Challenges in a tough global recovery
Protracted global output gap makes Korean economy less resilient
By Stephen S. Roach
The global economy is in the midst of its second growth scare in less than two years. Get used to it. In a post-crisis world, these are the footprints of a failed recovery, with profound and lasting implications for the Korean economy.
For an export-led economy like South Korea, the global backdrop has long been critical in shaping the external demand that drives macro growth. That’s become all the more the case in recent years, as Korea has upped the ante on its dependence on the rest of the world. In the first quarter of 2011, exports accounted for fully 50 percent of Korean GDP — up dramatically from the pre-crisis share of 36 percent in 2007.
If the world was in a typical recovery scenario, Korea would be in good shape to enjoy the tailwinds of a sustained sharp rebound in global trade. In such a classic recovery, the deeper the downturn, the more powerful the snapback and the greater the cumulative forces of self-sustaining revival. Moreover, the typical business cycle has a natural cushioning mechanism that wards off the ever-present, yet unexpected blows. Vigorous V-shaped rebounds have a built-in resilience that allows them to shrug off such shocks relatively easily.
But this is a post-crisis recovery — a very different animal from the garden-variety business cycle. As Carmen Reinhart and Kenneth Rogoff have shown in their book “This Time is Different” (Princeton University Press, 2009), over the long sweep of history, post-crisis recoveries in output and employment tend to be decidedly subpar.
Such weak recoveries, by definition, lack the cushion of V-shaped rebounds. Consequently, external shocks quickly expose their vulnerability. If the shocks are sharp enough and if they hit a weakened world economy that is approaching its “stall speed” of around 3 percent annual growth — the relapse could turn into the dreaded double-dip recession.That is the risk today — a still fragile post-crisis climate that poses a very challenging outcome for an externally dependent Korean economy.
Indeed, there can be no mistaking the decidedly subpar character of the current global recovery. Yes, on the surface, the numbers look strong: world GDP rebounded by 5.1 percent in 2010, and is expected to rise another 4.3 percent in 2011, according to the latest forecast of the International Monetary Fund. But because these gains follow the massive contraction that occurred during the Great Recession of 2008-09, they are a far cry from the trajectory of a classic V-shaped recovery.
Indeed, if the IMF’s forecast proves correct, the global GDP at the end of 2012 will still be about 2.2 percentage points below the level that would have been reached had the world remained on its longer-term 3.7 percent annual-growth path. Even if the global economy holds at a 4.3 percent cruise speed — a big “if,” in my view — it will remain below its trend-line potential for over eight years in a row, through 2015.
This protracted “global output gap” underscores the absence of a cushion in today’s world economy, as well as its heightened sensitivity to shocks. And there have certainly been numerous such blows in recent months — from Europe’s sovereign-debt crisis and Japan’s natural disasters to sharply higher oil prices and another setback in the U.S. housing recovery.
While none of these shocks appears to have been severe enough to have derailed the current global recovery, the combined effect is worrisome, especially in a still-weakened post-crisis world.
Most pundits dismiss the possibility of a double-dip recession. Labeling the current slowdown a temporary “soft patch,” they pin their optimism on the inevitable rebound that follows any shock. For example, a boost is expected from Japan’s reconstruction and supply chain resumption. Another assist may come from America’s recent move to tap its strategic petroleum reserves in an effort to push oil prices lower.
But in the aftermath of the worst crisis and recession of modern times — when shocks can push an already weakened global economy to its tipping point a lot faster than would be the case under a stronger growth scenario — the escape velocity of self-sustaining recovery is much harder to achieve. The soft patch may be closer to a quagmire. This conclusion should not be lost on high-flying emerging-market economies, especially in Asia — currently the world’s fastest growing region and the leader of what many now call a two-speed world.
Yet with exports still close to a record 45 percent of pan-regional GDP, Asia can hardly afford to take external shocks lightly — especially if they hit an already weakened baseline growth trajectory in the post-crisis developed world. The recent slowdown in Chinese industrial activity underscores this very risk.
Korea faces formidable challenges
Korea’s challenge is especially formidable in such a climate. The good news is that it has cut its direct exposure to external demand in developed markets. This served Korea well in the Great Recession of 2008-09 — reducing its direct exposure to the crisis-battered West. The U.S. share of total Korean exports fell to about 10 percent in early 2011 — down from the 12 percent pre-crisis reading in 2007. At the same time, the European export share has gone from 19 percent to 15 percent and the portion going to Japan has slipped from 7.1 percent to 6.8 percent.
Meanwhile, Korea’s export sector has become increasingly China-centric — drawing ever-greater support from the strongest piece of the post-crisis global growth equation.The Chinese share of total Korean exports rose to 23.9 percent in early 2011 (29.1 percent if Hong Kong is included). By both metrics, this represents about a two-percentage point increase from the pre-crisis Chinese share.
The impacts of Korea’s dependence on China have the potential to cut both ways. Over the near-term, any growth disappointments in China — clearly a risk for a world caught in its second growth scare in less than two years — would qualify as a serious external shock. With China currently in the midst of a slowdown of its own, this is not a risk that can be taken lightly. While Korea has reduced its direct exposure to end market demand in the developed world, its increased reliance on China — who continues to rely heavily on external demand in the West — underscores its indirect exposure to the developed world.
But there is an important silver lining to Korea’s China connection. As China now transitions from the highly successful producer model of the past 32 years to a growth dynamic that draws newfound support from internal private consumption, China’s major external suppliers stand to benefit greatly. Korea is a case in point. It is very well positioned to provide sourcing for Chinese demand for a broad array of consumer products — ranging from electronics and auto parts to appliances and food and beverages.
But the externally-dependent Korean economy hardly qualifies for special dispensation from a weak post-crisis global climate. Unfortunately, for Korea, as well as for other export-led developing economies, the economic outlook for their main markets in the developed world remains disconcerting. In large part, that’s because policymakers in those countries are ill-prepared to cope with a steady stream of growth scares. They continue to favor strategies that are better suited to combating crisis than to promoting post-crisis healing.
That is certainly true of the United States. While the Federal Reserve’s first round of quantitative easing was effective in ending a wrenching crisis, the second round has done little to sustain meaningful recovery in the labor market and the real economy. America’s zombie consumers need to repair their damaged balance sheets, and U.S. workers need to align new skills with new jobs. Open-ended liquidity injections accomplish neither.
European authorities are caught up in a similar mindset. Mistaking a solvency problem for a liquidity shortfall, Europe has become hooked on the drip feed of bailouts. However, this works only if countries like Greece grow their way out of a debt trap or abrogate their deeply entrenched social contracts. The odds on either are exceedingly poor.
Given tough post-crisis prospects in the United States and Europe, the likelihood of recurring growth scares for the next several years implies little hope for new and creative approaches to post-crisis monetary and fiscal policies. Driven by short-term electoral horizons, policymakers repeatedly seek a quick fix — another bailout or one more liquidity injection. Yet, in the aftermath of a balance-sheet recession in the U.S., and in the midst of a debt trap in Europe, that approach is doomed to failure.
Liquidity injections and bailouts serve only one purpose — to buy time. Yet time is not the answer for economies desperately in need of the structural repairs of fiscal consolidation, private-sector deleveraging, labor-market reforms, or improved competitiveness. Nor does time cushion anemic post-crisis recoveries from the inevitable next shock.
It’s hard to know when the next shock will hit, or what form it will take; otherwise, it wouldn’t be a shock. But, as night follows day, such a disruption is inevitable. With policymakers reluctant to focus on the imperatives of structural healing, the result will be yet another growth scare — or worse. A failed recovery underscores the risks of an increasingly treacherous endgame in today’s post-crisis world. Korea can hardly afford to ignore these risks.
Stephen S. Roach, a member of the faculty at Yale University, is the non-executive chairman of Morgan Stanley Asia and the author of “The Next Asia.”