The real action is in the developing world

If the US, the world's biggest economy, starts to contract again and the Europeans' government debt problems prompt more austerity, the world economy will be plunged back into recession. Is that what you think? If so, your picture of the world economy is about 20 years out of date.

There are cultural, historical, family and language reasons why we focus our attention on Europe and the US. The media keeps us well informed about what's happening in their economies. And since, between them, they account for a big chunk of the world economy, it's easy to assume that where they go the rest of the world follows.

Indeed, that used to be true. When I first got into this game, the Organisation for Economic Co-operation and Development used to make forecasts for its 24 rich-member countries, add them up and call it the world economy.

But consider these figures from the Reserve Bank's latest statement on monetary policy. Over the four-and-a-bit years since the March quarter of 2007, the world economy has grown by about 10 per cent in real terms.

The contribution of the North Atlantic economies (the US, Canada, Britain and the euro area) to that growth was near enough to zero. So all the net growth the world's seen in that time has come from the remaining, mainly developing, economies.

Between them, the Chinese and Indian economies have grown by nearly 50 per cent, while east Asia (excluding China and Japan) grew by almost 20 per cent.

The faster the developing countries grow relative to the rich countries, the larger their share of the world economy becomes. An article in The Economist points to the many respects in which the world economy is coming to be dominated by the "emerging economies", as they're increasingly called.

As many as 11 of these economies have emerged to the point where they've been reclassified as developed rather than developing. But when you do that, you understate the extent to which the developing countries are taking over the running. So the figures that follow classify as developing all those countries that hadn't made it to developed status before 1997.

The developed countries account for only about 15 per cent of the world's population, but in 1990 they accounted for 80 per cent of gross world product. By last year that share had dropped to 60 per cent. It is projected to fall to less than half within the next seven years.

But that calculation is based on converting each country's gross domestic product into US dollars at market rates. This understates the developing countries' share of gross world product (GDP) because one US dollar buys a lot more in poor countries than in rich countries.

When you adjust for "purchasing-power parity" you find the developing countries' share of gross world product reached 50 per cent three years ago and is expected to reach 54 per cent this year. Their share of world exports has reached half, which is almost double what it was in 1990.

Much of these exports would be produced by multinational companies operating in developing countries, so it's no surprise the developing countries attract more than half of all the inflows of foreign direct investment.

So far, this conforms to the popular perception of developing countries as economies that make their living selling cheap exports to rich countries. But The Economist observes that "foreign firms are increasingly lured by these countries' fast-growing domestic markets as much as [by] lower wages".

That's the point: developing countries are increasingly standing on their own feet, generating their growth internally.

The mainstays of "domestic demand" are capital (investment) spending and consumer spending. The developing countries now account for more than half the world's capital spending, compared with a quarter 10 years ago.

Last year the US's capital spending was just 16 per cent of its GDP compared with 49 per cent in China. (Ours was 28 per cent.)

The developing countries' share of world consumer spending is only 34 per cent, though this is up from 24 per cent 10 years ago (and would be higher if you allowed for the lower prices they pay for housing and services).

Even so, their shares are: 46 per cent of world retail sales; 52 per cent of all new car sales (up from 22 per cent in 2000) and 82 per cent of all mobile phone subscriptions.

You can see from this how rapidly living standards are rising in poor countries. And when the locals start spending, some of that spending is on imports. Last year the developing countries' share of world imports rose to 47 per cent.

So whereas we're accustomed to thinking of developing countries as dependent on rich countries, it's becoming more the case that the rich countries depend on the developing countries.

Even so, because the developing countries are still at the early stages of developing their economies, their demand for basic commodities - whether locally produced or imported - exceeds their demand for sophisticated goods and services.

They account for 60 per cent of the world's annual energy consumption, 65 per cent of all copper consumption and 75 per cent of all steel use. Yet, as The Economist remarks, there's plenty of room for growth: they use 55 per cent of the world's oil but their consumption per person is still less than a fifth of that in the rich world. (Always assuming we don't run out of oil, of course.)

And here's a pertinent reason the developing countries are likely to continue growing faster than the North Atlantic economies: they're responsible for only 17 per cent of the world's government debt.

No prize for having guessed the punchline: the rich countries likely to do best over the rest of this troubled decade are those most closely plugged into the developing world.

Heard of a poor, cautious, sorry-for-itself country called Australia? It sells less than 10 per cent of its exports to Europe and only 5 per cent to the US, but about two-thirds to developing countries.

Most of those countries are in Asia, of course, the most dynamic part of the world economy. In just the past 10 years, China's share of our exports of goods and services has gone from 5 per cent to 23 per cent, and India's has risen from 2 per cent to 7 per cent.

As Wayne Swan keeps saying, Australia is in the right place at the right time.

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Are we talking ourselves into a recession?

Is it possible for a country that is the envy of the developed world to talk itself into recession? I don't know. But it seems we're about to find out. It won't be easy, of course. It's a question of whether our increasingly negative perceptions can overwhelm the reality that our economy has a mighty lot going for it. Let's start with reality, then move to perceptions.

The Europeans, and now the Americans, are rightly worried about their yawning budget deficits and huge levels of government debt. Their problem is, the more they do to reduce deficits the more they weaken their economies, at a time when they're already pretty weak. By contrast, our budget deficit isn't particularly big and our level of government debt is laughably small.

Part of their problem is the money they spent bailing out their banks - many of which still aren't back in full working order. By contrast, we've had no problem with our banks.

Despite their weak economies, the Europeans and Americans have been worried about the rising cost of rural and mineral raw materials. But what's a problem for them is income for us. The prices we're getting for our exports have rarely been higher.

As a consequence of this boom, the mining companies are spending mind-boggling amounts building mines and natural gas facilities. Were we in our right minds we'd have no trouble accepting that, since you and I live in the same economy as the miners, a lot of this income and spending rubs off on us. Instead, the incessant talk about the alleged "two-speed economy" has allowed us to imagine that, while the miners are doing well, the rest of us are stuffed. Retail sales are flat? See, I told you I was doing it tough.

Trouble is, there's little hard evidence to support this impression. Unemployment in the North Atlantic economies is about 9 per cent; here it's below 5 per cent. And this holds around the country. Using trend figures, it ranges from 4.2 per cent in Western Australia to 5.6 per cent in Tasmania, with 5.1 per cent in sorry-for-itself NSW and 4.7 per cent in Victoria. Nationally, employment grew by 2 per cent over the year to June, with WA and NSW right on the average, resource-poor Victoria topping the comp with 3.1 per cent and resource-rich Queensland achieving just 1.1 per cent. Pay rises are few and far between in the US and Europe but in poor little Oz the wage price index rose by a too-generous 4 per cent over the year to March. Again, the growth was remarkably similar around the country. Wages in WA grew by 4.1 per cent and in Tassie by 3.5 per cent. NSW and Victoria were right on the national average.

Admittedly, mining wages grew by 4.6 per cent, but workers in the (genuinely) hard-pressed manufacturing sector got 4.1 per cent and even in retailing workers averaged rises of 3.3 per cent.

Conduct a focus group and punters will tell you they're suffering mightily under the rapidly rising cost of living - which is why politicians on both sides are always encouraging the punters to feel sorry for themselves.

But when you combine healthy growth in employment with too-high wage rises you get household incomes growing faster than consumer prices. So if retail sales are weak, it's not because we can't afford to spend, it's because we choose not to - whether out of prudence or fear for the future.

There's no doubt the retailers - along with manufacturing and tourism - are doing it tough. But there's nothing in the capitalist contract that guarantees businesses an easy life. And, as an indicator of the overall health of the economy, the weakness in retail sales is misleading.

Did you (or any of the journalists carrying on this week) know retail sales account for only about 40 per cent of consumer spending? They cover mainly goods bought in shops, particularly department stores. They don't include sales of cars, nor the growing proportion of our incomes we spend on services.

New car sales have been weak in recent months, partly because of the lack of supply from Japan since the tsunami, but (though no one thought it worth telling you) this week we learnt car sales jumped by 12 per cent in July.

And that's not the only sign we're more willing to spend than many imagine. This week we also learnt that plenty of people are spending big on overseas travel. Short-term departures of Australian residents rose by 1.4 per cent in June to be up almost 11 per cent on a year earlier.

In real terms, retail sales grew by 0.3 per cent in the June quarter and just 0.5 per cent over the year to June. But total consumer spending is expected to grow by 0.5 per cent in the quarter and 2.5 per cent over the year. That's not brilliant, but it's a far cry from death's door.

So if the underlying reality of the economy is enviably good, why are we so dissatisfied and anxious? Why are we so ready to think the worst about the prospects in America and Europe and to conclude - contrary to all the evidence - that tough times for them spell tough times for us? Well, not because the media are revelling in the bad news and forgetting to mention the good. They always do that. It's just that, when we're in an optimistic frame of mind we ignore the gloom mongering, whereas when we're in a pessimistic mood we lap it up.

Alternating waves of optimism and pessimism - "animal spirits" - do much more to explain the swings in the business cycle than it suits most economists to admit. And because we're such herd animals, we tend to contract these moods from one another - even from our cousins on the other side of the globe.

Will our increasingly negative perceptions overwhelm our strong reality? If they do, they'll have a fight on their hands: thanks to the mining construction boom, business investment spending is expected to grow by 15 per cent this year and another 15 per cent next year. For your own sake, pray reality wins.


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