other major growth engine to kick into high gear. While the US is relatively resilient, it would have to grow much faster than its present pace of 2.5 per cent to counteract China’s slowdown, and that seems unlikely given declines in productivity and labour-force growth. Europe and Japan show signs of economic stabilisation, but their growth rates are too meagre to make a difference.
This quarter there is little evidence to suggest the global economy is breaking out of its first-half rut, with growth still stuck in the 2 per cent-2.5 per cent corridor. This means the world is one shock away from recession.
A debt-laden China is the critical link, and another one or two percentage point decline in its growth rate could provide that shock.
Ruchir Sharma is head of emerging markets and global macro at Morgan Stanley Investment Management.