Shift to China deepens the global economic crisis
April 8, 2009
By Etienne Swanepoel
In last week's column, we looked at the intersection between politics, economics and geography - the science of geopolitics. The question was: broadly speaking, can geopolitics explain or shed any light on the current economic crisis?
In this column, we will see whether one can connect the current economic crisis with what has been said so far.
In a recent economics paper, Robert Levine of Rand Corporation, which is regarded as the best think-tank in the world, says the current crisis may resemble that of 1929, but the underlying economic situation is more like that which brought about "stagflation" (economic stagnation combined with inflation) in the 1970s.
This is so inasmuch as the fundamental causes of the problems of the 1970s and those at the beginning of the 21st century are similar. Both periods are marked by shifts of income and economic power from what has been the wealthy world to new regions and countries.
There is currently a fundamental shift of economic power from the West to the East. This is apparently caused by the shift of manufacturing capacity from developed countries to the East. In the 1970s there was a shift from developed countries to oil producing countries, caused by an increase in oil prices. According to Levine, though the two shifts have different causes, the political and economic outcomes are likely to be similar. Most importantly, such shifts cause major economic and political dislocations for substantial periods of time.
Joseph Schumpeter, regarded as one of the leading economists of the 20th century, explains economic fluctuations by looking at history, starting with the Industrial Revolution. Schumpeter perceived a series of long waves of economic activity, each reflecting radical productive innovations, mostly new technologies that replaced old ones in a process he calls "creative destruction".
The most recent wave is the information technology (IT) revolution of the 1980s and 1990s. Eventually, however, the new innovations run their course; investment overshoots; profits, production and demand decrease; and the process reverses itself into hard times, until the next technological wave.
Schumpeter also postulated two shorter cycles: one, lasting five to 10 years, is what is commonly thought of as the business cycle, including bubble cycles like the current one; another, less important cycle is based on overshooting business inventories.
Levine says the IT wave probably peaked in the early 2000s. Unfortunately, the timing coincided with the perceived structural shift from the West to the East.
Levine's thesis is: "The current credit crisis is … unlike most of its predecessors of the postwar era that were ameliorated and quickly reversed by monetary and Keynesian fiscal policies. Rather, the credit crisis has come not only on the downside of the IT wave, but also at a time of a fundamental structural readjustment of the world economy - a rapid shift of shares of global income and production to new countries and regions that is similar, although not identical, to the shift of the 1970s.
"In the earlier period, Opec's monopoly-enforced claim to an increased portion of the world's slowly growing production and income produced real losses for the rest of the world, the US in particular … Now, the developing world, led by China and India, is claiming a larger share, but the new claims are based on the rapid growth of their own production, thus increasing total world product as well."
Balance-of-payment deficits have, until recently, allowed the US to maintain absolute levels of real income even as its share of the world total has decreased. Much of this deficit has been funded by savings from China and other Asian economies.
According to Levine, the structural shift is taking place too fast for foreign financing of the American standard of living to suffice. Though comparative advantage (the economic theory that countries have different comparative advantages relative to other countries) can explain the migration of productive capacity from, say, the US to China, the shift does not benefit US manufacturing workers.
Over the past decade or so, this part of the US workforce has become economically dislocated. If such a dislocation coincides with high levels of gearing among such workers, the risk of credit defaults by these workers increases. Lastly, if credit defaults take place in an environment of complex financial engineering, it seems that systemic risk becomes a real danger - as has been the case in the last few months.
To complete the hypothesis, it is necessary to tie the US origination of the crisis with the geographical and economic drivers in China. China has an export-oriented economy. According to George Friedman of geopolitical consultancy Stratfor (see last week's column), China is in a position of dependency. No matter how large its currency reserve, how advanced its technology or how cheap its labour force, China depends on the willingness and ability of other countries to import its goods. Any disruption of this flow has a direct effect on the Chinese economy.
China's centre of gravity is that it has become the industrial workshop of the world. The more effective China becomes at exporting, the more it becomes a hostage to its customers and their economic problems.
As noted last week, China's geopolitical problem is economic. Its first geopolitical imperative, to maintain its unity, and its third, to protect its coast from encroachment, are more deeply affected by economic considerations than military ones. Its internal and external political problems flow from economics.
(The second imperative is to keep control of buffer regions such as Tibet.)
The dramatic economic development of the last generation has been ruthlessly geographic. It has benefited the coast and has left the interior, which contains the bulk of its population, behind. This leads to tension, conflict and instability. It also leads to economic decisions made for political reasons, resulting in inefficiency and corruption. It has left China vulnerable to global economic forces that it cannot control or accommodate. According to Friedman, current Chinese economic dynamism does not translate into long-term success.
Geopolitics is a method for thinking about the world and forecasting what will happen. As Friedman says, the most brilliant leader of Iceland will never turn it into a world power, while the stupidest leader of Rome at its height could not undermine Rome's fundamental power.
Geopolitics is not about right and wrong, or the virtues or vices of politicians, or foreign policy debates. Geopolitics is about broad impersonal forces that constrain nations and human beings, and compel them to act in certain ways.
It seems there are linkages between the shift of economic power from West to East, geographical drivers in China, and the origin of the economic crisis in the US. Whether these linkages are sufficiently plausible to explain the current crisis is probably too early to call.
It would, at least, appear there are no obvious inconsistencies in the hypothesis. The 1970s were massively disruptive. If the current crisis, as Levine says, is similar, it is likely to continue for some time.
Etienne Swanepoel is a partner at Webber Wentzel. The opinions expressed are his own
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