Rethink export-led growth paradigm, says UNCTAD

United Nations development body UNCTAD has warned countries with export-led economies to reconsider their strategies in view of the end of the US consumption boom.

Kanaga Raja

THE developing and emerging-market economies that have focused their current export-oriented strategies on the markets of the major developed economies for achieving growth and creating employment should rethink their policies, the United Nations Conference on Trade and Development (UNCTAD) has advised.

In its Trade and Development Report (TDR), UNCTAD said that export-led growth ambitions will meet with increasing constraints now that the debt-financed consumption boom in the United States has ended.

The United States economy will no longer serve as an engine of growth for the global economy. Neither China nor the euro area nor Japan is likely to assume this role in the foreseeable future.

Policies for sustainable economic growth, job creation, and reductions in poverty should be based on establishing a balanced mix of domestic and overseas demand, said UNCTAD.

'The shift in focus on domestic-demand-led growth is necessary both in developed and emerging-market economies with large current-account surpluses and under-utilised production potential in order to prevent the recurrence of imbalances similar to those that contributed to the outbreak of the global financial crisis,' said UNCTAD Secretary-General Dr Supachai Panitchpakdi in the overview to the report.

'Past experience and theoretical considerations suggest that a sustainable growth strategy requires a greater reliance on domestic demand than has been the case in many countries over the past 30 years... Especially for developing countries, this may call for a rethinking of the paradigm of export-led development based on keeping labour costs low,' he added.

Global imbalances

According to the report, there is widespread agreement that the persistently large imbalances in the world economy - with sizeable current-account deficits in some countries, particularly the US, and sizeable current-account surpluses in others, notably China, Germany, Japan and a number of oil-exporting countries - contributed to the outbreak of the current economic and financial crisis and facilitated its global spread.

There is also agreement that a smooth and non-deflationary reduction of these imbalances is indispensable for ensuring that the recent global economic upturn continues.

Although the US accounted for about 50% of the aggregate current-account deficits in the world economy, and China for about 22% of all surpluses in pre-crisis 2007, the global imbalances are far from being just a bilateral problem between the US and China. China began to show a strong current-account surplus only from 2003; prior to that the main counterparts to the US’ longstanding current-account deficit were surpluses in Germany and Japan.

However, while so far there is little evidence that adjustments in the two countries would be able to help bring about a global rebalancing, in the US, there appears to be no alternative to adjusting household consumption unless another asset bubble is allowed to occur.

In China, added UNCTAD, the need to embark on major structural transformation from investment- and export-led growth to consumer-led growth has been officially recognised.

The recent growth trajectories of the US and China appear to have moved in opposite directions. Consumption as a share of gross domestic product (GDP) increased in the US but fell in China; investment rose dramatically in China while its importance shrunk in the US.

Thus, the US current-account deficit has been associated with a low national savings rate and a continuously rising share of private consumption in GDP, while along with China's current-account surplus there has been a very high national savings rate and a very low share of household consumption in GDP.

'However, the external position of neither of these two countries is sustainable,' says the report.

It is now widely accepted that in order to recreate a favourable external environment for development, the challenge for policy-makers is to achieve a non-deflationary and durable rebalancing of demand in the world economy. Such rebalancing will probably have to include a decline in the share of consumption in aggregate income in the US and an increase in that share in China, adds the report.

'While there are different views on the causes and effects of global imbalances, there can be little doubt that the saving and consumption patterns of United States households have been a key determinant of those imbalances.'

Surge in consumption

The report examines a number of issues relating to rebalancing in the context of the national economies in the US and China.

It says that a decomposition of the national income and product accounts in the savings-investment balance, with the components of net national savings disaggregated, highlights the secular decline in the US household savings rate since the beginning of the 1980s, with a particularly sharp drop around the year 2000.

The decline in the US household savings rate went hand in hand with a rapid expansion of private consumption. Since the late 1990s, the share of personal consumption in GDP has considerably exceeded its average long-term trend of about 66%, reaching a peak in early 2009, when it accounted for 71% of GDP.

More importantly, notes the report, the increase in US household consumption was largely debt-financed.

'Facilitated by easy consumer credit, lax lending standards, a proliferation of exotic mortgage products, the growth of a global market for securitised loans and soaring house values, burgeoning household spending created strongly growing household debt and led to a sharp decline in the United States household savings rate to almost zero.'

The increase in private consumption was unsustainable because it was not supported by a similar expansion of labour compensation in the private sector. Compared to previous upswings, the economic expansion that ended with the onset of the current crisis had been characterised by a low increase in employment - a phenomenon sometimes referred to as 'jobless growth' - and by the relative stagnation of real wages.

As a result, said UNCTAD, private sector labour compensation grew at an unusually sluggish pace and fell short by more than $800 billion (in real terms) relative to the trajectory of the previous four business cycles.

Buoyant consumer demand in the US was the main driver of global economic growth for many years in the run-up to the current global economic crisis. Household debt to GDP was about 100%, in strong contrast to China where it has been relatively low, at roughly 20%. This means that in the US, consumer demand is likely to shrink - not just grow slower - while in China, it is likely to grow rapidly.

It is unlikely that the sharp decline in US imports of consumer goods could be compensated by an increase in consumer spending and associated imports of consumer goods by China or any other developing country. Given that China's consumption was only about one-eighth of US consumption and that its GDP at current exchange rates is only one-third that of the US, there is little reason to believe that household consumption in China could supplant US household consumption as a driver of global growth anytime soon.

In order for Chinese consumption to compensate for the reduction in US consumption, the share of consumer spending in GDP in China would need to increase by at least 10 percentage points - an unlikely occurrence in the foreseeable future.

According to the report, domestic demand could also expand in other relatively large and rapidly growing developing countries, notably Brazil and India. However, compared to the US economy, the economies of these countries are still small, making it unlikely that they could compensate fully for the decline in US consumption.

Rather, household consumption in developed countries in the European Union (EU), particularly Germany, as well as Japan, would be better placed to achieve this.

Dependence on external demand

The report finds that the most internationally visible characteristic of China's development path has been its strong export growth. The nominal value of China’s exports has increased more than 100-fold since the country’s economic opening in 1979, and its exports accounted for over one-third of its GDP during the period 2005-2008.

Such emphasis on foreign demand for economic growth inevitably increased China's vulnerability to a downturn in its major export markets. Thus, it is not surprising that China's exports fell sharply with the onset of the global economic crisis. This has led to renewed calls for a re-balancing of the composition of its aggregate demand, which would give less importance to investment and exports and more to a greater reliance on domestic consumption.

The report also notes that private consumer spending in China is low by international standards, regardless of whether it is measured in per capita terms or as a share of GDP. In 2008, per capita consumption was only $758 (in real 2000 terms), much lower than that of many other developing countries, including in Asia.

However, the report adds, a low and declining share of private consumption in aggregate demand is a characteristic frequently observed in rapidly industrialising economies during their early phase of economic take-off.

There is widespread agreement that measures such as an increase in government spending on social security (including pensions, health and education) and public investment in housing could help reduce household precautionary savings and may help increase consumer spending in China. Further reform of the financial sector may also help boost household consumption.

The report says that the tendency of a falling share of consumption in GDP results mainly from the decline in labour compensation as a share in GDP. The latter development, in turn, is closely related to structural change, involving a shift from activities with a high employment share (particularly agriculture) towards industrial activities with a generally lower employment share, and to an emphasis on capital-intensive production in the manufacturing sector.

However, achieving such structural change - which is a natural process in a country's economic development - without real wages growing more rapidly relative to productivity than in the past may become increasingly difficult.

According to media reports, minimum wages have been rising strongly in several provinces. While this evidence suggests a broad tendency towards rising wages, it must be interpreted with caution, says the report, adding that part of it could be a reaction to more supportive agricultural policies, such as the abolition of the agricultural tax.

All of these factors taken together could be a powerful stimulus to domestic consumption.

Effect of rebalancing

The report also examines the implications of the rebalancing processes in the US and China for other countries.

These implications are inferred from a simulation of the impact of reduced consumer spending in the US and increased consumer spending in China (both measured as a share in GDP) on changes in sectoral trade flows and employment.

The report suggests that the net effect of the adjustments in the US and China taken together would be deflationary for the world economy, while they would not be sufficient to unwind the large global imbalances.

This is due to the fact that not only the absolute value of the consumer goods bought by Chinese households but also their import content is much smaller than that of goods bought by US households. Moreover, the composition of consumer goods imported by China differs considerably from that of the goods imported by the US.

As a result, there will be a tendency towards a deterioration in the trade balance of many other countries in the world economy, unless the necessary adjustments in the US and the structural changes in China are accompanied by rebalancing efforts in other economies.

Since world exports are set to decline, especially for industrial goods, with the largest declines likely to occur in the most labour-intensive industrial sectors, the net effect of adjustments by China and the US could well have a sizeable adverse impact on employment worldwide. The impact will differ across countries, depending on their sectoral production and trade structure.

According to the report, even if China were to further reduce the contribution of exports and increase that of household consumption to output growth and employment, this adjustment still would not replace the stimulus to global growth that the US provided in the past.

The two large industrialised economies of Germany and Japan have also recorded sizeable and more long-lasting current-account surpluses as a counterpart to the US deficit. Both these countries have been notorious for slow growth of their domestic demand and they are again at the heart of imbalances among developed countries in the context of the current recovery.

The report points out that other countries that are often suggested as possible future markets for countries that pursue export-oriented growth strategies are some large emerging-market economies in the South, particularly India. If domestic demand in these countries were to expand, it would certainly help to make their industrialisation less dependent on export markets, and might also create a larger market for other countries that produce consumer goods.

However, the import potential of Brazil, India, Indonesia and South Africa combined is not even equivalent to that of Germany, and with the exception of Indonesia, these countries have not had current-account surpluses in recent years.

Thus, stresses the report, any additional contribution to global rebalancing will have to come from other major deficit and surplus countries. To the extent that it comes from other deficit economies, the impact will be deflationary, as it would have to rely on import retrenchment.

Hence, to achieve a recovery of global output growth and employment creation without reproducing the large imbalances that had built up in the run-up to the crisis, the key element in demand management worldwide would have to be expansionary adjustment in the major industrialised surplus economies, namely Germany and Japan.

Japan suffered the sharpest GDP contraction among the large economies in 2009, owing to its export dependence. Its recovery since then has also been driven mainly by exports, together with some revival of private consumption. Domestic demand in Japan  is  forecast  to  grow  at  a moderate  pace  of  1.5-2%  in  2010 and 2011.

China cannot replace the US' pre-crisis role of providing the growth stimulus to the global economy because of the size and composition of its imports. Major EU economies could fill this role, but it would require them to continue with their expansionary monetary and fiscal policy stance as well as increase domestic consumer demand, especially through wage increases in Germany.

However, notes the report, Germany's status as the main surplus economy in the euro zone has been built largely on wage restraint and its serious problem of unemployment also persists.

Moreover, the stagnation of private consumption in Europe, exacerbated by the tendency for EU governments, especially the German government, to hasten towards fiscal consolidation programmes, makes it unlikely that a major contribution to global rebalancing and a substantial stimulus for global output and employment growth will come from the European surplus economies.

Reorientation

This means that the developing-country exporters that had focused their export-oriented development strategies on the markets of the major developed economies should perhaps adapt to the new situation.

A reorientation towards private consumption, accompanied by a corresponding refocus on investment expenditure, would reduce developing countries' dependence on GDP growth in developed countries, the report says.

The report also argues that export-led growth strategies tend to lead to relative wage compression, which may seem indispensable for strengthening or maintaining the international competitiveness of producers in any economy.

But if many or all countries adopted this strategy, it would lead to a 'race to the bottom' with regard to wages. This would translate into insufficient growth of workers' purchasing power, which itself is an important determinant for aggregate demand growth and job creation. A more sustainable growth strategy would be one that relies on domestic demand from wage increases linked to aggregate labour productivity increases.

Such a strategy would build on a virtuous circle whereby a favourable environment for fixed capital formation enables productivity growth, the gains from which are distributed equally between labour and capital, so that the share of wages does not decline over time and domestic demand rises at least at the same pace as productivity.

This way, additional employment, new wage income and incentives for further investment in real productive capacity can be created, the report concludes.                       

This article is reproduced from the South-North Development Monitor (SUNS) (No. 6998, 16 September 2010).

*Third World Resurgence No. 240/241, August-September 2010, pp 12-15