Monday, January 19, 2009

ACCELERATING DOWNHILL

Why China and Germany need to do more to boost demand

EVERYONE knows that the financial system took a downward dive in mid-September. The failure of Lehman Brothers turned the rich world’s credit crunch into a global calamity, as the international banking system came close to collapse and even the most basic functions of finance, such as trade credit, seized up. To stop this financial breakdown sending the world economy into a tailspin, politicians scrambled with bank-rescue packages and promises of fiscal stimulus. Unfortunately, it seems increasingly clear that they failed. Just as the financial crisis went global at the end of 2008, so large chunks of the world economy went into free-fall.
Industry is in grave trouble. Around the world factory output is plunging at its fastest pace in decades as the consequences of slumping demand have rattled along the supply chain. In the three months to November American industrial production fell at an annualised rate of 16% compared with the three months before. Over the same period Japan’s fell by 21% and Germany’s by 15%. Some emerging economies have done even worse. South Korea’s factory output fell at an annualised rate of 25% in the three months to November, about as fast as in its financial crisis a decade ago.


Deep and dark

On the basis of these figures and the gloomy state of manufacturers’ order books, economists at JPMorgan reckon that global manufacturing production is likely to have fallen at an annualised rate of almost 20% in the last three months of 2008. The car industry is seeing the most savage drop in sales in its history (see article), but the collapse in demand is widespread. From computer chips to sophisticated machine tools, the production of goods is plunging. As a result trade flows, which had grown faster than output for decades, have recently shifted into reverse. Germany’s exports are falling at their fastest pace in many years. Taiwan’s exports fell by 42% in the year to December. After years of double-digit growth, China’s exports are now falling too, though by less than those in the rest of East Asia (see article).


Manufacturing is highly cyclical, falling first and fast in a downturn. Firms are quick to scale back capital spending and consumers skip new cars rather than scrimp on food or healthcare. A rapid rundown in inventories and temporary distortions in credit markets (see article) have not helped. The collapse of trade finance made it all but impossible for many producers to shift their goods abroad. The plunge in trade flows is partly a result of tumbling commodity prices.

Stumble or slump?

Trade finance is beginning to flow. Firms cannot run down stocks for ever: eventually, they will empty their warehouses. But the damage is done: those temporary factors triggered a collapse in global demand that has now spread way beyond the Anglo-Saxon economies at the heart of the credit crisis.
Output in the euro area probably fell as fast as in Britain and America in the last three months of 2008, even as Japan’s GDP sagged still more dramatically (see
article). The drop in industrial output has hammered export-dependent economies, from Germany to Taiwan, and there is little sign that domestic demand in these countries is stepping in to compensate. In some countries with big external surpluses, notably China, the opposite may be true. China’s imports have been falling faster than its exports and in recent months its trade surplus has risen.

Add these factors together and the outlook seems grim. This sharp global drop in industrial production will itself lead to more weakness, as unemployment rises around the world and demand therefore falls. And in America, too, the outlook has grown darker. Around three-quarters of output growth over the past two years came from net exports. That prop will go. And while domestic demand in surplus economies flags, the imbalances that have contributed to the current crisis will not right themselves, and will encourage protectionism. When rich-country economies were growing, China’s surplus was a political lightning-rod; how much more

dangerous will it be when unemployment is rising?

To mitigate these risks policymakers need to do more to prop up demand, especially in countries that have external surpluses. Fiscal stimulus packages that seemed sufficient two months ago may be too small, and too slow to take effect. Much of the infrastructure spending in the package that China announced in November will not kick in until later this year. This week’s decision by Germany’s government to add a second €50 billion ($66 billion) stimulus package is a step forward, though at barely more than 1% of GDP it is still far too small (see article). For the time being, the biggest and quickest fiscal boost is likely to come from America, as the Obama team seeks speedy passage of an $800 billion package of tax cuts and spending. That sort of money may put a brake on the global industrial collapse, but it will not set the world economy on course for a sustainable recovery. Others still need to do far more.

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