Sunday, November 26, 2006
A new locomotive for global growth
Posted by David Smith at 11:00 AM
Category: David Smith's other articles


What’s happening out there, beyond these shores? Is the global economy cruising, accelerating or braking hard? After a week in which the White House cut its growth forecast for the American economy, is the world in danger of losing its economic locomotive?

Last week the CBI, which starts its annual conference tomorrow, had some unexpected good news. A “surprise surge” in demand had lifted industry’s export orders to their best level since August 1995. After a difficult 11 years, firms don’t know whether to celebrate or rub their eyes in disbelief.

In many ways, though, Britain’s exporters should be doing well. We are at the tail end of what the International Monetary Fund has described as an “extraordinary purple patch” for the world economy, with three years of growth close to 5%, the best run since the early 1970s.

Thanks to an upturn in Europe, this year has produced the best combination of global growth, as far as Britain is concerned, since 2000. Weighted by UK export markets, the world economy has been expanding at its fastest rate for six years.

But all good things must come to an end. Partly for technical reasons, the French economy recorded no growth at all in the third quarter, cutting the “euroland” expansion from 0.9% in the second quarter to just 0.5% in the third. The big threat to Europe, however, is still in the pipeline — when German Vat goes up from 16% to 19% in January.

In America, meanwhile, growth slowed to just 0.4% in the third quarter, weaker even than euroland, and the debate is about the extent to which a pronounced housing downturn will spread to the rest of the economy. America’s enthusiastic shoppers have traditionally pulled everybody else along. What happens when their spending slows? The dollar fell sharply on Friday on fears of US economic weakness.

Forecasters have been busy trimming their numbers for the big economies. Ian Harwood, chief economist at Dresdner Kleinwort, thinks slowdown pressures will “intensify” and is particularly bearish about American growth, which he thinks will slow from 3.2% this year to 1.8% next, performing similarly to euroland’s growth, which he sees slowing from 2.7% to 1.9%.

Lehman Brothers is gloomier on euroland, expecting growth of only 1.5%, but more upbeat on America, at 2.4%. So far Japan has been doing well but Harwood expects growth of only 0.8% next year, after 2.7% this year.

Add in Britain, which Dresdner predicts will grow by 2.3%, after 2.8% this year, and a decisive slowdown in G7 growth is in prospect, from 3% to a mere 1.7%.

In the past, this kind of G7 slowdown would have meant only one thing; a decisive cooling of the global economy. But a debate has been raging about whether growth in China, India, other Asian economies and other emerging markets can “decouple” from the advanced economies.

Even a few years ago, the question would not have been worth asking. A G7 slowdown would have had an impact on the rest of the world, which relied on consumers in the advanced countries for economic momentum.

Now, however, these countries appear capable of growing in the face of a slowdown in the advanced world. It is happening in China, where consumers are taking on some of the growth baton from exports and investment. It is happening in the smaller Asian economies and also in India. For many emerging economies, particularly commodity producers in Africa and Latin America, trade with China is more important than trade with the G7.

Throughout Asia, including China, reliance on America as the motor of economic growth has declined. A quarter of Chinese exports still go to America but this is down on 34% five years ago.

What we have, sooner than anybody expected, is a set of new locomotives for the world economy, including India and the Asian economies, but most dramatically China. Since 2000 America has contributed 16% of global growth while China has contributed almost 25%, measured on a purchasing power parity basis.

So the world is changing. The global economy will slow next year, but not as much as you would expect. Global growth, having been at a boiler-bursting 5% for three years, will slow to just over 4%, according to Dresdner and Lehman. The difference will be that this growth will be tilted away from America, Europe and even Japan, and firmly towards China, India, other Asian economies and the emerging markets. These are the countries where 7%, 8% or even 10% growth is the norm. The People’s Republic will grow by more than 10% this year and could do slightly better next.

It looks good news and it probably is. The world is no longer dangerously reliant on the American consumer. It has a new loco- motive, with China providing much of the new motive power. The fact that overall growth is slower will ease global inflationary pressures.

The other side of the coin, however, is that the good times for Britain’s exports are unlikely to last. At a Treasury business advisory summit hosted by Gordon Brown a few days ago, mutual regrets were expressed about the fact that the UK is not doing better in China and India (roughly 1% of Britain’s exports in each case).

Business thinks government should be doing more to support firms in these markets, while ministers believe companies should be pulling their fingers out in the face of such obvious opportunities. Whatever the cause, something needs to change.

PS: Two years ago, in the autumn of 2004, the Daily Express ran a front page with a warning from David Miles, Morgan Stanley’s chief economist, that house prices could fall by up to 25%.

Last week, the Financial Times also led on Miles’s prediction of a housing bust, admittedly on the basis of some new research. I don’t know whether that says more about the Express or the FT.

The debate about whether house prices will crash is older than the hills. I have long taken the view that the market will not implode unless there is a serious economic accident, defined by a loss of control of monetary policy by the Bank of England — a very sharp rise in interest rates — and a big rise in unemployment.

The minutes last week of the Bank’s November meeting showed that even one of the deputy governors, Rachel Lomax, did not support the rise in Bank rate to 5%, suggesting no great pressure for big (or indeed any) hikes from here. Unemployment is up, but employment is also rising strongly, so it doesn’t really count.

Miles, a noted technical economist, has assembled a model that suggests between a third and a half of the rise in house prices over the past decade is due to speculation. People, he argues, have been drawn in by the expectation that prices will rise by 10% a year. When such hopes are dashed, prices will tumble.

Expectations are important.

The problem is that we have no information about what housebuyers expect to happen to prices and never have done Experts differ. Another top-notch technical economist, Steve Nickell, formerly of the Bank’s monetary policy committee, took the same data and concluded that house prices were not overvalued.

It is important to recognise too that Miles is predicting something that has never happened before in the UK — a housing-market crash driven by the reversal of speculative expectations. Every previous crash has been driven by real factors — unemployment, recession, higher interest rates and so on.

My view is that this is still the case, with support for prices provided rising population and limited housing supply.

Miles suggests that prices may well continue to rise for a year or two but “falling real house prices at some point are likely, but timing is very difficult to predict” and that prices could fall without damaging the economy much.

I don’t dispute that prices could fall but it will require the economy to hit the buffers. We’ve never had a housing crash in the absence of a recession. I don’t think we’re about to break the habit.

From The Sunday Times, November 26 2006



The problem with Miles report, is it takes 1996 as it's base and the say 60% of the house price movements can be explained.

The he goes on to say, that therefore 40% is due to "speculation", and therefore when this stops prices will fall.

However, this is a bit of a "all cats have four legs, my dog has four legs, therefore my dog is a cat" arguement, becuase he fails to show that house prices were correctly valued in 1996. Could it be that house prices were cheap in 1996, because of the "speculation" that house prices would fall further?

Posted by: kingofnowhere at November 27, 2006 08:36 AM

Hi David,

New economic growth locomotive, it, very nice concept!
I have enclosed a link counter simulating the US Trade deficit, i found it runs remarkably true!

Could anyone run similar models for UK Plc and EURO bloc?
we might be able to deduct some actual information that is fact rather than assumption or vague speculation.


Arik Schickendantz

Posted by: Arik Schickendantz at November 27, 2006 02:28 PM


I just googled the third quarter US growth rate. According to my search from a release of the Bureau of Economic Analysis, the US third quarter growth rate was 1.6%, not great but not .04% either. Did I miss something?

Posted by: Gary Bezowsky at November 27, 2006 08:46 PM

No, you didn't miss anything. The convention here is to report the rise in GDP on the quarter as a straight percentage change, while the convention on your side of the pond is to annualize it. So 0.4% and 1.6% (0.4% times four) are identical.

Posted by: David Smith at November 27, 2006 09:14 PM

Very good. Thanks for the input!

Posted by: Gary Bezowsky at November 27, 2006 09:30 PM


Export order at highest level since 1995 doesn't say much really, does it? Given the growth in world trade in the intervening years, it only tells you that export orders have been terrible since 1995, not that they are good now. I hardly think firms will be celebrating.

Posted by: HJ at November 29, 2006 08:54 PM

That's not the way these figures work. They're "balance" figures, which show the level of export orders in relation to what businesses regard as normal. It doesn't mean there has been no growth in exports in the intervening period. The volume of exports rose by just under 50% between 1995 and 2005. In 1995 firms were still benefiting from sterling's post-ERM devaluation.

Posted by: David Smith at November 29, 2006 11:11 PM


Having just looked up the figures on the ONS web site, I accept what you say.

However, in that case, your article was misleading because you wrote "...lifted industry's export orders to their best level since August 1995" which implied that August 1995 was the previous high, which it was not. You gave no indication that you were not talking about actual levels, so I took you literally.

The Guardian had an article a year or two back where it talked about a "record level of manufacturing output". When I investigated, it turned out that it meant a record upturn in orders, but this was from a level much lower than a year before. It was not a record level at all. They did publish a correction on their web site, although not in the printed version.

Posted by: HJ at November 30, 2006 10:55 AM

If I'd written that exports were at their best since 1995, yes, but orders and order books are a rather different concept. But I'm sorry if you were misled. Here's the start of the CBI's release:


A surprise surge in overseas demand for UK manufacturing goods has lifted export order books to their highest level since 1995, according to the CBI’s latest monthly industrial trends survey published today (Tuesday).

The balance of manufacturers reporting export orders to be ‘above normal’ was three per cent, the first positive balance since February 1996 and the highest level since August 1995 (+7%). This represents a marked improvement from October’s balance of minus 11 per cent.

Total order books also improved, regarded as 'below normal' by a balance of minus six per cent, up from minus 20 per cent in October, and more in line with the levels of August and September. All major sectors saw an improvement in total orders, with the capital goods sector the strongest and consumer goods the weakest.

Posted by: David Smith at November 30, 2006 03:41 PM