Ethos Issue 6, Jul 2009

The End of the World (Economy) as We Know It
Adeline Aw, Lee Chor Pharn and Wee Shu Lin

-Singapore’s Prime Minister Lee Hsien Loong in Parliament, 27 May 2009

Many economists have described the current economic and financial crisis as the most severe economic recession since World War Two. The crisis has indeed had far-ranging consequences: oncemighty banks and financial institutions have evaporated; major industries are experiencing significant consolidation; thousands of factories all over the world have shut down, and millions of workers have lost their jobs. Some economists have even speculated that the world was poised for a second Great Depression.

It is still too early to determine if the global economy has indeed seen the worst of the downturn as there are simply too many uncertainties that could destabilise any sort of recovery. However, it has become increasingly clear that the global economy will not revert to its pre-crisis status quo.

The years leading up to the financial crisis were marked by very benign economic conditions leading to structural imbalances in the global economy. At the global level, the developed economies saw strong growth in credit growth and private consumption, while the level of savings plummeted.¹ Emerging economies redirected their excess savings to finance consumption in developed economies. This cycle reinforced trade interdependence between the G3 nations (US, Japan and the European Union) and emerging Asian economies and meant that the Asian economic growth became more, rather than less, dependent on G3 growth.

The current financial and economic crisis has unravelled this intertwined relationship, which the historian Niall Ferguson has described as “Chimerica”.² Consumption in the US has fallen, perhaps for the foreseeable future.³ Exports from Asia to the developed countries have collapsed. Singapore has been affected severely, with its economy expected to experience its largest contraction since 1965. To date, Singapore’s economic success has largely been attributed to the openness of its economy and its concentration on activities which largely serve G3 demand. But with the unravelling of “Chimerica” bringing long-term change to the global demand landscape, Singapore, along with much of Asia, is likely to face significant challenges in the post-crisis future.

LEGACY EFFECTS FROM THE CRISIS: TIPPING POINTS FOR THE WORLD

The crisis of 2008–2009 will have at least four legacy effects that could permanently alter the global demand landscape.

• Rising public debt in the US, Japan and Europe has escalated with the high cost of    recovery fiscal spending. If these countries do not offer viable and sustainable    solutions to reduce debt levels in the longer term, investors’ confidence in assets    denominated in these currencies could diminish. In any case, investors would also    be wary that high levels of public debt now could lead to high levels of taxation    later. Reduced foreign appetite for G3 assets (in particular US assets) will impair    these governments’ abilities to invest in areas such as education, infrastructure    and social safety nets, reducing their long-term economic potential.

• Increased government intervention in the financial sector may stifle the innovation    necessary for wealth creation and the financing of the real economy. Over the long    run, private consumption and growth levels may be muted if access to credit is    restricted.

• Creeping protectionism could reduce the overall level of global trade and affect the    main mechanism that has supported Chimerica’s prosperity. Blatant forms of    protectionism, such as tariff wars, seem less likely. But more subtle forms of    protectionism, embedded as clauses in many fiscal stimulus plans, may hinder the    free flow of trade too.

• Fundamental changes in G3 consumption behaviour could affect the growth path    of the world economy. US consumption spending, in particular, accounts for    onethird of global growth in private consumption. Hence, any decline in G3    consumption, arising from higher levels of unemployment and the need to save    more, would significantly affect global GDP growth.

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