Emerging Hangover

As the economic crisis fades in the rearview mirror, some analysts on Wall Street and in Washington expect the world economy to enter a supercycle, a prolonged global growth spurt powered by the emerging markets. This isn’t just some fringe theory: The "Super-Cycle Report" by Standard Chartered Bank posits that world GDP will double in the next two decade as a result of "industrialization and urbanization of emerging markets and global trade." The sentiment was widely shared among the attendees of the latest World Economic Forum in Davos, Switzerland, and among such heavyweights as Goldman Sachs and PricewaterhouseCoopers. Emerging markets, rising to make up half the world economy by 2017, are expected to pull the sluggish, debt-laden advanced economies — United States, Europe, and Japan — along. In this bifurcated world, the emerging juggernauts such as China, South Korea, and India will decouple from the advanced nations, relegating the mantra "when the U.S. economy sneezes, the world catches a cold" to the ash heap of history.

But last week’s IMF governors’ spring meetings and the G-20 finance ministerial in Washington tell a very different story. Rather than celebrating a global liftoff, countries are wrestling with familiar global letdowns, from deepening global imbalances to China’s currency manipulation and soaring U.S. public deficits. The depressingly familiar policy agenda belies the supercycle hype. Rather, it suggests that emerging economies remain unsafe from flu in America and unable to power the world economy on their own.

Granted, emerging markets are due to grow almost thrice as fast as the advanced economies in 2011, according to IMF forecasts. They seem light-years away from the massive debts, currency crashes, and hyperinflation of the 1980s and 1990s. Now armed with historic reserves and led by pragmatists rather than populists, they appear stable and sound. Their corporations are globalizing; their financial markets are growing sophisticated; and with a few exceptions, their politics look orderly, with regular transitions of power instead of the coups and chaos of past decades. For all the gripes about the "Washington Consensus," developing countries have more or less followed its prescriptions and gained dramatic health benefits.

But the idea of a supercycle driven by emerging economies is tenuous. The American consumer is still the pivot of the world economy. IMF research shows that consumer demand in emerging economies is too limited to offset dips in U.S. consumption. At about half of GDP, China’s savings rate is among the world’s highest. Beijing’s glossy new five-year plan promises to expand household spending power, but consumption, now at some 36 percent of GDP, will in the best of scenarios rise to only 45 to 50 percent of GDP between now and 2025, well below that of advanced nations and such emerging economies as Brazil and Mexico. Similar trends hold across emerging East Asia. No wonder regional governments stick to their export-led growth models and keep their currencies artificially devalued, paying lip service to the G-20 rebalancing agenda.

Add to this rising oil and commodity prices, and global imbalances are heading toward their pre-crisis levels, risking trade protectionism and a new global economic crash. No one would escape such a debacle; rather than diverging, the fortunes of the emerging and advanced economies are converging. Their trade and financial ties are deepening, and their business cycles have only become more coupled: The correlation of advanced- and emerging-market outputs has tripled over the past decade. Emerging markets weathered the crisis not because they were decoupled from the advanced nations but because of their reserve buffers and improved macroeconomic fundamentals.

At the same time, the future rise of emerging markets is rife with uncertainties. Already, their governments are responding to economic overheating, inflationary pressures, and currency appreciations with counterproductive knee jerks — capital controls that disrupt global flows of finance and trade and exchange-rate manipulation to engineer artificial export competitiveness — instead of the best solution, fiscal and monetary tightening. The presumed champions of the 21st-century world economy, the BRICs (Brazil, Russia, India, and China), lack the institutions for sustained growth. Look for them rounding out the bottom of World Bank rankings on regulatory quality and ease of doing business. Corruption scandals are rocking the Indian government; graft and property rights violations cost companies billions in China.

What’s more, mass urbanization and widening income disparities will test these countries’ already feeble social cohesion. And if Samuel Huntington’s seminal 1968 thesis, Political Order in Changing Societies, holds, the rise of almost 2 billion new members of the global middle class in the next two decades will build pressure for political liberalization, especially in authoritarian China and the Middle East. When they reach the boiling point, emerging countries are bound to disrupt global growth much more drastically than the ongoing shake-ups in North Africa or the 1997-1998 Asian financial crisis that engulfed Russia, Brazil, and the rest of the emerging world.

In this imbalanced, coupled, and volatile world economy, the U.S. economy remains critical to global growth. The supercycle hype notwithstanding, emerging markets, coupled to advanced economies, cannot carry the world economy alone — nor can they be relied on to do so because of their many political and social unknowns. Aging and crisis-worn, Europe and Japan are stuck in a low-growth quagmire. Against this backdrop, lackluster "new normal" growth in the United States would be disastrous, destabilizing emerging markets and sparking zero-sum conflicts over a stagnant global economic pie.

The quintessential question in the post-crisis world is whether the U.S. economy, straitjacketed by fiscal deficits, new regulations, and soaring entitlements, can grow. What is clear is that what got us here won’t get us there. Instead of throwing money it doesn’t have at the problem, America must reinvent itself to pump up the world: balance the budget, bulldoze barriers to exports at home and abroad, cut taxes on high-growth companies, promote innovation, and unleash venture capitalists.

Global governance poses another problem. Global conflicts over imbalances, currencies, capital controls, trade protectionism, and resources require global management. The U.S.-built institutions — the IMF, G-20, WTO — are the best tools available, but they are hamstrung by the divergent demands of their diverse memberships, as epitomized by the G-20’s snail-pace progress on global imbalances last week.

Leadership is needed to bridge the divisions. Emerging economies prefer to free-ride rather than take responsibility in global governance, while Europe and Japan are neither able nor willing to lead. This leaves the United States. According to a February survey, the majority of Americans, 66 percent, still want to play a leading role in the world, but the level is the lowest recorded. For its part, Washington is playing defense instead of leading — procrastinating on pending free trade deals and the decade-long Doha trade round, backtracking on G-20 pledges, and failing to defuse the budget time bomb, the one policy fully within America’s control to revive the economy and reduce global imbalances.

Washington must step up to the plate. The world economy needs America as much as America needs the world economy. Promising unprecedented wealth in the United States and around the world, a supercycle would serve U.S. national interests. But it won’t spin without America.