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Economics Weekly

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Recession cannot disguise ongoing shift in global economy

Tue, Jun 16 2009, 12:24 GMT
by Trevor Williams

Lloyds TSB Financial Markets

Whilst the focus in global financial markets is, rightly, on when the recession will end, and on speculating on whether the proliferating signs of economic recovery are sustainable or not, there is another less observable trend that has not been changed by the recession: this is the higher share of global economic output taken by the emerging markets. Chart a highlights this trend. We have calculated the share of world economic output accounted for by the top ten developed economies (ranked according to their share of gdp) over the last 28 years and compared that group with the top ten emerging economies, also ranked by gdp. The results are clear: the share of the developed economies has fallen sharply, whilst the share of the emerging economies has, not surprisingly, risen equally sharply.

Looking at chart a, it can be seen that the output shares were pretty stable in the early 1980s but from about 1988 onwards the shares shifted at an accelerating pace in favour of the emerging country top ten (E10). These shifts will increasingly have implications for trade flows, for wealth creation, for the demand for raw materials and hence for commodity prices and trends, the future direction of financial markets and for a range of global institutions. It also clearly has implications for inflation, current account positions and fiscal trends. It is the latter that we look at more closely in the following analysis.

Faster growth in the emerging economies has driven up their share of global gdp…
The rising share of global gdp accounted for by the top ten emerging economies is not down to slowing growth in the developed economies but to much faster growth in the emerging economies themselves. Chart b illustrates how rapid the rate of growth of the top ten emerging economies has been in the last decade and also how stable it has been at a high rate. Although emerging market growth has slowed markedly as the world economy has entered recession, it is also clear that, as a group, the top ten emerging market economies have avoided recession, though only because of China and India. Chart b highlights the fact that the top ten developed economies (G10) also had a stable growth rate in the last decade but that on average their annual average economic growth was some 4 to 5 times slower than in the developing economies. It is this that explains the outperformance of the emerging economies in taking a rising share of total global gdp.

…but an improving trend shows up in other areas of economic performance as well
Table 1 compares the trend of the last 10, 5 and 2 years, in terms of gdp, inflation, current account and fiscal balances for the G10 and the E10. It highlights the better performance of the emerging top ten economies. In terms of gdp, the average annual growth average rate has been 2.3% for the G10 and 8.2% for the E10; in the last 5 years it been 2.2% for the G10 and 10.1% for the E10; in the last 2 years (to 2008) the average was 1.5% for the G10 but 10.3% for the E10. What about this year and next? The consensus forecast is that G10 gdp falls by 2.8% in 2009 and expands by 1.6% in 2010. For the E10, economic growth rises by 1.4% this year and accelerates to 5.6% in 2010. This means that there has been hardly any change in the trend observed in chart a and in table 1: the E10 share of global gdp continues to rise sharply, hardly slowed by the global recession.

But there are some other economic features of the relative performance of the G10 and E10 economies over the last 10 years worth focusing on as well. One is that inflation has fallen globally, driven by the decline of inflation in the emerging market economies and its stability in the G10, see chart c. Price inflation averaged 8.2% in the E10 over the ten years to 2008, but this slowed to 5.4% in the last five years, with a modest acceleration to 6.3% in the last 2 years. For the G10, price inflation was remarkably stable at between 2% to 2.6% in the last 10, 5 and 2 years.

Strong and stable economic growth and inflation were accompanied by a persistent trade deficit amongst the G10 and a growing but stable trade surplus for the E10, see chart d. Was this position ever sustainable? Probably not, as it implies that the G10 accumulated an internal financial deficit, as shown by chart e. To some extent, the recession has helped to reduce global trade imbalances as it has reduced the surplus of the E10 exporters and reduced the deficits of the G10 importers. But the problem is that it has been done at the expense of a worsening fiscal deficit in the G10. As chart e shows, the fiscal deficit of the G10 countries will, on average be around 8% in 2010, more than double its 2007 position.

What does this mean for financial markets?
Fast growth has led to a steady improvement in the finances of the emerging economies, with the last 2 years seeing a net positive position. This was of course related to rising exports and to increasing foreign currency reserves, so accumulating a net saving or creditor position with the rest of the world. Although both the G10 and the E10 will be in fiscal deficit over the next two years, the position of the E10 is clearly much better than that of the G10. This in itself is a remarkable fact of the last decade, that despite recession, the internal and external balances are better in the emerging market economies, as a group, than in the G10. This is just one reason why the trends analysed in this Weekly should interest all observers. There is a big pool of savings and capital sitting in the E10 area. Their fast growth and stable prices should mean a big and expanding market for goods from G10 economies but it also means a shift in the relationships between the G10 and the E10 in a number of other areas. From global banking trends and savings flows, to trading in commodities and the price of energy and the flow of capital and investment. These trends, therefore, have huge future implications for financial markets. This is why, despite the recession, we should not lose sight of what is happening in the global economy.

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Published on  Tue, Jun 16 2009, 13:11 GMT