PANIC MEASURES WILL RUIN THE BRIC RECOVERY / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

August 9, 2011 9:33 pm

Panic measures will ruin the Bric recovery

By Jim O’Neill


Perhaps not surprisingly given the coincidence of major economic issues in both Europe and the US, many respected commentators are arguing that the world is about to end. Immense challenges now face the downgraded US and the eurozone, as it tries to keep its currency alive. Luckily, however, there are other important global players and economic drivers – most importantly China, and its worries about inflation.


Demand in the so-called Bric economies of Brazil, Russia, India and China is now more important to the world economy than the US and Europe. In the decade that finished in 2010, the Brics added around $8,000bn to global gross domestic product, equivalent to about 80 per cent of that of the Group of Seven leading economies. The Brics will probably add around $12,000bn more over the next decade, double the US and the eurozone combined.

China is obviously the most important of the Brics, and in this regard, Tuesday’s new Chinese inflation figures are especially significant. For the month of July, these showed prices rising slightly again, to 6.5 per cent. Any rise worries China’s leaders, but this is actually likely to be the last increase for some time. By the end of the year the rate should fall back to – or perhaps below – 5 per cent. Next year, it should move back down towards 4 per cent. If this were not to happen, it might end up being an even bigger problem for Europe and the US, especially if the same were true elsewhere in the Growth World.


What happens to China’s inflation rate is now a topic of great significance for the wider world. It will of course be important for the advanced economies to respond to their domestic challenges. But in the new era, it is also ever more vital to think through the external consequences of any policy changes they make. The west’s central banks are doubtless contemplating fresh monetary stimulus. But given the wider global context, they might be better off taking actions that would help to reduce inflationary pressures in their current and future export markets.


Over the coming decade other important developing economies, such as South Korea, Indonesia, Mexico and Turkey, will also grow quickly. Yet for all of these countries, just as with China, what really matters for their domestic demand (and therefore for the world economy) is reduced inflationary pressures, helped by lower commodity prices. Exports to the US and Europe matter much less.


The same is true in China, only more so given the size of the economy. Indeed, the world needs a strong domestic Chinese economy more than ever. I think we are likely to get one. Pre-global crisis China was led by exports and investment. Post-crisis, it will be led by its consumers. Yet this cannot happen if Chinese inflation is rising.


The latest retail sales indicators suggest that Chinese consumption is probably rising by around 20 per cent per year. The current size of Chinese consumption is $2,100bn. Assuming the level is as low as the 35 per cent of GDP in the official data, then a 20 per cent growth rate translates into an extra $400bn a year. The combined rate of consumption growth in the other Bric nations is similar, meaning that these four countries alone will add something like $800bn to global growth this year alone.


If you then add up the domestic consumption of all the next tier of developing markets, you find that the world is no longer dependent on the leadership of the US and Europe. Indeed, the leaders of the G7 will now have to be even more hopeful that the current degree of fast consumption increases continues, given it is really the only plausible means by which they can recover from their current mess.


Insofar as much of the inflation that China and the other developing economies have recently experienced comes from food and energy prices, this should make G7 policymakers think carefully about the consequences of any fresh monetary and other forms of stimulus. This action might indirectly make their own problems even worse, if it resulted in fresh weakness of the dollar and thus a new bout of rising commodity prices. More specific policies aimed at unblocking their own domestic growth would probably be more useful, and support any declines in commodity prices. Our policy aim should be simple: to boost the economies of these crucial export markets, whose help the west is going to need ever more in future.
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The writer is chairman of Goldman Sachs Asset Management
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Copyright The Financial Times Limited 2011