WHERE THERE’S SMOKE . . .

WAITING for fireworks to begin to usher in 2016, leading Indian businessman, Kumar Krishnan Modi (known as KK), saw a large building on fire.
Relieved that the fire was far away in Dubai and not a terrorist attack in Bangkok, where he was holidaying, he returned to the festivities of the night.
Modi, Chairman of Modi Enterprises, one of India’s largest diversified business groups, recounted the incident in a preamble to his panel discussion on the global economy at the Asian Financial Forum in Hong Kong.
“That symbolises to me what 2016 is likely to be.  There will be a lot of fires. And the attention (of world leaders) will be diverted from the real problems to tackling fires. That is disturbing,” he said.
The world has witnessed many spot fires in the past year — the collapse of the global equities market, the oil and commodities glut, fears over China’s economic health, emerging market debt and so on.
London-based Stephen Jen, one of the most astute commentators on global currencies and economic trends, has just one word for the outlook for the global economy — “gravity”. And if you ask him whether the global economic growth rate has decelerated, his answer is a blunt: “Affirmative.’
The International Monetary Fund, which downgraded its global growth forecast by 0.2 per cent to 3.4 per cent in January, warns of  “a year of great challenges”.
IMF Chief Economist, Maurice Obstfeld, says that unless the key transitions in the global economy are successful, the economy  could be derailed.
Hong Kong-based economist, Jim Walker, says the global economy is entering what he calls an “activities” recession. He emphasises, however, that he is not talking about a
financial crisis.
So what is in store for the global economy in an uncertain 2016?
China is everybody’s preoccupation. Now, malaise in the world’s second-largest economy has started to create a contagion effect, already evident in emerging markets.
The bigger question, however, is not what will happen to the Chinese economy, which Walker believes is probably close to the bottom now. The spotlight should be on the United States.
Is the US strong enough to withstand the contagion that is spreading to emerging markets? Country after country in Asia, for example, is bracing for further slowdown.
Perhaps to get a better handle on the world’s largest economies, and indeed the global economy itself, one should start to differentiate the old economy from the services sector and the new economy.
The services sector is thriving, growing in double-digits in China, which itself has evolved into a two-speed economy.
Walker says China’s manufacturing sector has been in “outright” recession the last couple of years. Saddled with excess capacity, debt issues, rising wages and declining exports, the sector will need time to recover.
It is phenomenon that does not just apply in China. Jen says there is global deceleration centred around the global manufacturing sector. The world, he says, is witnessing an important and consequential bifurcation between a relatively strong services sector and a relatively weak industrial sector.
This is taking place in the US and China, but Europe, especially Germany, is not showing the same trend.
Jen says the US industrial sector accounts for just 18 per cent of GDP, compared with 82 per cent for services, including the construction sector. In his opinion, if the services sector can hold up, a downturn in the manufacturing sector need not drive the US aggregate economy into outright recession.
 “Indeed, this very sectoral rotation — a weakening manufacturing sector offset by a prospering non-manufacturing sector — is taking place in China and helping to turn what looks and feels like an economic hard landing — looked at from outside China — into a soft landing in the aggregate inside China,” he writes in a client note.
Jen says that, in the current cycle, China is at the epicentre of an industrial sector slowdown across the world.
“We argue that China’s sectoral rotation was so powerful that growth in the services sector was sufficiently robust to offset much of the hard landing that was taking place in the industrial/construction sector,” he says.
In contrast — and unlike virtually all past cycles — the current global economic downturn is not centered on the US because it is no longer the epicentre of the global manufacturing cycle. 
Since the GFC in 2008, Jen says nine of every 10 jobs created in the US has come from the services sector, meaning that, of the 200,000 plus new jobs created each month, just 12,000 come from the industrial sector.
The outlook for the US services sector and employment growth is embedded in two key sectors — healthcare and education.
“As the US economy develops and becomes wealthier and older, it is natural to expect that there will be an uptrend in education and health services,” he says.
Education and health services produce roughly half a million jobs a year, more than triple the 150,000 jobs generated in the manufacturing sector.  Pre-2008, these two sectors combined to employ around two million people, compared to the manufacturing sector, which employed 15 million.
And the Affordable Care Act, implemented by the Obama Administration, has given an added boost to job creation and value-add in the healthcare sector, which now accounts for just under 20 per cent of all new jobs created in the US.
“Consumption — a primary driver for services – has been a key and steady contributor to US GDP growth since 2008, reflecting (1) steady job creation and wage growth and (2) rapidly rising housing and portfolio wealth,” says Jen.
“On (1), it is important to note that the ‘product’ of jobs and wages yields the total wage bill or labour income for the economy.  Total wage income has grown quite significantly, by around 14 per cent since 2008.
“Similarly, on (2), US private sector wealth has grown extremely sharply, thanks in part to the Fed’s multiple rounds of QE, which have inflated asset values.”
US official data shows that US private sector wealth has risen from a crisis low of US$70 trillion to around US$100 trillion now — significantly higher than the pre-crisis high of US$82 trillion. However, Jen qualifies this by saying that whether the services sector in the US can remain supported will also be a function of the buoyancy of US equity and property prices.
So far, Europe has been — and will remain — relatively sheltered from the global downturn in the industrial sector, partly because intra-Europe trade is large.
Another factor is that Europe exports more higher-value-added capital goods that are less sensitive to cutbacks in demand from China.  Jen points out that just six per cent of Germany’s exports go to China —a tenth of what Germany exports to other European countries. 
“Thus, a cyclical recovery in domestic
demand in Europe has been a powerful counterforce, offsetting weak demand from China and emerging markets,” he says.

*Florence Chong is Editor of ATI Magazine