Through the looking glass
How to cut through the global economic madness to assess real prospects for growth.
Looking at the global economy can feel like we have gone among the mad people:
- Some interest rates are negative — you have to pay in order to lend.
- Financial papers call for “helicopter money” in a Eurozone that is growing above potential.
- Innovation is moving at its fastest pace but productivity at its slowest.
- The drivers of many years of rising global prosperity — free circulation of goods and people — are vilified as ruinous.
- The fact that a key production input — energy — has become a lot cheaper is seen as a threat to global growth.
- The gloomiest economists keep giving us optimistic forecasts.
- There is a seemingly incurable pessimism even as global growth has held close to its historical norms.
I could go on. Nothing is what it seems. And nothing feels right.
My colleague Shlomi Kramer and I have just released a paper where we try to make sense of this madness and calibrate expectations of global economic growth in a way that can help business decisions.
We find that uncertainty and risks are indeed significant. Years of exceptional monetary easing have created distortions in financial markets. And populism and protectionism are on the rise nearly everywhere, fueled by broad discontent with growth and income distribution, and concerns about technology’s impact on jobs.
We are concerned that the widespread recurrent pessimism seems incurable. There is a negative feedback loop between widespread pessimism, popular discontent, and weak policy leadership in many countries. Breaking this vicious circle will be key to securing stronger and more stable global growth.
Still, the global economy is resilient and offers plenty of growth and business opportunities. We need to calibrate expectations — we are not going back to the bubbly pre-crisis growth — but neither have we entered a global terminal slump. We need to be aware of the real dangers, ignore the many imaginary ones, and focus on taking smarter risks.
We dig into these dynamics more deeply in the paper, but here are a few highlights from our analysis.
“I give myself very good advice, but I very seldom follow it”- Alice
The optimism of pessimists has dominated the last few years: Predictions of doom and gloom have accompanied over-optimistic forecasts, setting the stage for repeated disappointments, which fuels further pessimism.
We feel that consensus forecasts and actual economic strength have now converged for advanced economies, but we see much more uncertainty on emerging markets.
“I know who I was when I got up this morning, but I think I must have been changed several times since then”- Alice
A key source of uncertainty is China’s economic transformation. The policy strategy is the right one, and so far has been well executed. But there is no precedent of such a major economic transformation undertaken on such a scale. Our baseline is for a soft landing, where growth will average 5% per year through 2030, and 5 ½–6% in the next five years.
As liberalization proceeds, though, policymakers will have less control of the economy and China will experience the business cycles typical of a market economy. The danger is that early episodes of volatility could slow or derail ongoing reforms. China has entered a more difficult phase of its complex economic transformation; the uncertainty and risks are higher.
“You’re not the same as you were before. You were much more …muchier … you’ve lost your muchness”- The Mad Hatter
The U.S. recovery is entrenched, and concerns of an impending recession are unjustified. The labor market is close to full employment and job creation continues at a robust pace. Household consumption remains a reliable growth engine. Headline inflation is rebounding towards the 2% level now that energy prices have stabilized (core inflation had always remained well anchored, and is now also rising).
The pace of growth, however, is lower than before the crisis by about 1 percentage point. This is partly due to population aging, which has slowed the growth of the labor force.
But productivity growth has also decelerated: over the last two years it has been running at about ½ % annualized, a sharp fall from its 3% pace of 1995–2004 and its long-term average of over 2%.
There are divergent views on whether the US economy has settled onto a permanently lower path. Pessimistic theories, unsurprisingly, tend to be more popular: the “Secular stagnation” idea revived by Larry Summers and Robert Gordon’s view that innovation can no longer fuel growth stand out.
We believe that new waves of innovation can deliver major productivity gain. But we see two significant risks:
- Persistent uncertainty and pessimism, or continued growth-unfriendly policies could hold investment back.
- The normalization of US monetary policies could result in greater instability in financial markets with a sharp impact on economic activity.
“Where should I go?”- Alice “That depends on where you want to end up” — The Cheshire Cat
Emerging markets (EM) are set to recover as commodity prices stabilize in the next two years. We need to calibrate expectations, however: EM are not likely to go back to their all-time best performance. Both monetary and fiscal policy are constrained — the former by the prospect of higher U.S. interest rates, the latter by already high fiscal deficits.
This will shift the focus to fundamentals: infrastructure investment and a better business environment, together with sustainable macro policies, low indebtedness and low vulnerability to international capital flows
These factors will drive greater differentiation across regions and individual countries. Emerging Asia, Sub-Saharan Africa (SSA) and the Middle-East & North Africa (MENA) offer the greatest opportunities, but SSA and MENA also have some of the higher risks.
But overall, the global growth story of EM gradually catching up to advanced economies remains in place. There is often a temptation, sitting in advanced economies, to look at the EM slowdown and think, “I knew it, they will never catch up.” Such complacence is dangerously misguided.