World economy remains trapped in period of slow growth

The world economy in 2016 recorded its lowest growth rate since the Great Recession of 2009, according to the UN, and a robust recovery is being hindered by weak investment levels and slow growth in trade and productivity.

by Kanaga Raja

GENEVA: The world economy expanded by just 2.2% in 2016, restrained by the feeble pace of global investment, dwindling world trade growth, flagging productivity growth and high levels of debt, the United Nations has said.

In its World Economic Situation and Prospects 2017 report, released on 17 January, the UN has forecast world gross product (WGP) to expand by 2.7% in 2017 and 2.9% in 2018, with this modest recovery more an indication of economic stabilization than a signal of a robust and sustained revival of global demand.

In per capita terms, this equates to average global growth of just 1.5% per annum in 2016-18, compared to an average of 2.1% in 1998-2007.

At a media briefing here on 17 January, Alfredo Calcagno, Head of the Macroeconomic and Development Policies Branch, Division on Globalization and Development Strategies, at the UN Conference on Trade and Development (UNCTAD), said that some improvement is being experienced in the world economy, but without solving the main problems that led to the crisis and that have prolonged the exit from the crisis for almost 10 years now.

“We remain trapped in a slow-growth situation,” he said. The recovery that is forecast for 2017 and 2018 will not be enough to recover the pre-crisis growth rates, he added.

Asked about the possible impact of US President Donald Trump’s proposed tax reforms, Calcagno said that the potential reduction of taxation on firms and the wealthy would have an impact on capital movement. One thing that has been mentioned is the repatriation of cash held by US firms outside the country in order to avoid paying taxes on it. This could also have an impact on the US dollar, he said.

The tax reduction, if undertaken in parallel with increasing public investment, might also generate a fiscal deficit in the US in the short term, Calcagno said. “That could bring us towards a challenge for the global economy – what would happen with the US budget deficit going up again.”

According to Calcagno, another element of tax reform that has been mentioned in the press but that has not been formally announced yet is its impact on imports; it is unclear if it would mean a kind of higher protection for US producers. This would incorporate a huge challenge for the multilateral system and the World Trade Organization (WTO), he said.

Sluggish global economy

According to the UN report, in 2016, the world economy expanded by just 2.2%, the slowest rate of growth since the Great Recession of 2009.

Underpinning the sluggish global economy are the feeble pace of global investment, dwindling world trade growth, flagging productivity growth and high levels of debt. Low commodity prices have exacerbated these factors in many commodity-exporting countries since mid-2014, while conflict and geopolitical tensions continue to weigh on economic prospects in several regions.

“The global economy remains trapped in a prolonged period of slow economic growth and dwindling international trade growth,” said the report.

While some of the exceptional factors that restrained global growth in 2016 – such as the de-stocking cycle in the United States and adjustment to the sharp terms-of-trade shock faced by commodity exporters – can be expected to ease, the longer-term pressures restraining the global economy continue to prevent more robust growth.

“The relatively slow pace of economic growth will hamper progress towards achieving the Sustainable Development Goals (SDGs), as defined in the 2030 Agenda for Sustainable Development, which was adopted by the Member States of the United Nations in 2015.”

If downside risks to the outlook were to materialize, this could push global growth rates down even further, with additional setbacks towards achieving the SDGs, particularly the goals of eradicating extreme poverty and creating decent work for all, the UN cautioned.

It noted that the factors underlying the protracted economic slowdown have a tendency to reinforce one another, through the close linkages between demand, investment, trade and productivity. Economic and political uncertainties have also weighed on investment demand in many countries, while the nexus between profits and investment has weakened in both developed and developing countries. The declining demand for capital goods associated with weak investment restrains global trade, which in turn curtails investment further.

“In the absence of concerted policy efforts to revive productive investment and foster a recovery in productivity, there is a risk that the protracted episode of weak global growth may linger for several more years.”

The report said that in the developed economies, stable private consumption will remain the mainstay of growth.

The slight increase in gross domestic product (GDP) growth that is forecast for the developed economies in 2017 is driven primarily by the end of the de-stocking cycle in the United States and additional policy support in Japan, including an expansion of government investment spending.

Uncertainty related to the withdrawal of the United Kingdom from the European Union (EU) has led to downward revisions to growth forecasts for the UK and several other countries in Europe in 2017.

Meanwhile, the lack of clarity about the future direction of policy in the US, with potentially far-reaching spillover effects on both domestic and global economic prospects, has increased the margin of uncertainty around global baseline forecasts.

In developing countries, especially in East and South Asia, GDP growth is expected to remain driven by domestic consumption, said the UN report.

China’s expansion is expected to remain stable, supported by the strong policy stance, but the rebalancing of the economy continues to weigh on global trade flows.

India is expected to remain the fastest-growing large developing economy, as the country benefits from strong private consumption and the gradual introduction of significant domestic reforms.

“Among the largest countries,” the report says about trends in South Asia, “India has positioned itself as the most dynamic emerging economy. India’s economy is projected to expand by 7.7% and 7.6% in 2017 and 2018, respectively, benefiting from strong private consumption. Investment demand is expected to slightly pick up, helped by monetary easing, government efforts towards infrastructure investments and public-private partnerships, and the implementation of domestic reforms such as the introduction of the Goods and Services Tax (GST) Bill.”

“This reform constitutes a major change by establishing a new uniform tax rate, and it should promote investment in the medium term through lower transaction and logistic costs and efficiency gains. Importantly, an effective GST implementation also requires adequate capacity building of the tax administration. Nevertheless, low capacity utilization and stressed balance sheets of banks and businesses will prevent a strong investment revival in the short term.”

(According to Indian media reports, the new GST regime in India will come into effect from 1 July 2017. There appears to be no mention in the UN report on the recent “demonetization” of high-value currency in the country and its likely immediate effects on GDP growth. – SUNS)

Meanwhile, growth in the least developed countries (LDCs) is expected to rise modestly from an estimated 4.5% in 2016 to 5.2% and 5.5% in 2017 and 2018, respectively.

The economies in transition suffered a sharp collapse in domestic demand in the Commonwealth of Independent States (CIS) region in 2016, while net trade made a positive contribution to GDP growth, reflecting the impact of lower imports as a result of steep exchange rate realignments in several countries. In 2017, the economy of the Russian Federation is expected to register its first year of growth since 2014, as the country has largely absorbed the sharp terms-of-trade shock suffered in 2014-15.

The UN said global economic prospects remain subject to significant downside risks with the potential to obstruct the modest acceleration in growth that is currently forecast for 2017-18.

“Considerable uncertainty shrouds both the path and impact of monetary policy actions in major developed economies.”

The effects of introducing untested monetary policy instruments – such as the negative interest rate policies in Japan and Europe – remain unclear, with a risk of unintended consequences, such as a deterioration of bank balance sheets and tightening of credit conditions, which could destabilize fragile and under-capitalized banks.

While the path of policy interest rates in the US remains unclear, interest rate differentials relative to other developed economies are expected to widen, potentially triggering financial volatility, capital outflows from developing economies and abrupt adjustments in exchange rates.

“The future direction of certain international policy stances is uncertain. There is a lack of clarity over the shape and timing of future changes by the new Administration of the United States to crucial policies in international trade, immigration, and climate change.”

The UN said the decision by the UK to leave the EU, or “Brexit”, and its potential implications for the free movement of goods and workers in Europe, also poses considerable regional uncertainty.

Finally, risks facing developing countries include vulnerabilities associated with high levels of debt and rising default rates in a number of countries, with the potential to push up borrowing costs, raise de-leveraging pressures and increase banking sector stress.

Such risks are exacerbated by the volatility of international capital flows. “All of these uncertainties have the potential to undermine any projected recovery in business investment, impede international trade growth and prolong the self-propagating cycle of weak global growth,” said the report.

Weak investment

According to the report, weak investment has been at the foundation of the mediocre global economy, through its interplay with demand, productivity and international trade.

The contribution of investment to global growth has declined from an average of 1.4 percentage points per annum in 2003-07 to 0.7 percentage points per annum since 2012.

Both global and country-specific factors have contributed to the weakening of investment. Protracted weak global demand has reduced firms’ incentive to invest, especially those in export-oriented industries.

Since the onset of the broad-based decline in commodity prices in late 2014, commodity sectors in particular have suffered from delays and cancellation of infrastructure investment and exploration activities. Global investment in energy sectors, for example, declined by 8% in 2015.

Policy uncertainty and in some cases social unrest have also held back investment in several countries, including Brazil, South Africa, Turkey, the UK and the US.

A lack of access to finance has also created barriers, especially in Europe where certain banks remain under-capitalized as well as in developing countries that are struggling with high interest rates or where financial markets are under-developed.

In developed economies, private non-residential investment growth has been exceptionally weak in the past two years, especially when compared to the pre-crisis years 2005-07. In the first half of 2016, most major developed economies experienced a contraction in private non-residential investment activity.

The sharp contractions in Australia and Canada largely reflect large cutbacks in mining-related capital expenditure, while the US has seen a significant decline in investment in the shale-oil sector.

The report said these declines have not been matched by a commensurate expansion of investment in renewable energy and are likely to prove temporary, rather than signal significant structural progress towards a less fossil fuel-intensive economy.

“In the United States, in particular, an expansion of investment in fossil fuel industries would be expected in 2017, should the new Administration lift certain environmental restrictions on production in the shale, oil, natural gas and clean coal sectors, risking setbacks to environmental targets in the SDGs and the Paris Agreement on climate change.”

Despite record-low, often negative bond yields, governments in developed countries have been reluctant to increase public sector investments to fill the gap in private investment. Steep cuts in government investment largely reflect fiscal adjustment policies that have been implemented in many developed economies since 2010 in response to soaring levels of government debt.

“While the policy outlook for the United States remains highly uncertain, proposals to boost infrastructure spending would support a revival of investment in the fiscal year starting October 2017 if implemented,” the UN said.

In major developing countries and economies in transition, investment growth has also slowed notably in recent years.

As in developed economies, a sharp decline in investment in the commodity sector has weighed on investment growth, particularly in Brazil, the Russian Federation and South Africa. In the Russian Federation, the decline also reflects the impact of international sanctions on access to capital and business sentiment.

In the case of China, weaker investment growth reflects large over-capacity in a number of industrial sectors, including iron and steel, cement and even the solar energy sector, as well as sluggish market demand and higher corporate financing costs.

Slower investment growth in major developing economies has been largely driven by the private sector. In line with their greater scope to exploit fiscal space, East Asian and South Asian economies have generally seen stronger growth in public investment, especially in infrastructure.

The slowdown in private sector investment growth in many developing economies raises some concerns, as it suggests that the significant increases in corporate debt burdens, particularly in East Asia, have failed to deliver a comparable increase in productive capital stock.

“Going forward, these high debt burdens may begin to restrain access to finance or prompt firm de-leveraging, perpetuating the slowdown in investment growth, and may also increase the risks of debt distress and financial instability in some developing countries.”

According to the report, dwindling world trade growth is both a contributing factor and a symptom of the global economic slowdown.

The current weak investment trends in major developed and developing economies have constrained trade in capital goods, while at the same time, the weakness in trade is propagating and reinforcing the slump in investment, especially in other export-oriented sectors. There may also be spillovers from weak global trade to productivity, especially in developing countries.

The volume of world trade in goods and services is estimated to have expanded by just 1.2% in 2016, the slowest growth rate since the financial crisis, marking a significant downward revision of nearly 3 percentage points compared to projections in the World Economic Situation and Prospects 2016 report, said the UN.

The estimated global trade growth of only 1.2% in 2016 will stand out as the third-lowest rate of growth in the past 30 years.

Financial fragilities

Looking ahead, said the UN, significant fragilities in the international financial system pose major risks to developed and developing economies.

The main underlying factor is the widening divergence between buoyant – and complacent – financial markets and persistently weak global economic growth resulting from the over-reliance on monetary policy to stimulate economic activity.

Years of expansionary monetary policy coupled with the lack of support on the fiscal side encouraged excessive risk-taking and considerable distortions, leading to very high equity and asset prices, without ensuring a robust growth trajectory.

“Significant uncertainties and risks persist in the financial market, which may suddenly alter the volume, destination, composition and pace of international capital flows.”

As global divergences in policy rates and yields continue to widen, this may trigger disorderly adjustments in asset prices and change capital flows, with significant adverse effects on the real economy, especially in large developing countries with high openness to foreign capital, such as Mexico, South Africa and Turkey.

“In the first days following the election in the United States, emerging market assets dropped noticeably, along with a sharp depreciation in several emerging market currencies. A further surge in risk aversion – driven, for example, by concerns related to the possible introduction of protectionist measures by the United States or the implementation of Brexit – could destabilize financial markets worldwide.”

While the dispersion of global current-account deficits and surpluses has narrowed somewhat from the peaks leading up to the global financial crisis, a significant degree of imbalance still persists, posing a potential risk to global financial stability.

The US current-account deficit narrowed from 1.6% of WGP in 2006 to 0.5% in 2013, combined with a decline in China’s current-account surplus from 0.5% of WGP to 0.2% over the same period.

However, the US current-account deficit has been widening since 2014 and is expected to widen further in 2017-18. The current-account surplus in East Asia, after widening slightly in 2014 and 2015, has narrowed again, and a return to the level of global imbalances in 2006 is unlikely.

The report noted that the US dollar has appreciated by more than 15% since mid-2014. The strong dollar has restrained US exports and has been an important factor underpinning the recent widening of the US current-account deficit. As interest rates in the US are expected to rise relative to other major developed economies in 2017-18, some upward pressure on the dollar is expected to continue, further unwinding some of the improvement in the US current-account deficit since 2006.

Major uncertainties and risks

The report said there is considerable uncertainty related to the evolution of international policy. For example, the new administration in the US has discussed far-reaching changes to the current direction and stance in policy related to macroeconomics, trade, immigration, foreign affairs and the environment, as well as the nature of its participation in multilateral organizations and institutions.

“Should some of these changes be implemented, the substantial economic impact would mostly manifest itself beyond the forecasting period of this report, but heightened uncertainty could weigh on investment decisions in the short term as well,” said the UN.

This uncertainty may also trigger capital withdrawal from developing economies with open capital markets, such as Mexico, South Africa and Turkey, in a general “flight to safety”.

Some measures recently proposed by the new US administration may have the potential to accelerate GDP growth in the short run, such as a large expansion of infrastructure investment coupled with significant cuts in taxation, although it is not clear whether the US Congress would agree to the rise in government debt levels that such a move would entail.

“The introduction of ad hoc tariff barriers to some important trade partners, such as China and Mexico, on the other hand, would be counterproductive and slow economic growth, especially if such actions trigger retaliatory measures that could potentially spread to other countries,” the report cautioned.

It said the decision by the UK to leave the EU also raises questions regarding international policy, which can be broadly grouped into three different levels: uncertainties about the future trade, financial and migration arrangements between the UK and the EU and between the UK and other countries; the likelihood that similar actions will be taken by other EU members; and the extent to which this signals a change in the trend of global economic integration at large.

From a global perspective, the shifting direction of policy in the US and the UK partly reflects increasing discontent with the imbalanced distribution of the burdens and gains that deepening global economic integration has brought in the past few decades.

For example, more open international trade has indeed generated substantial economic gains for many countries through improved efficiency in allocating resources worldwide. At the same time, more open trade has been associated with widening income inequality in many countries, along with job losses and declining wages for certain categories of workers, although these developments also reflect factors such as technological progress. “These concerns have enhanced the appeal of protectionism and inward-looking policies in many countries.”

More concerted international efforts to improve global governance, along with more effective domestic redistribution policies, are needed to ensure that the gains from global economic integration are more inclusive, said the UN.

“In the absence of such efforts, protectionist tendencies may escalate, which could prolong the slow growth in the world economy and lead to a less-efficient allocation of resources and slower pace of technological diffusion.”

The report noted that developed economies continue to rely heavily on monetary policy to support their macroeconomic objectives.

As the scope for conventional monetary stimulus was to a large extent exhausted when interest rates were cut to near zero levels in the aftermath of the global financial crisis, central banks have made greater use of unconventional policy, such as quantitative and qualitative easing, negative interest rate policies and yield curve targeting. Proposals have also been made to explore new tools such as “helicopter money”, which is essentially a fiscal expansion financed by a central bank.

“The longer-term impacts of these measures, which have limited historical precedence, remain unclear.”

The UN also said the significant rise of corporate debt in emerging markets in recent years has emerged as an important risk to the global growth outlook. This trend has been largely driven by loose financing conditions in the post-crisis period, facilitated by capital inflow seeking higher-yield assets.

Government debt has also risen in many developing countries, reflecting the deterioration of fiscal positions related to slower growth, subdued commodity prices and higher financing costs, especially in countries that have suffered sharp currency depreciations.

According to the report, other risks and uncertainties in the world economic prospects include banking sector fragilities, especially in Europe but also in some developing and transition economies, which could trigger financial distress in response to a further squeeze on bank lending margins or rising defaults related to exchange rate shocks; the response to recovery in commodity prices, which could lead to a stronger pass-through to inflation than currently forecast; as well as the political, geopolitical and security risks which continue to weigh on regional prospects in many parts of the world. (SUNS8384)               

Third World Economics, Issue No. 631, 16-31 December 2016, pp2-5