Thursday, November 18, 2010

Last week I suggested that slowly the consensus is shifting towards a recognition that Chinese growth may slow sharply in the next few years.  When I discuss this prospect with analysts and investors, however, they almost always worry about two things.  First, since China represents the largest component of global growth, it seems reasonable to expect that a sharp slowdown in China will also mean a sharp slowdown in global growth.  Slowing Chinese growth, in other words, should be terrible for the world.  Secondly, if growth does slow sharply, this should cause an equally sharp rise in social instability and, with it, rising political instability.
I disagree with both claims — not that they are necessarily wrong but rather that they are not obviously true, and depend heavily on the way China rebalances.  To see why it is worth considering what happened to Japan in the past two decades.
In 1990, Japan was 17 percent of the global economy and was easily the second largest economy in the world.  It also accounted for the largest share by far of global growth, having completed two ferocious decades during which time it’s economy had grown annually by eight to ten percent.  Only the most skeptical doubted that within a decade or two Japan would overtake the US as the world’s largest economy. 
Imagine at the time that you had been smart enough, and foolhardy enough, to predict that over the next two decades Japan’s growth rate would collapse to substantially less than one percent annually, and that by 2010 it would be less than one-third the size of the US.  Had anyone believed you (and of course no one would have believed you), they would have almost certainly made two very obvious predictions.
First, a collapse of that magnitude in the Japanese growth rate would create an enormous drag for the rest of the world.  Without Japan to power it, global growth would be anemic at best. 
Second, the Japanese people would have been unwilling to accept with equanimity such a disaster.  At the very least there would be a surge in social instability and Japanese voters would have revolted against their leaders.
Although the first prediction, about a dramatic slowdown in Japanese growth, would have turned out to be completely accurate, the two subsequent predictions would have been completely wrong.  First, in spite of the virtual collapse of the Japanese growth machine, the world experienced robust growth in the 1990s.  Second, the Japanese people turned out to be remarkably docile about the terrible turn the Japanese economy took.

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