Global Growth Plateaus As Economic Risks Materialize

By Maurice Obstfeld, the Economic Counsellor and Director of Research at the International Monetary Fund

The latest World Economic Outlook report projects that global growth will remain steady over 2018-19 at last year's rate of 3.7 percent. This growth exceeds that achieved in any of the years between 2012 and 2016. It occurs as many economies have reached or are nearing full employment and as earlier deflationary fears have dissipated. Thus, policymakers still have an excellent opportunity to build resilience and implement growth-enhancing reforms.

Last April, the world economy's broad-based momentum led us to project a 3.9 percent growth rate for both this year and next. Considering developments since then, however, that number appears over-optimistic: rather than rising, growth has plateaued at 3.7 percent.

And there are clouds on the horizon. Growth has proven to be less balanced than hoped. Not only have some downside risks that the last WEO identified been realized, the likelihood of further negative shocks to our growth forecast has risen. In several key economies, moreover, growth is being supported by policies that seem unsustainable over the long term. These concerns raise the urgency for policymakers to act.

Growth in the United States, buoyed by a procyclical fiscal package, continues at a robust pace and is driving US interest rates higher. But US growth will decline once parts of its fiscal stimulus go into reverse. Notwithstanding the present demand momentum, we have downgraded our 2019 US growth forecast owing to the recently enacted tariffs on a wide range of imports from China and China's retaliation. China's expected 2019 growth is also marked down. Domestic Chinese policies are likely to prevent an even larger growth decline than the one we project, but at the cost of prolonging internal financial imbalances.

Overall, compared with six months ago, projected 2018-19 growth in advanced economies is 0.1 percentage point lower, including downgrades for the euro area, the United Kingdom, and Korea. The negative revisions for emerging market and developing economies are more severe, at -0.2 and -0.4 percentage point, respectively, for this year and next year.

These revisions are also geographically diverse, encompassing important economies in Latin America (Argentina, Brazil, and Mexico), emerging Europe (Turkey), south Asia (India), East Asia (Indonesia and Malaysia), the Middle East (Iran), and Africa (South Africa) - although Nigeria, Kazakhstan, Russia, and Saudi Arabia are among the petroleum exporters that will benefit from higher oil prices. Broadly speaking, however, we see signs of lower investment and manufacturing, coupled with weaker trade growth.

Rising risks

With their core inflation rates largely quiescent, advanced economies continue to enjoy easy financial conditions. This is not true in emerging and developing economies, where financial conditions have tightened markedly over the past six months, as the new Global Financial Stability Report explains in detail. The chart indicates the preponderance of recent policy tightening actions across central banks represented in the Group of Twenty. For emerging market and developing economies, gradually tightening US monetary policy, coupled with trade uncertainties and - for countries such as Argentina, Brazil, South Africa, and Turkey - distinctive factors, have discouraged capital inflows, weakened currencies, depressed equity markets, and pressured interest rates and spreads. The high levels of corporate and sovereign debt built up over years of easy global financial conditions, which the latest Fiscal Monitor documents, constitute a potential fault line.

We do not see recent developments as part of a generalized investor pull-back from emerging and frontier markets, nor do we expect the current problem cases necessarily to spill over to countries with stronger fundamentals. Many emerging economies are managing relatively well - given the common tightening they face - using established monetary frameworks based on exchange rate flexibility. But there is no denying that the susceptibility to large global shocks has risen. Any sharp reversal for emerging markets would pose a significant threat to advanced economies, as emerging market and developing economies make up about 40 percent of world GDP at market exchange rates.

Other downside risks that now appear more prominent for the near term relate to further disruptions in trade policies. Two major regional trade arrangements are in flux - the United States-Mexico-Canada Agreement (which awaits legislative approval) and the European Union (with the latter negotiating the terms of Brexit). US tariffs on China, and more broadly on auto and auto part imports, may disrupt established supply chains, especially if met by retaliation.

Reflecting these developments, news-based indicators of policy uncertainty have spiked recently, even if advanced-country asset markets remain less concerned. The impacts of trade policy and uncertainty are becoming evident at the macroeconomic level, while anecdotal evidence accumulates on the resulting harm to companies. Trade policy reflects politics, and politics remain unsettled in several countries, posing further risks.

To gauge the severity of the threats to growth, one must ask how governments could respond if risks are realized and widespread recession ensues. The answer is not comforting. Mechanisms of multilateral global policy cooperation are under strain, notably in trade, and need strengthening. Governments have less fiscal and monetary ammunition than when the global financial crisis broke out ten years ago, and therefore need to build their fiscal buffers and enhance resilience in additional ways, including by upgrading financial regulatory regimes and enacting structural reforms that raise business and labor-market dynamism. Despite the possibility of less "political space" in some countries, making consensus on sound policies harder to reach, there will not be a better time than now for positive action.

Long-term forces

Given the uncertainties of the moment, it is too easy to lose sight of the longer-term forces and challenges that have brought us to the current economic and political crossroads and will shape the longer-term future. Perhaps the biggest secular challenge for many advanced economies centers on the slow growth of workers' incomes, perceptions of lower social mobility, and, in some countries, inadequate policy responses to structural economic change. Emerging market and developing economies are diverse and face an array of longer-term challenges, ranging from improving investment environments to reducing labor-market duality to upgrading educational systems. The dangers of climate change loom in the background, but are rapidly intensifying.

Regardless of income level, all countries must prepare their workforces for the ways that new technologies will change the nature of work. Ensuring that growth is inclusive is more important than ever. Unless growth can be made more inclusive than it has been, centrist and multilateral approaches to politics and policy will become increasingly vulnerable - to the detriment of all.