Monday 11 December 2017

The 'conventional wisdom' on economics is often not so wise

British Prime Minister David Cameron and Bono.
British Prime Minister David Cameron and Bono.
Dan O'Brien

Dan O'Brien

A shift in thinking about the global economy, highlighted at last week's Davos meeting, has gathered pace in recent months. Views on the relative prospects of the rich world and the developing world are rapidly turning around, with the former having their growth prospects upgraded and the latter subject to almost across-the-board downgrades.

This is a significant change. For well over a decade, the "emerging markets" of the less developed world were all the rage. They were to be the future engines of global economic growth, according to a well-established narrative.

The second strand to this story was the inevitability of the decline of the relatively slow-growing west. The financial crash of 2008, which caused the worst slump in living memory, made the declining-west/rising-rest narrative all the more compelling.

In large part, the change in the consensus narrative has come about because economic indicators in many rich countries show that they have been doing better than expected over the past six months or so.

By contrast, there have been recent signs of weakness in many big emergers. Political crises in some of the former stars of that grouping – including Egypt, Thailand and Turkey – have further undermined faith in the prospects of the developing world.

But beware grand global narratives. Like much else in human affairs, economics is prone to faddishness. Fads inevitably fade. Ideas that take hold and become conventional wisdom often simply go out of fashion – detailed economic planning by governments in the post-World War II era is one example. On other occasions the basic facts change, showing that the conventional wisdom was wrong all along – the belief that modern financial systems function efficiently was blown out of the water by the great crash of 2008.

Both the old and brand new narratives on the developed economies versus the emerging economies tend towards over-simplification and reductionism. Headline-grabbing street protests, short-term indicators and forecasters' prognostications do not tell a great deal about the future of the developing world as a whole and can serve to obscure.

An even bigger error is to group diverse countries together and make assumptions that trends in those countries will move in a similar direction. Divining trends is best done by panning out and looking at underlying strengths and weaknesses of individual economies over the long term. This is particularly important as analysts of all kinds have a tendency to focus on the strengths of countries that are doing well while ignoring their weaknesses (Germany is a good example today). Conversely, when an economy is doing badly, the focus is on explaining poor performance by examining weaknesses, while strengths are often underplayed or ignored completely (Germany, again, is a good example, having been frequently called the sick man of Europe as recently as a decade ago).

Two weeks ago, this column discussed the long-run growth prospects in the rich world (concluding that there is real cause for concern, and a few months of good data has not changed that), so the focus here is on the developing world.

Almost invariably when the emerging economies are discussed and debated, mention will quickly be made of the BRICs – Brazil, Russia, India and China. This term, more than any other, epitomises the liking for too-neat narratives in discussion of emerging economies.

Lumping countries as diverse as the BRICs into the same category is perplexing. There is no big common thread among them that would justify grouping them together. The differences among them – demographic, social and political, as well as economic – are enormous, and even greater than those among countries in the western world.

Russia and Brazil, for instance, are chalk and cheese. The former superpower, located in the frozen northern hemisphere, has high levels of education but a shrinking population and an authoritarian political system that discourages investment. Brazil in the tropics of the south has a burgeoning population but a disastrous education system and an ingrained anti-meritocracy that stifles growth and social mobility.

China and India are at least as different from each other and the other big emergers. But they do share one very important characteristic that marks them out from all others. As the accompanying chart showing the world's 15 largest countries by population illustrates, the two Asian giants are in a different league from everyone else. There are nearly 1.4 billion Chinese and more than 1.2 billion Indians (the planet's third most populous country – the US – has a paltry-by-comparison 320 million).

Both economies would really change global dynamics if either even came close to reaching developed world levels of prosperity. China has been moving fast in that direction over more than three decades, and, while India has made strides since it opened up its economy in the early 1990s, it is decades if not generations from mass prosperity (this columnist happened to be in that country last week for the first time in 11 years and there was less by way of visible differences in standards of living and quality of infrastructure than the economic growth figures would suggest, while environmental degradation appeared to have worsened).

Writers of columns (and their readers) usually prefer concrete conclusions. But sometimes neat tie-ups are not possible. The world is a messy and inherently unpredictable place. While big trends, such as the gradual closing of income gaps among the countries of the world and the rise of China, are likely to continue over the longer run, nothing is inevitable. Don't be surprised if by mid-year rich world recoveries look less strong, some emerging markets have got back on track and an entirely new narrative has emerged.

Irish Independent

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