GOING by economic history and theory, it would not be unusual for the world to be heading towards another recession. Economic downturns occur every seven to 10 years. At this time, the world has been in the recovery mode for seven years; the Great Recession of 2008-09 ended formally in 2009.
If a recession were to happen its impact will be different from the one that hit in the late 2000s. Then China was able to exercise its pull on the rest of the world. This time as the Chinese economy weakens, the United States was supposed to be the engine of global growth.
There is a debate among economists and financial analysts whether economic indices point towards another slowdown in the United States. We should recognise that economists need to gaze into the future in order to inform the making of public policy.
However, they are seldom totally right and often seriously wrong. Forecasters in places such as the International Monetary Fund and the World Bank are always adjusting their projections up and down. Both institutions have lowered their sights for the year 2016 for the world economy. Economists' problems with predictions are related to their discipline. The ground on which they walk is constantly shifting.
Those who are given to pessimism look at some of the indices that were in the past associated with recessions. Industrial production in the United States, for instance, fell in 10 months in 2015 - a figure that has since 1919 always been associated with recession. A well-regarded survey of purchasing power in manufacturing which over the long run has shown a strong correlation with growth in the economy has signalled contractions for the last several months.
However indices such as these focus on the state of the manufacturing sector but that sector is now only a small part of the US economy. In 2015, manufacturing accounted for only 16 per cent of the US gross domestic product while the share of the service sector had climbed to 80 per cent. Surveys for the non-manufacturing activity indicate that they are in much better health. We should note that the world's four largest companies - Google, Apple, Microsoft and Facebook - are in the service sector. The book value of General Electric, the world's largest industrial company, is one half of that of Google.
The optimists drew some comfort from the jobs markets report for January issued on Feb 5, which indicated that the US unemployment rate fell to 4.9 per cent, the lowest in 10 years, and wages picked up significantly.
Economists who continued to believe in the strength of the American economy said that the new figures suggested that the economy was holding up well despite a slowdown in China, growing problems in emerging markets and turmoil in the stock market. In spite of the good labour market report the Dow Jones industrial average fell 1.3 per cent.
However, if developments in the United States economy don't necessarily indicate a recession is on the horizon, some of what is happening in the emerging world is a cause for worry. There is a consensus among policy analysts that what we are dealing with in the developing world is not run-of-the-mill economic downturn but the reversal of a 35-year trend.
From 1980 when Deng Xiaoping opened the Chinese economy and until the arrival of the Great Recession in 2008, economists settled into the belief that the world had found a durable model of growth. As discussed by the World Bank in its 1994 study of the "miracle economies" of East Asia, the model was based on the labour-abundant economies of the region producing cheap manufactures for consumption in rich countries. Guided by the state, large privately owned enterprises produced for the markets in North America and Europe.
The success of this model brought many Western corporations into China and other East Asian countries. Firms such as Apple and IBM made large investments in China to have their products assembled from the parts and components made in several different places.
For several decades, China was by far the largest destination of foreign direct investment. However, foreign firms were not the only source of capital. As the central banks in Europe and America brought down interest rates to fight two successive downturns in the 1990s and 2000s, domestic companies found it cheaper to raise capital abroad than at home. The result was a capital bubble which left both countries and firms with large debt burdens. However the direction of capital flows has now been reversed, a subject I will discuss in a later article.
The "miracle economies model" yielded high rates of economic growth based on high levels of investments. These investments increased the demand for commodities. The world was thus tied in two different ways - East Asian manufacturing with rich countries' markets and East Asian manufacturing with commodity exporters around the globe. The Great Recession loosened the first link which contributed to the weakening of the second link.
The story unfolding in the United States is proceeding as follows: Tumult in emerging markets and the commodities sector is testing an economy that was going through tepid growth. From 2013 to 2015 the average growth was about 2.1 per cent a year. The recession in 2008-09 followed a much healthier economy. Pessimists have, therefore, concluded that not only is the United States heading towards another downturn but that it will be much deeper and destructive than the one in 2008-09. However, the optimists are not troubled; they were pleased with the jobs report for January 2016.
The writer is former vice-president of the World Bank and also former Pakistan finance minister.
This article was first published on February 18, 2016.
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