Even at the present stage of globalization, the global economy is not a monolithic entity. In spite of integration through trade and capital flows (and to some extent movement of labour), it remains a conglomeration of national economies. Starting from the early stage of economic interaction the economies of different countries have moved closer to each other within this globalised framework.
Countries with greater economic heft have wielded more sway over smaller and even middling economies, impacting on their growth and development. But lesser integration with bigger economies shielded them from repercussions of economic turbulence in the former. The Great Depression of 1930s affected developed capitalist countries more severely than it did the other economies.
When market mayhem followed the aftershocks of the financial crisis in 2008, the American and European economies bore the burnt of the economic upheaval. The financial crisis started in America with the sub-prime mortgage binge taking Lehman Brothers as the first casualty. As it threatened to have a domino effect on other financial institutions bringing down the financial system developed economies plunged into a slump.
Caught unawares in an environment of complete de-regulation, the US Administration was forced to take measures to bail out the vulnerable banks and financial institutions. When this proved inadequate the Federal Reserve Bank (Fed) was used to introduce Quantitative Easing (QE) which added liquidity to cash strapped banks and financial institutions. The rate of interest was kept at its near zero level to enable investors and consumers to have cheap money. The pump priming operation succeeded and the American economy has now a growth rate of above 2 per cent and an unemployment rate little over 5 per cent.
Across the Atlantic, the countries of the European Union (EU), particularly Ireland, Italy, Spain and Greece, tried to weather the storm by borrowing from more affluent member-countries and from the International Monetary Fund (IMF). Italy, Spain, Ireland and Portugal managed to bring financial stability using borrowed money but Greece was caught in a quagmire. Even after two bailouts extended by the IMF, the European Central Bank (ECB) and Germany it remained mired in debt failing to repay. After much wrangling, a third bailout has been given, almost as a last chance.
Cheap money for the struggling EU countries has also been delivered from the Financial Stabilisation Fund set up to meet emergencies. Laterly, the ECB also followed QE policy like the Fed in America. As a result, economic growth averted a nose dive though the growth rate has been lower than in America.
The financial crisis of 2008 starting in America could bring about a worldwide recession if China did not pursue a firm monetary policy. It was the great saviour of the world economy in 2008. Alongside a stable monetary policy, China launched an unprecedented stimulus package sparking an infrastructure boom. The huge demand for commodities to fuel its construction boom boosted oil and resource rich emerging economies.
The Chinese investment in Latin America, Asia and particularly in Africa propped up otherwise anemic economies. The emerging markets also benefited from capital flows from America because of the higher rate of return.
Developing countries like Bangladesh having fewer transactions with the financial markets of the developed countries remained immune to any economic upheaval. But a jitter went through the emerging countries as Fed announced winding down of QE. An impending crisis was averted when Fed postponed the decision. Later, as the deadline for withdrawal of QE and particularly raising of interest rate by Fed approached in September 2015, economies, big and small, held their breath. This was going to change the financial architecture that had been in place for several years.
Uncertainty loomed over most economies that were already undergoing volatile movement in the markets. The IMF lowered its global economic outlook to 3 per cent, slashing half percentage points from its earlier forecast. The uncertainty was not unexpected and the economies, developed and emerging, were making their plans and retooling policies to adjust to the new situation.
Suddenly, a bomb shell burst over the world economy making markets topsy turvy. China announced devaluation of its currency Renminbi by 3 per cent sending shockwaves through the global economy. The Chinese stock market crashed overnight. It had repercussions in other stock markets in the world. Stock markets crashed from Shanghai to New York and $1 trillion was wiped off the values of shares in one day.
The main reason for China's decision to devalue its currency was found to be the slowing down of its economy as it shifted from investment to consumption-led growth. This followed 3 decades when Chinese growth averaged 10 per cent a year, delivering the fastest economic development in world history.
As already pointed out, China rode out the 2008 financial crash by pumping public investment into the economy, delivering 78 per cent growth between 2008 and 2014 while the US managed only 8 per cent. That breakneck speed of growth has left China with a huge debt pile, estimated at 280 per cent of national income. With 80 per cent of the economy in the public sector China borrowed from banks without hesitation. This is now threatening to bring her economy to a grinding halt or at least lead to a hard landing with feeble growth. The debt being owed mostly by state-owned institutions may allow its financial institutions to escape a Lehman-type collapse, warranting a massive bailout.
The central bank, the People's Bank of China has pursued several measures to boost the flagging economy. The rate of borrowing has been slashed from 6 per cent to 4.8 per cent. Opting to devalue was the last resort. It signals that the booming era of Chinese economic growth is rapidly approaching denouement. Its economy will recover but it will be difficult to post a growth rate higher than 7 per cent. It will cease to be the economic powerhouse of the world for quite a while.
Slowdown in the Chinese economy has triggered recession in Canada, Brazil, Russia and many in African countries. Their exports of commodities to China have nearly halted and Chinese investment overseas has reduced to a trickle. Even America took serious note of the economic slowdown in China and postponed the decision to raise the interest rate.
According to some analysts, the main reason for the weakness of the Chinese economy is not the failure of its own economic model but stagnation in the rest of the world. Global trade has suffered its largest contraction since 2008 in the first 6 months of this year partly as a result of the ongoing crisis in the Eurozone. Seven years after the financial crisis erupted in the US, its aftershocks are still being felt across the world, it has been pointed out. There may be some truth in this but it does not explain everything. It seems more plausible that transitioning from one strategy of development (investment and export-led growth) to another (consumption-led growth) has been behind this economic upheaval.
State management of the economy and market forces that have been given some space to play have been at loggerheads, weakening each other. The economic slowdown along with stock market crash has been the outcome. Being the second largest economy this has contributed to volatility world wide affecting economies variously, depending on their size and integration into the world economy.
The world economy now awaits two major developments. The first is the raising of the interest rate by the Fed. The second is the resolution of the crisis in the Chinese economy, either through a soft or a hard landing. The future course of the economies of other countries depends on how these two giants of world economy decide to cope with the emergent situation. In the absence of appropriate policy changes, they can trigger a crisis engulfing all the economies in the world. Globalisation of the world economy is now at a cross-roads.
Hasnat Abdul Hye
Ataturk Pasha,
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