Global Crisis is Brewing

The World Bank has estimated in the recently released ‘Global Economic Prospects’ report that the growth rate of the developed countries is likely to increase from the present 2.2 per cent to 2.5 per cent in 2012. The growth rate of the developing countries is likely to remain firm at the respectable six per cent. The Bank, in the same breath, has cautioned that the problem of government debt of the developed countries can become dangerous. Other analysts have expressed concern that inflation in the developed countries can become a major problem. We thus have two contradictory scenarios before us. Economic growth rate is slated to rise but debt and inflation problems loom on the horizon. The question is: which of these tendencies will be dominant?

We must examine the reasons of the global economic crisis of the last three years in order to unravel this question. The developed countries were growing robust before the crisis hit in 2008. Wages of their workers were high. An unskilled worker in the United States earns about Rs 4000 a-day against Rs 300 earned by his Indian counterpart. People of the developed countries were consuming large amount of goods on the back of these high incomes. The developing countries were supplying goods for their consumption—China was supplying footwear, toys and electronics while India was supplying basmati rice and software. New technological developments like personal computer, internet and hybrid cars were being commercialised by the developed countries. The developed countries were earning huge amounts by selling these high-tech goods to the developing countries. They were paying high wages to their workers on the strength of these incomes.

This happy circumstance of the developed countries has come under severe pressure during the last few years because commercially profitable advanced technologies have been few and far apart, if at all. The last such technology, perhaps, was the internet. No major profitable technology was developed thereafter. The problem has been further aggravated by the developed countries speedily transferring their advanced technologies to the developing countries through Foreign Direct Investment. Hybrid cars, for example, are now being manufactured in India. The special advantage enjoyed by the developed countries has, therefore, eroded. The developing countries are producing the same goods as them cheap because the wages are low. The result is migration of entire industries to the developing countries. Textile mills, for example, have totally closed down in the United States. Financial and software services are also being increasingly outsourced to the developing countries. The developed countries have little left to compete with in the global markets. They are being forced to reduce the wages of their workers as seen in the recently concluded agreement entered into by General Motors with its workers. These wages will have to decline much more for the developed countries to re-establish their competi-tiveness vis-à-vis the developing countries in the global markets. This lack of new technological innovations and the consequent reduction in incomes of the developed countries is the fundamental reason of the global economic crisis of the last three years.

Leaders of the developed countries have failed to grasp this underlying tendency of wage reduction. They thought that they will be able to maintain their competitiveness on the strength of new technologies or better management and infrastructure. It is doubtful if such will happen. The developing countries are fast imbibing advanced management practices and making first class infrastructure. One sees no difference whatsoever between the Heathrow and IGI Terminal-3 airports.

The developed countries ignored their lack of competitiveness at their peril. They anticipated that somehow their incomes will rise again. They implemented huge stimulus packages and encouraged people to continue with their high levels of consumption. They borrowed heavily from the world financial markets for providing loans to their people. They also loosened the purse strings. They printed notes to support the already bloated government expenditures. They printed more money to make up for the tax cuts given in the stimulus packages. This printing of money has led to inflation. The developed countries are now mired in the double problem of debt and inflation. This policy would have been successful if a major technological innovation—say, a personal helicopter—had happened. The same policy has become their undoing in absence of such innovation.

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THE outlook for 2011 can be made on this background. The pressure on wages in the United States and United Kingdom will persist. They will have to withdraw their stimulus packages because of increasing inflation and debt. This withdrawal will further exacerbate the downward pressure on wages. Citizens will be up in arms. These countries will have to adopt protectionist policies. But this will not provide them much relief because they are dependent on imports of textiles, oil, food and minerals from the developing countries. This will push them into a deeper crisis. The unanswered question is exactly when would the withdrawal of the stimulus package begin? It is possible this may happen in 2012. In that case the situation in 2011 will remain as it is.

The problems of Europe are deeper. The United States and United Kingdom have allowed the wages of their workers to decline in tandem with global pressures. Mainland Europe has done less of this. As a result their economies are being eaten away from the inside as seen in the crises of Greece, Ireland and Portugal. It is likely that this problem will make inroads in the leading countries of Germany and France. This will put the very existence of the European Union at stake as countries clamour to find and implement different solutions to their predicament. It must be repeated that this scenario may unfold in 2012, not in 2011.

The situation of China, India and other developing countries will be, relatively speaking, better. They will face two opposite pressures. The deepening crisis in the developed countries will push them down. Foreign capital may frighten and seek to fly back. Exports of the developing countries will be down. On the opposite side, there will be a positive impact. Their goods will become more competitive in the world markets as the stimulus packages in the developed countries are whittled down. The price of a car made in the United States has been lowered, for example, by the soft loans provided by the US Government under the stimulus package. Withdrawal of the stimulus package will make the goods produced by the developed countries expensive and thereby improve the competitiveness of the developing countries. This positive impact will be somewhat mellowed by the adoption of protectionist policies in the developed countries. But the fundamental tendency will be of improved competitiveness of the developing countries.

In conclusion, the outlook for the developed countries is negative for 2011 while that for the developing countries is positive.