The overblown September crisis

The global economy is again swept up in the talk of looming crisis in September. This time the epicenter is China. Concerns for a hard landing of the world’s second largest economy and skepticism about Chinese authorities’ emergency navigation skills are simmering. The Chinese economy is portrayed now as a troublemaker. But in my opinion, all the anxieties are overblown and misleading. The global economy has been stumbling ever since it was shaken by the financial crisis in 2008. Its lackluster performance in September would be nothing out of the ordinary.

The global and local economy is not looking at a catastrophic disaster in the likes of the Wall Street-triggered financial meltdown. The U.S. economy then and China’s today is completely different. The entire U.S. economic system - the public finance, bank and enterprises - had been in a mess at the time. It had to resort to unconventional monetary policy such as quantitative easing under which the central bank prints out money in order to buy financial assets to artificially boost liquidity and revive the economy.

Few had been aware that the complicated and sophisticated financial instrument called derivatives veiled so many flaws and wrongs. They exploded and spilled over before anyone was prepared and could do anything. It is how the subprime mortgage crisis triggered by bursts in housing and credit bubbles developed into national and global emergency.

But China’s situation is different. Talk of crisis sprouted from the Chinese slowdown. But the news is nothing new. From a few years back, Beijing has pronounced that it would change its growth model. It was charting a new normal under which the economy would grow at a slower and steady pace as it balances out and moderates the economy from overreliance on external demand and inequalities.

China’s growth has slowed to 7 percent range from the latter 2012. The government has changed its policy and direction because of various side effects from decades of running at a fast pace. Income inequalities have widened, local governments are saddled with heavy debt, speculation is rampant in the real estate market, shadow finance that is beyond regulatory surveillance has gotten colossal and industrial sites are weighed by overcapacity. Authorities have been trying to solve the problem of overcapacity and deleverage under moderate growth.

Korea underwent similar restructuring in the heavy chemical industry in late 1970s and early 1980s. The government pursued the restructuring under the catchphrase of promoting stable growth. Korea has become stronger as the result. China could turn out similarly.

There are concerns about a market crash as it can hurt consumption. It would bode badly for the government’s policy to promote domestic demand to work as a new growth engine. But people overestimate the Chinese stock market if they think bearish stock performance could lead to a slump in consumption. Stock takes up just a small portion of household assets. Stocks account for about 15 percent of retail financial assets including savings, stocks, bonds and insurance products.

Despite its massive size, the Chinese economy is still in developing stage. Under a new strategy, it still has ample room to grow. For example, the central western region remains poor and underdeveloped. It needs more infrastructure investment and industrial and services development. China has foreign currency reserves of nearly $4 trillion. It has the affordability and room for further growth. It cannot be compared to the U.S. economy in 2008.

Another fear in September is an interest rate hike in the U.S. Emerging economies and fragile markets like Korea are jittery about capital flight seeking safe and higher returns in the U.S. But the U.S. Federal Reserve won’t move to increase interest rates if it can risk a global crisis.

The global economy will be under a fog as long as the fundamental problems are not addressed. The biggest setback is sluggish demand. Despite all-out quantitative easing, demand fails to fully recover. Lethargic demand in other words means excess in supply. The global economy won’t pick up without restructuring in an overcapacity problem. Turbulence and troubles in September would be a part of a lengthy journey through a depression period. They are no extraordinary emergency signs.

That does not mean we should let our guard down. All possible scenarios must be studied and contingency plans mapped out. It is always good to tighten watch over the downside risks such as household debt and corporate insolvency levels. We must continue with our longer goals and work such as labor sector reform. Regular workers are over-protected and nonregular ones endure discriminatory work conditions including pay. Competitiveness in the labor market is among the bottom in global scale and labor productivity is poor. We already are fully aware of our problems and what to do. The labor market must become more flexible and salaries and other conditions must be consistent for the same type of work. Wage peak and a performance-based salary system must be enforced. Yet we aren’t making any steps forward. If crisis hits us, we should blame our procrastination, not others. Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, Aug. 27, Page 32

*The author is an adviser at the Korea Institute of Finance.

by Kim Yeong-ook