Asia stumble a major risk for global economy

By Charles Riley

Here's a scary thought: What if the economies of China and India -- the world's two major growth engines -- slowed suddenly and dramatically?

Is the world prepared for such an event? How far would the collateral damage extend? Perhaps most importantly, what are the chances of a crash in Asia?

According to Larry Summers and Lant Pritchett, these are questions that policymakers should be thinking about -- and the all-star economists have produced some new research that warns of danger ahead.

Their argument goes like this: China and India are in the midst of sustained periods of economic growth that are exceptional in both their pace and duration. At some point, this will end.

"India and even more so China are into essentially historically unprecedented episodes of growth. China's super-rapid growth has already lasted three times longer than a typical episode and is the longest ever. The ends of episodes tend to see full regression to the mean, abruptly," Summers and Pritchett write in a preliminary research draft.

In other words: China and India are overdue for a major slowdown. And when rapid growth ends, it tends to stall in a dramatic and immediate way.

Already, China has endured a mild pullback from double-digit growth levels, and is on track to post a gain just north of 7.5% this year. India too has slowed, with GDP forecast to hit around 5% in 2013.

Summers and Pritchett are careful to shy away from any predictions about when a major slowdown might begin. This is probably wise, as China and India have defied doomsday forecast after doomsday forecast in recent years. But the economists do have more to say about the potential global fallout from slower growth in Asia.

To quantify the impact, Summers and Pritchett examine potential global economic output over the next 20 years. In the first scenario, the economists project that India and China maintain their very high growth levels until 2033. In the second scenario, the two economies slow to the global GDP growth average. The difference? A whopping $42 trillion, or three times current U.S. output. Put another way, a severe slowdown in China and India would cut global GDP growth over the next 20 years by half.

This is a big deal, especially if other countries are unable to pick up the slack: "Hitching the cart of the future global economy to the horse of the Asian giants carries substantial risks," the economists write.

What can be done to mitigate the risk? The authors suggest that both China and India would be wise to improve their institutions, and work to equally apply the rule of law.

"It is impossible to argue that either China or India have the kinds of 'quality institutions' that have been associated with the steady dynamic of growth in the currently high productivity
countries," the paper states. "The risks of 'sudden stops' are much higher with weak institutions and organizations for policy implementation."

China may have taken some steps to improve the reliability of its governance just last week (after the paper's publication), pledging to allow market-based reforms and modify some of its divisive social policies. But over the long run, the proposed changes will only make a difference if Beijing follows through on the plan.