By Jim O’Neill – Financial Times

Published: November 27 2008 18:59 | Last updated: November 27 2008 18:59

For much of the past three years, as it became evident that the US housing bubble was bursting, I believed that the old adage “the US catches a cold, the world catches pneumonia” would be laid to rest, helped by the emergence of the so-called Brics – Brazil, Russia, India, China.

Until September and the collapse of Lehman Brothers, the US investment bank, this was still a reasonable model for the evolving world. However, since mid-September maybe the real question has – unfortunately – become: “What happens if the US itself has caught pneumonia?”

At the heart of this is the dramatic tightening of US financial conditions that took place from mid-September until recently. For the over-levered US consumer, coming on top of declining housing values, the era of buoyancy is almost definitely over.

At its 2007 peak, US domestic consumption reached as much as 72 per cent of the country’s overall gross domestic product, which is more than 20 per cent of global GDP. Not bad for a population of some 300m people, out of more than 6bn globally. By the end of 2008, consumption will be back below 70 per cent and will probably be on its way down to something around 65 per cent or less in a few years. How can the world cope?

The answer is that unless Chinese, German and Indian shoppers start spending more freely, it will not.

Aggressive infrastructure-based fiscal expansion in the US from the incoming administration will help the country recover and rebuild but, as with the UK, there has to be a chance that any direct stimulus for the indebted US consumer will be saved, not spent. Indeed, it is no bad thing that domestic private savings will be rebuilt. Among other things it means the US will not need to keep gobbling up the world’s savings.

To avoid global pneumonia, what we need is shopping in Berlin, Frankfurt, Beijing, Shanghai, Delhi and Mumbai. Here is how to do it.

China looks like it does not need too much guidance judging by the media focus on its $586bn (€453bn, £380bn) “stimulus” package. China has to regard export strength, especially low-valued exports, as a thing of the past. This will involve some redeployment of people, which in some regions could be quite challenging. But boosting domestic spending, especially for consumption and investment, is vital.

Such spending should feed through to renewed import growth, so China can help offset the end of import growth in the US. Of course, annual retail sales growth as measured by October’s numbers was a strong 22 per cent but, until consumption represents a bigger share of GDP, the government should seek to increase this further. Noises about the potential development of a proper nationwide social security system are encouraging; this is vital to reduce China’s huge savings rate.

As for India, its demographic dividend makes it arguably the most interesting of the Brics in the next decade. According to the United Nations, by 2020, India’s population could grow by as much as the current size of the US. If Indian policymakers can boost infrastructure spending, the escalating urbanisation that will accompany this could unleash massive consumption. Indian policymakers should stop worrying about the May 2009 election and introduce steps now to allow more foreign capital to help the financial sector fulfil these exciting prospects. Among other things it would diminish fears about India’s external financing challenges also.

It is not just India and China that could help. Germany and its policymakers should take a long, hard look in the mirror. At 85m, Germany’s population is equivalent to more than a quarter of that of the US. It needs to make a contribution to world consumption in a similar ratio, relative to that of the US consumer.

Next year is the 20th anniversary of the fall of the Berlin Wall. German consumption has barely budged since then. Why not celebrate by giving its people a surge in consumer spending? Raise real wages and cut value added tax: Germany owes it to itself and the world after such a long period of adjustment to both unification and European monetary union. It certainly needs to, as the export machine is set to struggle.

Who knows, if Germany “gets it” maybe even Japan might then consider change. Then we would know the world really was being turned upside down.

The writer is chief economist at Goldman Sachs