Friday, 28 January 2011

The new normal

The business landscape has changed fundamentally; tomorrow’s environment will be different, but no less rich in possibilities for those who are prepared.

The new normal article, new economy, Strategy
This short essay by McKinsey’s worldwide managing director, Ian Davis, is a Conversation Starter, one in a series of invited opinions on topical issues. Read the original essay, then see what readers had to say

It is increasingly clear that the current downturn is fundamentally different from recessions of recent decades. We are experiencing not merely another turn of the business cycle, but a restructuring of the economic order.

For some organizations, near-term survival is the only agenda item. Others are peering through the fog of uncertainty, thinking about how to position themselves once the crisis has passed and things return to normal. The question is, “What will normal look like?” While no one can say how long the crisis will last, what we find on the other side will not look like the normal of recent years. The new normal will be shaped by a confluence of powerful forces—some arising directly from the financial crisis and some that were at work long before it began.

Obviously, there will be significantly less financial leverage in the system. But it is important to realize that the rise in leverage leading up to the crisis had two sources. The first was...

The global economic landscape has changed after the 2008 financial crisis


I PARTICULARLY like the annual Per Jacobsson Lecture.

Per was the managing director of the International Monetary Fund (IMF) who died in May '63. By September, I had joined the IMF where I remained for about a year. Per's long shadow dominated its work, starting with the creation of the Finance Committee of League of Nations working alongside Sir Arthur Salter, Maurice Frere and Jean Monnet.

At the annual meetings of the IMF/World Bank, the Per Jacobsson Lecture is delivered by the very best from anywhere in the world to share their experiences and beliefs. Last October, Mohamad A. El-Erian spoke on “Navigating the New Normal in Industrial Countries”. He is the CEO of PIMCO, the world's largest bond fund manager.

The new normal for the US

El-Erian coined the term “New Normal” in 2009 which has since become widely used. It now means many different things to many different people. Indeed, it has spawned applications in almost every field - in technology (referring to its transformative power); lifestyle (US women getting fatter); medicine (early puberty in girls); management (constant change); higher education (less state financial support); the new rich (showing off its purchasing power); the internet (new mindsets for innovation); etc.

For El-Erian, the economic crisis of 2008 changed everything. He used the new normal to codify for the US a new era of slower growth with much higher than normal unemployment; increased government regulation in the face of wide-ranging banking reform and fiscal austerity; and decreased US role in the global economy. There is no returning to “business as usual”. The US, Europe and the world now needs a re-configuration of mindsets, institutions and approaches. Those who recognise this early and act on it will fare better this year: “a year that promises both the best and worst of times for businesses.”

Fresh data showed the US economy limping toward the end of 2010, its fitness much improved in the last year, but with the recovery still hobbled by high unemployment. — AFP
How the new normal will shape up will depend on its reaction to and interaction with a number of challenges. In my view, the US economy is today still facing the aftershock and lagged effects of major policy and institutional changes since the crisis; a new political configuration; and continuing disarray in the financial services industry.

In the process, we can begin to see the convoluted impact from the interplay of factors like the healing of financial markets and the second round effects of the European debt crisis; continuing high unemployment; and a re-configuration of the medium term landscape, bearing in mind that sooner rather than later, the US will need to credibly tackle its deficits and debt. All these get very complicated in terms of where the eventual outcome will be.

Suffice to say that the US is already in for a very bumpy ride to the “new normal”. Much of the growth we have seen is artificial - the result of the biggest fiscal and monetary stimuli in US history. The stimulus was not designed well enough to get back to a strong self-sustaining growth path. And now that most of the 2008/2009 packages have ended, the new expansionary programmes have begun to hold back any back-slides. At some point private sector initiative and entrepreneurship will need to take over as the engine of growth.

Even so, growth today remains anaemic - a recovery muddling along at too slow a pace to create enough new jobs or become a durable expansion. Overall, the size of the economy still hasn't surpassed its last peak in the fourth quarter of 2007, three years on.

Unlike the recovery in the 80s, this time the rebound reached 5% for one quarter before decelerating to today's un-recovery-like speed. GDP in the fourth quarter of 2010 is expected to rise at a 3.5% annual clip. For 2011, forecasters have now shifted their predictions to 3% plus growth. Statistically, growth is here and there. But for most Americans, it still feels like recession. The US economy needs to grow at 2.5%-3% a year to keep unemployment from rising. The rule of thumb is - need to grow 2 extra points over a year to bring unemployment down 1 point.

Nobel laureate Paul Krugman suggested that even with 4% growth a year on from now, US unemployment would be “close to 9% at the end of 2011 and still above 8% at the end of 2012 whatever the recent economic news, we're still near the bottom of a very deep hole.” Unemployment, including underemployment, stands at a high 17.5%. Unemployment among 20-somethings is at least 15%.

In the new normal, consumers' purses still hold the key; they continue to face strong headwinds. High unemployment has changed their behaviour. The financial crisis also left behind loads of debt. Some 5.5 million US households are tied to mortgages that are 20% higher than their home values.

Consumers have since been spending relatively less, leading to feeble consumption growth. De-leveraging (reducing gearing-up on debt) explains why growth since 2009 has been so slow. Consumption accounts for 70% of US GDP and it grew less than 2% so far. Overall, household debt is too high - 90% of GDP (last seen in 2005); it will take years to return to 80%, last seen in 2002/2003. Underlying it all is its low savings rate. De-leveraging is slowly working. Personal savings peaked at 6.3% in July, but has since fallen to 5.3% reflecting much pent-up demand. Rising savings is good in time. The trouble is the transition. History suggests savings need to be 8%-10% to make a credible comeback. It's not yet there.

How the US adjusts to the new normal hinges on how it addresses four new challenges:

How far will the balance shift from markets to government? More government is a reality, even though their involvement in markets is still non-commercial. Nevertheless, businesses will now need to factor in more influential public policy risk.

How is this growing involvement to be financed? Markets get edgy with worries of crowding-out and rising debt servicing. In the end, US needs fiscal austerity and budget surpluses. History teaches this is easier said than done.

How will US role in global economy change? The US provides two global public goods: US$ as reserve currency and deep & transparent financial markets. Today, both are questionable; the more the world does, the less their exposure to US assets. The US needs to get off denial and lead international monetary reform efforts.

De-risking the financial system: how far will it go? This is politically driven. At risk is the flow of credit that lubricates activity. The old normal was a world where credit flowed freely. Now, with ever present systemic risk, credit will no longer be easy, and its cost will rise.

There is still the inflation risk.

The new normal for euro zone

Global crises have dramatically changed the euro zone's economic orientation. Growth reflected disappointing performance in US, euro zone and Japan. They all share a common trait: all are mired in debt “sucking their capabilities and constraining their efforts at remedial measures”. Credible growth remains elusive. Euro zone is also confronted with a policy dilemma: a choice between fiscal restraint now and continuing stimulus to secure sustainable growth. Unlike the US (choose growth now and tackle budget deficit later), most euro zone nations opted for (or forced into) fiscal austerity now, hoping budget discipline would help growth more than renewed stimulus. The euro zone's choice is based on fear, according to the European Central Bank's (ECB) Jean-Claude Trichet, of the “solid anchoring of inflationary expectations”. Even now, policy makers are grappling with the surge in global food and commodity prices before inflation hits, as in mid 2008. The European obsession with inflation is far, far more intense than in the US where job creation is the number 1 issue.

For Europe, fiscal austerity and debt reduction is the new normal - to fend off inflation in the face of rising risks from sovereign debt contagion and euro's survival.

The spread to Portugal, Spain, even Italy, is of serious concern. So much so, O. Issing (the much respected former ECB chief economist) warned that Europe's reaction coupled with unsound fiscal policies in some nations, threatens “the survival of the monetary union financial rescue of Greece and Ireland risks setting in motion an unstoppable momentum towards a transfer union', and gives rise to potential for blackmail on more solid member states the resulting tensions may prove fatal for the euro.”

There are no easy answers. An unbalanced recovery (Germany now expands solidly) with peripheral nations lagging far behind, could upset the balance, enhancing the risks.

The new normal for emerging nations

The disparity in growth between the US, Europe, Japan and emerging nations is well known. Less well known is Asia's three biggest developing nations (China, India & Indonesia) witnessing the emergence of a viable middle class.

The chase to join this evolving consuming class has become the new normal in Asia. As I see it, this year could mark the tipping point when Asia's export-led growth turns inward towards more self-generated growth. Not only in China (1.4 billion people) but nations including India (1.2 billion), Indonesia (240 million), Thailand (66 million), Vietnam (89 million) and less obvious Philippines (98 million), have gathered enough growth momentum to spin a growing consuming class.

Its emergence beyond the prosperity that exists in Japan, South Korea, Taiwan, Singapore, Hong Kong and Malaysia will have far-reaching consequences.

“Consuming China” now has about 300 million people with significant discretionary spending; their “GDP” is equivalent to two thirds the size of Germany's.

China is not alone. India, with a middle class of about 75 million (200 million by 2015) is like China in 2001. Indonesia now has a middle class not far behind India's.

Together they are witnessing something new a growing consuming class outside the big urban areas.
Nomura estimated that by 2014, retail sales in China may surpass that of the US.

The new normal in Asia is for growth to be increasingly driven by the newly empowered and aspirational middle class.

Today, China purchases more cars and mobile phones than the US and soon will buy more computers. Realistically, Asia's middle class is not yet ready to spur global expansion. But it will soon enough drive a larger share of Asia's growth.

Even in economics, the new normal is viewed differently depending on whether you are American, European or Asian. But one thing is for sure: it means fundamental change to face new realities following the 2007/2008 great recession.

For Malaysia, the new normal is reflected in national transformation programmes to elude the middle-income trap (see this New Year column on The Mystique of National Transformation” and:

  • transform Malaysia into a high income, inclusive & sustainable economy through invigorating the private sector
  • enter a new era of higher growth, driven by rising productivity from innovation and smart human resource deployment. To succeed, the underlying drivers must be very robust in practice.
I think the government has a good grasp of the issues it needs to tackle to set the new normal.

l Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome: email:

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