Market Mover - BNP PARIBAS - Investment Services India

Japan: Lessons from a ‘Lewis Turning Point’• Japan’s era of rapid economic expansioncoincided with massive internal migration. Butwhen the supply of surplus rural labour forurban industries was fully absorbed, the era ofrapid growth ended. This is the ‘Lewis turningpoint,’ where wages rise as the labour supplyfrom the countryside tapers off: a modeldescribing the industrial revolution in Europethat applies surprisingly well to Japan.• Looking back, Japan’s trend growth ratestarted falling in the early 1970s after internalmigration began tapering off a decade earlier.But the authorities at the time misunderstoodthis and adopted stimulative policies to shore upgrowth, resulting in rampant real estatespeculation and soaring inflation of 25% y/y.• Conditions in China today resemble Japanwhen its era of robust growth ended. With wageshaving risen for several years in China’s coastalregions, surplus labour from the countrysidecould be tapering off (the Lewis turning point). Ifso, Chinese trend growth could be shiftinglower, and the authorities ought to adjust to anew cruising speed in order to avoid a hardlanding.• While it is just a risk scenario, prematurelyshifting to stimulative policies could put Chinaon the same path as Japan in the 1970s.65605550Chart 1: Manufacturing PMI –China, Brazil and India45China40BrazilIndia3508 09 10 11Source: Markit Group Limited, EcoWin, BNP paribas1612840-4-8Chart 2: Japan’s Real GDP (% y/y)195719739.4197419904.2 199120081.2-1257 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11Source: Cabinet Office, BNP Paribas *Note: Trend calculated using HP filter.The global economy is slowing these days in largepart because the emerging market economies(EMEs) like China, Brazil and India, which havespearheaded growth since the Lehman shock, arelosing momentum. Developed economies like the USand eurozone have until recently somehow continueda modest expansion on the back of exports to theEMEs, while their own internal demand has stayedsluggish because of unresolved balance-sheets. Butwith the EMEs losing steam since the spring,recovery in the US and Europe has also stalled. Thishas aggravated structural problems in the US andEurope, including the sovereign debt woes insouthern Europe. That the US and Europe shouldsuccumb to economic soft patches, or even outrightrecession, whenever the global economy turns souris very much like the Japanese business cycle overthe past 20 years. Increasingly the EMEs are callingthe tune for the developed economies.EMEs look for early end to tighteningIn China and the other EMEs, economic growth isdecelerating alongside accelerating inflation. In otherwords, the economies are slowing not because ofweak aggregate demand but because aggregatedemand has expanded so briskly in the past threeyears that it has outstripped generating capacity.This has resulted in supply constraints that aredampening economic growth and pushing priceshigher. As such, to ensure sustainable growth,continued tightening policies are now needed to coolthe red-hot aggregate demand so inflationarypressures can be adequately neutralised.Unfortunately, concerns about slowing growth haveprompted many EMEs to start looking for an earlyend to tightening policies. In fact, Brazil has alreadyreversed course and slashed its policy rate in lateAugust and again in October.Ryutaro Kono 27 October 2011Market Mover21www.GlobalMarkets.bnpparibas.com