How US-centric is the global economy?

The global economy seems better balanced with both China & the US being equal drivers of growth

Despite the stream of almost continuous positive economic news, and strong global stock markets, most investors are still in their heart of hearts unconvinced about the sustainability of the current economic upturn.

They will point to the fact that the global economy is still horribly unbalanced, with the US being the only engine of growth. They will also use the huge 7.2 per cent third quarter GDP growth number to argue that growth has peaked in the US and must come off in the second half of 2004 as the fiscal and monetary stimulus wear off.

The burden of excess consumer debt and production capacity has to eventually weigh on the economy, they will argue.

While the jury is still out on the extent of a growth relapse the US will suffer in the second half of 2004(if at all), with perfectly rational arguments being made by both sides, is the US really the sole driver of global growth?

There is no doubt that the US has been the main driver of global economy over the past half a decade. This partly reflects the extremely poor economic performance of Japan and the euro area over this time frame.

But it also reflects the greater flexibility and dynamism of the US corporate sector, more forceful policy action by its economic administrators and the sheer size of its economy.

The relative size and dynamism of the US economy and its better relative performance have lead some commentators to conclude that the global economy is too US-centric.

They show the unbalanced nature of the global economy by pointing out that since 1995 the US has accounted for virtually all of the growth in global GDP.

On a first cut analysis these commentators are right, for between 1995 and 2002, the increase in US GDP did account for virtually the entire rise in global GDP when measured in nominal US dollars at prevailing exchange rates.

However, what is not obvious is that this reflects not only the 3.3 per cent average annual real growth of the US economy(over this period), but also a roughly 25 per cent appreciation of the US dollar.

Although the euro area economies grew by an average of 2.4 per cent per annum over this same period, their nominal GDP when measured in US dollars actually declined due to the depreciation of their currency.

Something similar occurred in Japan, where admittedly poor economic growth was reduced further in dollar terms by currency weakness.

As a further example of the effect currency fluctuations can have in these calculations, because of the strength of the euro, Europe would show up as the main driver of global growth in 2003.(when measured in dollars.) Clearly, as anyone who has been to Europe recently can testify, this makes no sense at all.

A better way to measure global growth would be through using estimates of output based on Purchasing Power Parity(PPP) exchange rates. The International Monetary Fund (IMF), for example, calculates its global growth estimates using GDP in PPP terms. When one switches to this methodology you get a much more balanced picture of global growth.

The US far from being the sole driver of global GDP, accounts for only about 20 per cent of global growth between 1995-2002, broadly similar to its share of global output.

The disappointing economic contribution of Japan and the euro area during this period continues, as on a combined basis they account for only 16 per cent of global growth despite having 27 per cent share of global GDP.(source:IMF, BCA)

The use of PPP also highlights the rising importance of developing Asia and especially China. Developing Asia is now larger than either the US or Europe, accounting for 23 per cent of global output in 2002 compared to 21per cent for the US and 20 per cent for Europe.

Despite the Asian crisis, the region grew faster than 6 per cent per annum between 1995 and 2002, accounting for 40 per cent of global growth during this period.

China's greater than 8 per cent growth during this period contributed more to global growth (25 per cent), than did the US (20 per cent),clearly refuting the argument that the global economy is entirely dependent on US economic performance.

Given the size and relative economic performance of regions, to bet against the global economy is to effectively bet against both China and the US. A slowdown in the US alone may not be enough to push the global economy into a recession.

Reinforcing the above point is the fact that the growth in China's imports over the past year was roughly equal to the US's in value, and Chinese imports are on course to rise by over $ 100 billion this year, providing strong support to the global economy.

China is already the world's third largest importing economy and the biggest beneficiaries of China's strong import demand are Japan and developing Asia.

The global economy thus appears to be stronger and better balanced then one would imagine on first glance. Investors who are negative on the global growth outlook based purely on a negative view of the US may have to rethink their investment stance.

The world today clearly seems to have two growth engines with both China and the US being key and equal drivers of global growth. Of course some investors may point out that China's growth is itself driven by trade with the US.

This argument has some merit but domestic demand has accounted for the dominant share of China's growth in recent years, and for many sectors Chinese consumers are the drivers of growth.

Keeping all of the above in context, a bigger risk to the outlook for 2004 in my mind is the risk of a hard landing in China. There is great deal of debate among Asian economists as to the growth trajectory of China in 2004.

There seems to be an equal split among those who expect a significant slowing of Chinese growth and those who see continued boom times.

I see far greater debate among investors about the growth prospects of the US in 2004 than one does about China. Many global investors just seem to automatically assume that China will keep chugging along at a 9-10 per cent growth trajectory.

If growth were to slowdown in the US, investors are far better prepared and the degree of undershoot may be limited. But if China were to slow, we could easily see investment demand compress and import growth drop from 40 per cent plus to single digits.

Investors are far less prepared for such an outcome and thus its impact on financial markets and the real economy is that much more pronounced.

Therein lies the risk in my mind, for the Chinese economy is showing signs of strain and the authorities in Beijing are clearly worried about the investment cycle.

The fact that I am more worried about a slowing in China than the US highlights the fact that the most important development in the global economy over the coming decades will be the growing power and importance of developing Asia. Any global investor worth his salt has got to come to grips with this region.