Next week, I am off on a business trip to Asia, meeting contacts and officials from China, Malaysia, Japan and various other places on a whistle-stop fly-through (tour is definitely too grand a word). I will, of course, be telling them all about my view of the global economy, and in particular Europe’s fate now the euro area has lurched grudgingly towards fiscal consolidation. But my biggest challenge, perhaps, will be not getting too depressed by conditions in the other half of the world.
When I first started learning about economics in the late 1980s or so, one of the questions I regularly used to ask was why the rest of the world wasn’t as rich as the UK. Various teachers rattled on about poor property rights, home investment bias and the rest, but it really didn’t make that much sense to me. Over the past couple of decades, however, things have been changing rapidly. China’s move toward a more market-led economy is the classic example of positive network effects – as vast swathes of developing Asia have also seen their economies develop rapidly thanks to China’s voracious appetite for raw and intermediate goods, as well as demand for consumer products as urban affluence has spread. The region also learnt the lessons from the late 1990s crisis, stocking up on reserves to insulate their public balance sheets, and understandably guarding their currencies, despite the problems this poses for others. To be sure, China still faces serious issues, not least rising income inequality, and the economic picture throughout the rest of Asia is patchy in places. But the rise of the slumbering superpower has reaped serious dividends throughout the region, and indeed further afield. After all, who would be buying all those US Treasuries if the Chinese weren’t?
At the same time, though, developing Asia’s success has only accelerated the shift of economic power from west to east. This process will take many years – even if China overtakes the US by 2050, as some think, in per capita terms it will lag behind for much longer. Fundamentally, even weak, sclerotic Europe is still a very rich region in global terms. But anyone looking for a good return on their investment would be daft not to start by looking east – as growth is set to be stronger there, especially in compound terms, for the foreseeable future (and probably beyond). The west simply ain't where it's at, in macro terms.
At the same time, Asia also offers a clear example of what happens when economies age and lose their drive. Japan was the envy of the world during the 1960s and 1970s, and even for much of the 1980s. But the property boom and bust in Japan – which made ours look like minor wobbles – then exposed the weakness of the banking sector, and led in turn to the so-called lost decade. As we have seen western governments do during the recession, Japan responded to its economic crisis by running large fiscal deficits to prop up the economy – the key difference being they kept at it for much longer, with the deficit averaging around 6.5% of GDP each year from 1997 to 2006. That meant that public debt shot up, but Japan has managed to maintain the largest gross stock of any developed nation because of the home investment bias of its population – around 95% of JGBs are held domestically.
Ultimately, though, Japan’s choices have not been much of a recipe for success. Before central banks went into printing mode, the big debate was whether we would end up like Japan or Zimbabwe. It’s now clear that, if we’re travelling anywhere, it will be Japan. But with fiscal consolidation on the cards throughout Europe, will our economies fare any better than the (ex) second largest in the world? For Japan itself, further fiscal tweaking is very unlikely to raise aggregate growth, or rebalance the economy, given that the past 13 years haven’t had much impact. But with the Japanese government unwilling to consider other options – such as setting a higher inflation target, and forcing the BoJ to hit it, thereby pushing real interest rates through the floor – Japan serves as a useful example to the West. If fiscal retrenchment here does hit growth, and more QE proves underwhelming, full-blown deficit financing or stoking inflation may be the only ammo left in the locker. And that would be really depressing.