Standard & Poor’s downgrade of the US sovereign credit rating is the latest twist in the saga of economic woes plaguing the developed world. Whatever one thinks of the announcement by the rating agency, it cannot be denied that there are legitimate fears that developed countries will not be a robust source of global demand in the foreseeable future. Their governments are now too indebted to expand and will concentrate on mending balance sheets even as their rapidly aging consumers will be held down by anxieties about pension, unemployment, taxes and household debt. The question is, can emerging markets fill the gap?
The conventional view is that emerging markets cannot fill the void since they are producers rather than consumers. China, for instance, may be the world’s second-largest economy but it consumes barely 33 per cent of its gross domestic product (GDP), compared to 71 per cent in the United States. Measured in nominal US dollar terms, US consumption demand was five times China’s in 2010 and double that of China, India, Brazil and Russia combined. Thus, it is argued that global demand is still about the developed world. In other words, stagnation in the West implies stagnation for the world. Fortunately, there is reason to believe that a major shift is taking place.
Measurement in US dollars understates consumption in emerging markets because their prices are significantly lower than those in advanced countries. Adjusted for purchasing power parity (PPP), the combined private consumption of China, India, Brazil and Russia already amounts to 93 per cent of the United States (China contributes 39 per cent, India 29 per cent, Brazil and Russia 12.5 per cent each). Moreover, this ratio is rising very quickly. Readers who are suspicious of PPP conversions should consider that Chinese retail sales rose by around 20 per cent in nominal dollar terms last year. Which is why China sold 55 per cent more cars in 2010 than the US did. Moreover, consumer demand is decompressing in China since wages are rising by 15 to 17 per cent every year. No matter how one looks at it, incremental global demand is already being generated almost entirely by emerging markets. This is why 2010 was the best year ever for global automobile sales even though sales in the US remained 30 per cent below its 2005 peak.
Within the emerging world, Asia dominates with a 60 per cent (and growing) share of consumer demand. Latin America contributes 20 per cent, emerging Europe 14 per cent and Africa six per cent. Even if one ignores the two giants, China and India, emerging Asia includes populous countries like Indonesia (245 million) and rich ones like South Korea and Singapore. Indeed, the combined nominal GDP of the four “Newly Industrialised Countries” – Singapore, Hong Kong , South Korea and Taiwan – is now $2.2 trillion, about the same size as a major western economy like the United Kingdom.
The point is that emerging markets as a whole and Asia in particular have the economic strength to generate consumer demand on a scale that can compensate for stagnation, although perhaps not a collapse, in advanced countries. Of course, Asia is susceptible to its own imbalances. Real estate prices, for instance, are arguably frothy in many countries. There is, however, a less appreciated but longer-term problem that will accompany the shift of consumption from the West to Asia.
In theory, the shift could be expected to remedy the global imbalance problem as China shifts its economy from tradable goods to non-tradable services. We can already see this with rapid wage increases generating strong domestic demand but, at the same time, making China less competitive in many labour-intensive exports. In turn, this would cause the Chinese yuan to appreciate in real terms even without requiring the nominal exchange rate to rise significantly. Unfortunately, the transition is unlikely to be quite as frictionless.
Consumption and production require an ecosystem of human capital, physical infrastructure, financing, social preferences and government policy. The transition from one ecosystem to another can often be painful for both people and places. The debris of past transitions is strewn across northern England, America’s Rust Belt and former East Germany. Thus, the shift to the new order can be expected to have a major impact on the human and physical landscape of China, the United States and other countries. In the United States, for instance, we could well see a period in which skill shortages co-exist with persistent unemployment. Similarly, Chinese cities that witness the construction of new shopping malls and cinemas may not be the ones experiencing the closure of old smoke-stack factories.
All this churn will make investing very difficult for financial investors because the sources of future growth in a particular economy may not yet be publicly listed whereas the listed companies may represent the old economic order. Furthermore, note that this transition will take place in the overall context of aging across the world. China itself will soon have to deal with the problem of rapid ageing and this may entail yet another re-ordering of global consumption in barely a decade’s time.
The author is Deutsche Bank’s Global Strategist
The views are strictly personal
