Debt-driven model of economic growth is bankrupt
Three years have passed since the advanced economies of the Western world reached their nadir, and economic growth continues to disappoint, while aggregate debt ratios remain close to record levels, as the deleveraging of private-sector balance sheets has been offset by the deterioration in public finances. Further, persistently elevated unemployment rates, alongside relatively subdued investment in the productive capital stock, threatens to lower potential growth rates already pressured by an unfavourable demographic picture.
The debt-driven model apparent in most of the developed world is bankrupt, but troublingly, the growth models applied in emerging market economies can no longer be relied on to drive the global economy forward.
This is true not only in India, where persistently large fiscal deficits, a deteriorating external position and stubbornly high inflation have undermined the subcontinent’s status as emerging-market darling, but also in China, where an unprecedented investment boom has limited the central government’s scope to offset the sharp slowdown in economic growth via a fiscal stimulus package centred on infrastructure spending.
The Middle Kingdom’s economy is already in desperate need of rebalancing towards household consumption, which at less than 35 per cent of GDP is well below that of countries at a similar level of income. Additional infrastructure spending at this juncture may well ease cyclical pressures but would undoubtedly result in greater economic turbulence later.
China’s policy response to the global financial crisis precipitated a 9 percentage point increase in the investment share of GDP to close to 50 per cent between 2007 and 2011. However, the investment boom has been accompanied by an increase in the incremental capital/output ratio – the quantity of new capital required to generate an additional unit of growth – to levels comparable to its East Asian neighbours just before crisis struck in 1997.
Further, central government and corporate debt ratios are not far removed from Japanese levels just before its economic miracle came to an end in 1989. Rebalancing, and not fiscal stimulus, is what the Chinese economy requires, and simple arithmetic suggests that this is not possible without a significant drop in the economy’s long-term growth rate.
Investors continue to push stock prices higher on hopes that stimulus measures will return the world economy to a more familiar growth trajectory. Cyclical solutions cannot solve structural problems, however, and it is troubling to note there are no growth engines available to push the world economy forward.