Faculty Insights on World Economy, China's Woes and Oil Prices
With China’s economic slowdown and the turbulence in global stock markets, oil prices and world stocks have gone down, and panic has spread among investors who fear the beginning of a new financial crisis.
Tarek Selim, chair of the economics department; Adel Beshai, professor of economics and director of graduate studies; and Ahmed Kamaly, associate professor of economics, share their insights on China’s economic woes and the global economic repercussions.
1) China’s rapid economic growth in the past 20 years has made it one of the world’s largest economies, according to the IMF. What caused its economic plunge?
Selim: China has expanded its economy to unprecedented levels in the past 20 years, reaching the highest rate of economic growth on a global scale, and achieving world trade competitiveness based on cost and imitation advantages, coupled with superb infrastructure and a stable exchange rate (yuan). There are several scenarios for China’s economic slowdown, including the devaluation of the yuan a couple of weeks ago, investment “saturation” on the supply side within the Chinese local market and speculations toward stagnation, among other causes.
Kamaly: With China’s rapid, continuous and extraordinary growth over the past two decades, it was expected that the rate would eventually slow down; it’s a normal stage of a country’s economic cycle. In fact, the strong growth of China and other emerging markets since the 2007 - 2008 Global Financial Crisis is what has kept the world economy running, but it would have slowed down at some point. Even after this plunge, China’s growth rate is at 6 or 7 percent, which is still very good. The real source of worry, though, is hard lending, which can cause a big drop in growth.
2) How does the 2007- 2008 Global Financial Crisis come into play here?
Beshai: What we are seeing these days cannot be understood without reference to 2007. The issue is much more complex than “China’s economic plunge” or “financial crisis.” The so-called financial crisis of 2007 - 2008 is not really financial. Its root cause, as explained by the pioneering work by Professor Abadir of Imperial College London, was a slowing down of the “real economy.” The trick is that the financial models that were used and crafted by physicists and engineers would work as long as the economy is growing, but would not if it slows down. Had the real economy been growing, all that talk of toxic financial assets spreading would not have taken place. And when it came to the cure, the United States fared reasonably well with fiscal stimulus, but Europe did the opposite and raised the interest rate, which slows the economy further. Banks should have been regulated, but this does not happen. In our world today, a crisis spreads in nano seconds. Yes, we teach in physics that if you lower the coefficient of friction, the pendulum would work better. Here, in our case, we need friction to work better; friction here is financial laws for banking.
3) Why did China’s economic slowdown cause such turbulence and panic in world stock markets?
Selim: China is one of the world’s leading exporters in global trade and yes, the world economy is now immensely interconnected to the extent that the Chinese slowdown can affect countries ranging from Afghanistan to Peru to Germany. However, the world has learned from the recent global recession, which has led to an increasing importance of government regulation of markets, or the institutional economic path of development.
Beshai: We can look at the whole picture as a tale of two countries: the United States and China. This is the framework. America is still the biggest economy and is setting the tone now to raise the interest rate, which eventually affects currencies around the globe. China has been the fastest growing economy. These two big entities are pulling in different directions. The slowing down of China’s growth does not mean that China is bad. China is becoming a mature economy and, by definition, it will never grow as fast as when it was starting from a low level. This is elementary mathematics and economics. Whether we like it or not, we are going to see a fall in stock prices. It is the natural correction to this setting. All of this will impact the rest of the world and emerging markets. Countries may find their exports dwindling and prices going down.
4) Why has the price and demand for oil been negatively affected?
Kamaly: The reduction in oil prices started in 2008 or 2009 and has affected oil-exporting countries, which are still suffering from depressed oil prices. China’s current situation has just put more pressure on the price of oil to go down. In other words, the lessening demand for oil has been exacerbated by China’s economic slowdown, but is not a direct result of it. Other factors that come into play are the Ukrainian-Russian war, which creates uncertainty and hence affects demand, as well as the Iran-U.S. nuclear deal, which may lead to a further decrease in oil prices as Iran begins to export oil again, thereby raising the supply.
Selim: In the short term, the demand for oil will be negatively affected, but a rebalance is expected in the medium term.
5) What impact will this global economic turbulence have on Egypt and the average Egyptian?
Kamaly: Until subsidies are phased out, we as Egyptian consumers are not greatly affected by oil prices. However, with oil prices going down and Gulf countries bearing the brunt, this means that Egypt will need to find other potential sources of foreign investment. Of course, for this to happen, we need security and a good investment climate. With the slowdown in the world economy, the demand on exports will also go down. Most importantly, though, is the exchange rate war. China has recently devaluated its currency to improve competitiveness, and similar emerging economies are doing the same because they’re all competing together. The problem is that the Egyptian economy is not that competitive, and with the exchange rates of emerging economics being depreciated to enhance competitiveness, Egypt will be hit hard if it doesn’t take this into account. This is similar to what happened in 1997, when an economic crisis hit East Asia and the exchange rates went down. Egypt did nothing and kept its exchange rate stable and constant. As a result, at the turn of the century, there was a very big deficit in its current account, which, in turn, led to a significant balance of payment deficit.
Beshai: The crisis is an economic crisis, not just a financial one. Financially, stock values will go down. A country like Egypt, which has a diversified economy can take this as a chance and develop a vision for new exports and tuning of the industrial sector. Egypt can do a lot in its internal economy. Question marks remain as to what will happen in the Gulf Countries given the economic and political situation at the moment.
Selim: The availability of very cheap Chinese goods for the average Egyptian citizen may not be the same as before.
6) When should we expect a comeback, or stabilization, in global markets?
Selim: Most economists expect a comeback within one or two quarters, unless the recent rebalance policies by the Chinese government, such as cutting interest rates, do not have enough channel effects.
Kamaly: There is a difference between stabilization and being back on track. Such crises, or recessions, create a “shock,” or deviation from the global economic trend. My anticipation is that the world economy might be back on track by 2018.
7) What are the main lessons learned from this crisis?
Selim: (1) Economic growth is not perpetual, and a saturation level will be reached at some point; (2) Free trade has advantages in terms of cost and innovation, yet carries the risk of financial slowdown and unemployment cycles; (3) Achieving low-cost trade competitiveness without sufficient quality standards is not sustainable; (4) Size matters, but “per capita” living standards matter as well in terms of consumption-savings choices, which trigger the investment growth cycle.
Kamaly: The accumulation of private or public debt that is not consistent with a country’s income is the main source of many economic crises and has the potential of affecting the economy for a long period of time as the economy goes into the painful process of “deleveraging."