Great Divergence

By Ichiro Suzuki

Covid-19 is widening the gap between the two worlds of developed and developing, reversing a move toward convergence prior to this decade since the beginning of the 21st century. The U.S. is coming off the pandemic with relatively small damages to the economy despite heavy tolls on human lives. Its average growth rate of 2020 and 2021 does not deviate materially from the trend line growth that had been in place prior to the pandemic’s outbreak. Europe and Japan are underperforming the U.S., with their growth rates held to lower trajectories than the pre-pandemic trend-lines. Nonetheless, lowered growth prospects for Europe and Japan are still considerably better than those in the developing world in general, which is suffering from severe slowdowns caused by the pandemic. In late spring, India’s ordeal made headlines frequently, on a spike in infections due to the Indian variant. Resulting human tolls and economic damages are being brought to an atrocious level. Populist leaders with authoritarian instincts failed miserably in containing COVID-19. They tried to downplay the seriousness of the pandemic and failed to impose effective measures to control the virus. India’s Modi stands out in his incompetence. Taking the virus lightly, he let political rallies become super spreader events, bringing down the economy sharply. Brazil’s Bolsonaro is not much better than Modi. Having been contracted to the virus himself, he still did not take COVID-19 seriously. Then there is Mexico’s Lopez-Obrador, populist of the left unlike others in the right who are in trouble. Russia’s Putin isn’t doing particularly well and his country is said to be considerably under-reporting the number of cases. Their economies are seized. Entering the 2020s, the developing world was already afflicted with mounting problems they accumulated in the previous decade. As the Federal Reserve Bank, the European Central Bank and other leading central banks embarked on a monetary policy of printing money in response to the 2007-09 Great Recession, many in the developing world got themselves addicted to borrowing heavily, often in currencies that are not their own, often in the U.S. dollar. As long as the greenback was soft, such indebtedness did not cause serious problems. However, once the dollar regained resilience upon strong growth brought by massive fiscal and monetary stimulus, heavily indebted countries found themselves faltering. Rising bad debt in weaker economies adversely affected their economic performances. Non-performing loans in the banking system exerted significant downward pressure on India’s growth rates. Even before the pandemic, India grew at a paltry, by the country’s standard, 4.2% in 2019. Brazil was even lower at 1.1% and Mexico failed to grow at all. These numbers are far cries from the rosy pictures painted during the hyped years of emerging market boom. Amid these heavyweights' struggle, a number of smaller developing economies fared even worse, especially petrostates and other economies that are dependent on extraction of mining resources. They were already struggling and then they were hit by the pandemic. These countries’ inadequate public health system has made them unable to cope with the pandemic. Then, their problems were compounded by insufficient financial resources to procure vaccines. The 2020s are turning out to be a rough decade for the developing world, filled with disappointments that deny all the promises made for them earlier. Great divergence is unfolding between the developed and developing worlds. Then within the developing world, another great divergence is unfolding. This is between China and the rest. Despite China’s well publicized debt problem, Beijing has displayed an ability to manage the economy far better than other developing countries. Others have their own debt problems, too, and theirs are far more serious than China’s. While the Chinese economy is no longer growing at double digit rates, its rate of slowdown over the last decade is less serious than others. China today is growing faster than India that is far behind China in its stage of economic development. China also has accumulated immense financial resources during the years of hyper-growth, and is capable of attracting investments from developed countries, primarily because of its technological prowess and scale that is unmatched outside the U.S. China’s public sector debt is essentially owned by domestic investors, making it free from external pressure at the time of volatility events in the financial markets, quite unlike others in the developing world. On top of this, China is coming off the pandemic relatively unscathed. Its economy’s growth trend is not bent downward, in sharp contrast to the suffering of developing country peers. With successful containment of the coronavirus, China is leaving the rest of the developing world far behind. This achievement places the country in a position to draw anger easily. Aggressive attempts to impose its will in a thinly disguised manner, flexing muscle as a creditor, on these counties could develop a fertile ground for anti-Chinese sentiment. The Belt & Road Initiative has already caused apprehensions among aid recipient countries. The Communist Party has to learn to tread carefully in a subtle manner. While these weakened countries remain in China’s orbit for financial reasons, winning their hearts is another matter.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.