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BW Businessworld

The New Order

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The road to global economic recovery has been quite slippery and is far from uniform across nations.  True, the doomsday did not arrive after the meltdown of financial markets, but one crisis after another, in different parts of the world, certainly paralysed the process of economic resurgence. Moreover, unevenness in the speed of recovery among nations has already led to burgeoning tensions between them. 

Broadly speaking, the countries can be classified into the three categories. First, there are economies which are struggling hard to maintain status quo, like, the USA, the UK, France, Japan, etc. For example, though the recession (defined as negative growth rates of GDP in at least three successive quarters) is officially over in the US since 2009 June, the growth rate is still far short of the trend from the pre-crisis era and unemployment figures still hover around 10 per cent. The UK manufacturing is still struggling and despite the 25 per cent fall of pounds in last three years, exports have not picked up substantially and budget deficits in both countries are at near alarming level. These economies are also exhibiting ‘jobless recoveries'  with a nosedive in consumers' confidence indices.

The Euro zone, falls in the second category where signs of stress are littered almost everywhere except for Germany, Netherlands and a handful of others. Important partners in this zone are besieged with problems of unemployment, sovereign debt, fiscal deficits and crumbling house prices. The average unemployment rate is 10 per cent in the zone with Spain (20.1 per cent) and Ireland (13.9 per cent) having the largest shares in the overall figures.

The third group primarily consists of China, India and Germany which had weathered the storm fairly well and is on a steady recovery path to growth.  This global picture is also consistent with the IMF's prediction last week which asserts an expected fall in global economic growth from 4.8 per cent this year to 4.2 per cent in 2011. The Euro area will suffer a further decline from 1.7 per cent to 1.5 per cent next year while China's growth will touch around 9.8 per cent.

Given this uneven recovery, it is not surprising that these countries are resorting to protectionist policies to further their own interests at the expense of others. The Global Trade Advisory (GTA) recently reported that countries are imposing on an average ‘100' protectionist measures per quarter. There is a growing tendency on the part of the nations to adopt ‘beggar-thy-neighbour' policies (4 per cent above the trend but still below the level of 1930s) this year. In addition, major trading nations like the US, Russia, China are actively involved in taking discriminatory trade measures against others. On the other hand, harsh domestic adjustment in the form of cutback of Government expenditures affected European countries like Portugal, Ireland, Spain and Greece (PIGS), which are also creating domestic disturbances in the form of agitations and strikes and dealing a blow to so-called European harmony. 

In this scenario full of uncertainty, negativity and pessimism, the big question is: will such conflicts both within and between nations escalate and destabilize the world economic order? Since a major global warfare always starts with the war between powerhouses, such questions are best answered by looking at those nations which matter for the rest. Take for example, the trade and currency disputes between the US and China. Currently, it has received huge attention from the media, central banks as well as the IMF and quite a few pundits are predicting a large-scale war of protectionism between them. So, will this happen?  

It is certainly true that there exists huge trade imbalance between the US and China, partly caused by currency manipulation by the Chinese authorities in the form of its deliberate purchase of US dollars (Treasury bonds) to support its currency.  The US is demanding reduced intervention of the Chinese Central Bank in the currency market to allow a depreciation of US currency so that it ends the implicit subsidy offered to China's exporters. Otherwise, it is threatening to impose direct tariff on imported Chinese goods.    

Certainly, this issue has soured Sino-US relationship in recent times, but a full-scale economic confrontation, as argued by many pundits, is very unlikely to unfold in the immediate future. That is, neither US will impose a drastic amount of tariff or pursue quantitative easing nor the Chinese will make efforts to appreciate the value their currency significantly vis-à-vis US dollar but both would follow a gradual, incremental and ordered path to pursue their conflicting objectives. The frontal trade wars involving currency and trade markets, mirroring confrontation of the 3os, will not happen because it would seriously jeopardise stakes of both.

One must note that the trade imbalance between these two nations is not new and existed prior to financial crisis. It was decided in 2005 that China would let its currency appreciate on a gradual basis which she did until the recession kicked in. The reason for the current tension is this: Much of China's prosperity lies in export-led growth and China, though an emerging superpower, still has a GDP equal to one-fifth of US. The economic inequalities across the regions and absolute number of people below poverty lines in that country are still very large. Huge stimulus spending financed by the prudent Government savings in the years of unstinted growth had helped the economy to overcome perils of the crisis without straining its current budget. The Chinese economy needs to undergo structural changes in order to diversify its production base geared towards domestic demand and at the same time it has to narrow the gap between rich and poor regions. Otherwise, huge social instability may derail China's gains. However, these are at best medium term (if not long term) goals and if the fledgling recovery from a combination of stimulus and manipulation of exchange rates is at stake, so will be its other goals. Hence, policies that shift from exports to domestic production may occur but not now and it is unlikely that China would let its currency appreciate instantaneously by a huge amount.

The US on the other hand has the following dilemma: Badly spent (unlike China's) surpluses on tax cut to rich and financing wars had already created huge budget deficit. With its stimulus running out of steam, further borrowings or any other measures to finance another effort to boost up demand is bound to meet political opposition domestically. Hence, fiscal policy is now a blunt weapon to tackle jobless recovery. Next, with the lowest interest rates, monetary policy via quantitative easing   (in the form of purchasing both private and public financial assets and thus injecting liquidity ) is also  ineffective. It is left only with exchange rate or trade policy to combat the downturn.  However, a trade war or currency battles will not help US very much immediately for a number of reasons. First, barring steel and a few  other products, most of the importable in US ( like Toys, refrigerators and other consumer durables and non durables) are no longer produced in US. The production bases of such previously US made goods, have been shifted to either China or other to other low wage economies.  Second, many US multinationals own stakes in the companies based in China which exports to US. Hence, devaluation will not increase the demand for US goods because it is no longer produced there and tariffs on Chinese exports will hurt profits of US multinationals. Third, manipulation of exchange rate is not something that can be raised in WTO because it is harder to prove. However, politicians are clamouring for it because they ran out of both fiscal and monetary instruments to end declining growth in US and blaming China is an easier way out for escaping the responsibilities, especially at a time when November election is around the corner. But in reality, the exchange rate is equally ineffective instrument for US to boost up the domestic demand. 
 
Of course, multilateral pressures on a limited scale will be mounted on China to reduce its surplus so that it helps a world recovery by spending goods and services for other countries and China will also comply to appreciate its value of currency in a gradual and phased manner and it will take some time for her to complete the course of adjustment.

However, once the Chinese currency appreciates to its fullest extent, the whole of US will be open for sale because with huge accumulated dollar reserve, the Chinese companies  and Government will find it cheaper to buy American companies through the process of mergers and acquisitions. Exactly this had happened in the nineties when the Japanese were on a buying spree (from real estate in New York to Hollywood) following a large-scale depreciation of Yen due to US pressure. 

Recent attempt of China to buy an oil company met with serious political troubles. A cheaper  US dollar, huge reserves of dollars held by the Chinese and large number of ailing US companies, are very likely to give impetus to Internal mergers and acquisitions and will result in transfer of ownership and control from US to China in a large number of sectors including strategic ones like steel,  natural gas etc. Given the huge US political opposition in 2005 on the communist China's  effort to buy the US oil company Unocal, it remains to be seen that whether further weakening of dollar would transform the current  tensions in the economic front to political arena in the future.

The writer teaches at Essex Business School. 
He can be reached at sbanerji(at)essex(dot)ac(dot)uk