World economy to grow by 2.5% this year, says UNCTAD

Global economic growth this year is projected to be 2.5%, according to the United Nations Conference on Trade and Development (UNCTAD) – much the same as in 2014 but significantly below the pre-crisis level. In its Trade and Development Report 2015, UNCTAD looks at how different regions of the world economy are expected to fare and considers whether the lower post-crisis growth trajectories reflect a “secular stagnation” in developed countries.

by Kanaga Raja

GENEVA: Growth in the world economy in 2015 is expected to remain more or less unchanged from the previous year, at 2.5%, the United Nations Conference on Trade and Development (UNCTAD) has said.

In its flagship annual publication, the Trade and Development Report 2015, released on 6 October, UNCTAD said that there will be a slight acceleration of growth in developed economies, a moderate deceleration in developing economies and a contraction of gross domestic product (GDP) in transition economies.

“Therefore, world output growth will remain significantly below the 4% rate posted in the pre-crisis years.”

In the section of its report focusing on recent trends in the world economy, UNCTAD said developed countries are expected to grow at around 1.9% in 2015 compared with 1.6% in 2014. The eurozone and Japan, in particular, are experiencing a moderate acceleration of growth, although from very low rates in 2014.

Developing countries as a whole will continue to expand at a rate of more than 4%, mainly owing to the resilience of most countries in the Asian region. However, other regions are experiencing a significant slowdown due to lower commodity prices and capital outflows, which have prompted tighter macroeconomic policies in some countries. The worst hit by all these developments are Latin America, the transition economies and West Asia, while the African sub-regions present a more mixed picture.

In developed countries, recent improvements in economic activity reflect a pick-up of domestic demand, owing to greater household consumption and to a less stringent fiscal stance. The increase in household consumption is largely due to lower energy prices and improvements in some labour markets, with lower unemployment rates in countries such as Germany, Japan, the United Kingdom and the United States.

Monetary policies remain expansionary, with very low interest rates in all developed regions and “quantitative easing” (QE) programmes in the eurozone and Japan.

In Europe, the QE programme of the European Central Bank (ECB) helped to further reduce yields on sovereign debt, but so far this has had little impact on credit flows to the private sector.

Nevertheless, household delevera-ging has already eased in recent months, fiscal austerity has been moderated or slightly reversed, and real wages have improved on account of the fall in commodity prices.

However, said the report, fragilities persist: in many countries higher rates of employment have not been matched by better-quality jobs, and some banks are showing signs of weakness, while downside risks have increased with the uncertainty over the sustainability of debt in Greece.

“The latter represents the most immediate threat to the sovereign debt yields of Portugal, Spain and other European countries which had recently started to recover from the depths of the crisis.”

In Japan, following the recession in 2014, economic activity is starting to improve, aided by consumer and investment spending. Lower energy prices will have a positive influence on the balance of trade and on consumption expenditure, as will exports to the United States, which rose in the first months of 2015.

The United States is expected to continue its post-crisis growth trajectory with a 2-2.5% growth rate, which is below previous recoveries but allows steady job creation. Fiscal austerity is easing at the federal and state levels, and residential investment is recovering from a low base.

However, said UNCTAD, with scant evidence of nominal wage increases, there are concerns that households’ balance sheets will remain fragile. Even if the expected very gradual increases in the policy interest rate do not represent a significant tightening of monetary conditions, they have already impacted international capital movements and led to a dollar appreciation. This in turn may result in net exports having a negative impact on GDP growth.

Outlook for developing world

Economic trends in developing economies have followed a different pattern since the crisis, said the report. In response to the initial shock in 2008-09, many developing economies applied ambitious countercyclical policies, including increased fiscal spending and incomes policy measures that were sustained long enough to encourage a continuing rise of household expenditure and, by extension, private investment.

Some of these countries are now scaling back or even reversing their policy stimuli as they face capital outflows or lower export prices. By contrast, for oil importers, the recent improvements in their terms of trade enlarge the room for manoeuvre.

Among those most affected by lower commodity prices and capital outflows have been the transition economies, whose GDP is expected to decline in 2015. In the Russian Federation and Ukraine, balance-of-payments problems were aggravated by political conflicts. Steep currency depreciation and inflation dampened domestic demand and deepened economic recession. This in turn affected neighbouring countries for which the Russian Federation is a major market and source of remittances.

In Latin America and the Caribbean, the economic slowdown which started in 2011 is forecast to continue, with an estimated growth rate of less than 1% in 2015. In particular, South America and Mexico have continued to experience losses in their terms of trade and reversals of portfolio investment inflows since the second half of 2014.

“Lower export prices have affected tax receipts and have also led to the paralysis of several investment projects, particularly some linked to oil exploitation and mining, and to a fall in gross fixed capital formation.”

Governments have generally sought to sustain real wages and keep unemployment in check despite the slowdown of economic growth. As a result, private consumption is still the main engine of growth for the region, though its rate of expansion was less dynamic in 2014 and early 2015.

The report said that the more stringent external environment, and in some cases the inability to maintain countercyclical policies and credit expansion, resulted in less supportive policies in the first months of 2015, and even austerity measures in the case of Brazil.

By contrast, most Central American and Caribbean countries benefited from lower oil prices and were also less vulnerable to speculative capital outflows.

“The linkages of their manufacturing sector with United States markets, together with the increase in remittances from abroad, should contribute to significant growth of these sub-regions, which is likely to be well above the regional average.”

The picture in the African region is also varied. In the last decade, growth in sub-Saharan countries has been mostly driven by rising private consumption and infrastructure spending, linked in many countries to commodity production, with a positive impact mainly on the construction and service sectors. Recently, however, some large oil-exporting countries such as Angola and Nigeria have announced cuts in public spending, notably capital investment and subsidies.

Meanwhile, growth in most East African countries, whose terms of trade have improved, is expected to continue at a relatively fast pace. By contrast, West African countries are likely to continue to suffer from the consequences of the Ebola epidemic. Economic growth is forecast to remain subdued in South Africa due to supply-side constraints in the energy sector, coupled with restrictive fiscal and monetary policies.

According to UNCTAD, as in previous years, Asia is the most dynamic region, and is estimated to account for almost half of total growth in the world economy in 2015.

“Growth is being driven essentially by domestic demand, with an increasing contribution of consumption, both public and private. Hence, even though investment rates have been very high in comparison with other regions (and should remain so, given the region’s infrastructure needs), most Asian countries (particularly China) seem to be rebalancing the structure of their demand.”

In the past few years, the contribution of domestic demand to growth has exceeded that of net exports, and the share of consumption (private and public) in GDP has tended to increase. However, the bursting of the stock market bubble in China has created economic uncertainty, as it could affect domestic demand.

Nevertheless, said UNCTAD, the growth of private consumption is essentially based on rising incomes rather than on credit or an appreciation of asset values, which should ensure sustainability.

Meanwhile, lower oil prices have eased current account deficits in several countries, such as India and Pakistan, and the Indian economy is forecast to expand by more than 7%.

In West Asia, Turkey also benefited from lower oil prices, but most of the oil-exporting economies in the sub-region face deteriorating terms of trade. In addition, military conflicts have reduced growth prospects in parts of this sub-region.

International trade trends

The report noted that like global economic activity, international trade remains subdued. Between 2012 and 2014, the rate of growth of world merchandise trade (by volume) oscillated between 2% and 2.6%. These growth rates are significantly below the average annual rate of 7.2% recorded during the 2003-07 pre-crisis period.

In 2014, world merchandise trade at current prices grew at even lower rates (only 0.3%, to reach $19 trillion) due to the significant fall in the prices of major commodities.

Preliminary estimates for 2015 indicate that merchandise trade volume could grow at a rate close to that of world output. This remains largely insufficient to provide, by itself, a significant stimulus to economic growth.

Data for the first five months of 2015 indicate that growth in world merchandise trade in 2015 may be slightly weaker than in 2014. During these five months, the volume of international trade grew by a year-on-year average of less than 2%.

Overall, said the report, world trade has displayed little dynamism. The moderate trade growth mainly reflects an improvement in North-North trade, with only limited positive effects on exports from developing to developed countries.

On the other hand, according to UNCTAD, trade in services maintained its growth, to reach $4.9 trillion in 2014 – a year-on-year increase of 5.1% (at current prices), which was higher than the growth of merchandise trade.

Transport services grew by 2.7% while travel and goods-related services increased by 6% and 2.8% respectively. Transport and tourism represent 55% of services exports from developing countries and 62% from least developed countries (LDCs), compared with only 39% from developed economies.

Turbulence in commodity markets

According to the report, commodity markets witnessed turbulent times in 2014 and the first half of 2015. Most commodity prices fell significantly during the course of 2014, continuing the downward trend from their peaks of 2011-12. The most dramatic fall was that of crude oil prices since mid-2014, which had widespread influence.

The report said the main reason for the recent fall in most commodity prices has been abundant supply, as the investment response to the price boom of the 2000s has significantly increased production over the past few years.

The resulting tendency towards oversupply has been reinforced by weakening demand due to sluggish growth in the world economy more generally, and the recent slowdown in a number of large developing economies in particular.

Apart from supply and demand fundamentals, the financialization of commodity markets continued to influence price developments, as financial investors have been reducing their commodity positions in conjunction with the downturn in prices and returns from commodity derivatives.

Another important factor in the commodity price decline has been the strong appreciation of the dollar over the past year.

According to the report, the market for crude oil took the lead in commodity price developments in 2014. After having remained at a relatively stable level since April 2011, with oscillations within a $100-$120 band, crude oil prices plummeted in the second half of 2014. For example, the price of Brent crude fell from a monthly average of $112 (a barrel) in June 2014 to a low of $48 in January 2015. This decline of 56.7% pushed the price of crude oil to its lowest level since 2009.

The plunge in oil prices was mainly caused by greater world production, particularly of shale oil in the United States. In 2014, world oil production increased by 2.3%, while in the United States it grew by 15.9%. Indeed, in the short period between 2011 and 2014, United States oil production increased by 50.6%, reaching levels not achieved since the early 1970s.

The report said this led to significant increases in inventories. Substantially higher oil production in the United States contributed to the relative stability of oil prices between 2011 and mid-2014, as it compensated for production disruptions in other producing countries. When these disruptions became less of a problem and the oversupply more evident, prices started to fall in mid-2014.

However, the price decline accelerated after the November meeting of the Organization of the Petroleum Exporting Countries (OPEC) where it was decided not to change production quotas, a decision upheld at the subsequent OPEC meeting in June 2015. “This has been widely interpreted as an attempt by OPEC to defend its market share and to undercut higher cost producers, such as shale oil, tar sands and deepwater oil producers, so as to drive them out of the market.”

Overall, said UNCTAD, international crude oil markets present a new landscape, with the increasing importance of production in the United States and an abandonment of OPEC’s price-targeting policy. As long as this persists, the United States could replace Saudi Arabia as the key swing producer.

This would mean that when prices fall to very low levels, investment and production in the United States could be cut, pushing prices up; and once prices reached a certain level, United States oil production could rise, thereby exerting a downward pressure on prices.

Indeed, a significant characteristic of shale oil drilling is its flexibility. As a result, there would be an upper cap on oil prices which would depend on the break-even price of profitability for shale oil producers.

“However, there appears to be little agreement on what that price is. In sum, it is not likely that prices will approach $100 per barrel any time soon. As shale oil production has a short life span, this will depend on how long the shale oil boom lasts.”

On the demand side, expectations of lower economic growth also played a role in the collapse of oil prices. Indeed, specialized agencies made continuous downward adjustments to their projections for demand growth.

“In any case, the reversal of the upward trend in commodity prices is a new reminder of the challenges faced by developing countries that depend on only a few commodities, as they are exposed to boom and bust cycles resulting from price changes. Therefore, to achieve and maintain sustained growth, it is crucial for them to implement policies that facilitate economic diversification and structural change.”

The phenomenon of “secular stagnation”

The report said that the observation that the growth trajectories of many developed countries have remained at substantially lower levels than before the crisis, despite several years of accommodative monetary policy, somewhat improved financial conditions and some relaxation of fiscal consolidation, has created a sense of a “new normal” that now defines the future evolution of incomes in developed countries.

The concern is that the crisis that erupted in 2008 may have had a long-lasting effect on the growth potential of these economies. This could be for a variety of reasons. One is that a financial crisis of this magnitude has necessarily affected the balance sheets of a wide range of economic actors – including private and public agents, financial and non-financial sectors – and it has generated significant spare production capacities.

Normally, these negative impacts are eventually overcome, although it may take several years, especially in the absence of appropriate countercyclical policies. However, this time there is a concern that the abnormally prolonged period of low investment and high unemployment will become self-sustaining because of their lasting repercussions in terms of reduced production capacities and productivity.

Another impact of the crisis may be more subtle: to the extent that it brought to a sudden end an extraordinary period of credit expansion that had supported asset bubbles and artificially boosted consumption and growth, it may have released a number of underlying factors that tend to hamper growth in the long term.

These pre-existing long-term factors, and not the financial crisis per se, would be the true cause of protracted slow growth. And rather than a cyclical downturn, developed economies could be entering into a period of “secular stagnation”.

According to UNCTAD, this has revived the debate on the drivers of economic growth dating back to classical economists such as Adam Smith, David Ricardo, John Stuart Mill and Karl Marx, which received a further twist in the “secular stagnation thesis” presented in the late 1930s by Alvin Hansen.

The Hansen thesis refers to “sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment”.

In his original analysis, Hansen stressed the problems of “inadequate private investment outlets” in the context of declining population growth, the relative ineffectiveness of monetary policy, and technological change that failed to stimulate substantial capital disbursement.

According to the report, all these factors were eventually reversed in the post-war period, not least because of massive public intervention – including deficit spending – which was a possible solution proposed by Hansen himself.

However, the sluggish recovery from the 2008 crisis, in which it is possible to identify traces of those very same elements, has led to a reappearance of “stagnationist” analyses in the public debate.

The modern twist on the “secular stagnation hypothesis” suggests that, since the crisis, the traditional macroeconomic toolkit, and especially monetary policy, has lost much of its effectiveness.

“With the deleveraging processes after the crisis, and nominal interest rates already close to zero, monetary expansion has not translated into increasing credit to finance private sector expenditures; instead it has been directed to investment in financial assets. High levels of indebtedness that adversely affect investment demand have been identified as an explanation for the sluggish growth rates in developed countries, which would also affect future performance.”

In the academic debate on the secular stagnation hypothesis, agreement has yet to be reached on whether in fact secular stagnation exists and, if so, which are its long-term or structural determinants.

Some hold that the deceleration of growth has been due to a combination of supply-side factors. According to them, the size of the labour force has diminished due to developed countries’ shrinking and ageing populations, and a hypothesized reduced speed of technological innovation is holding back productivity growth.

Also, especially in most severely crisis-hit countries in Europe, some governments have taken measures to increase the flexibility of labour markets and to reduce social benefits, aimed at addressing “supply-side constraints” in order to boost competitiveness, while maintaining contractionary fiscal policies for prolonged periods.

Other observers argue that secular stagnation reflects a decade-long tendency of inadequate aggregate demand growth. They attribute the major cause of secular stagnation to the lack of growth of labour incomes.

From this perspective, the decline in the wage share in developed countries by about 10 percentage points since the 1980s has considerably constrained income-based consumer demand, with attendant adverse effects on private investment.

These adverse demand effects resulting from worsening functional income distribution have been reinforced by widening gaps in the distribution of personal income, as the share in total income of the richest households has strongly increased, and these households tend to spend less and save more of their incomes than other households.

These trends have been strengthened by policies that seek to address the demand shortfall essentially through monetary expansion. However, instead of inducing firms to invest in productive activities, such a policy has resulted in firms investing in financial assets, which spurs asset price bubbles and worsens wealth distribution, without addressing income stagnation for the majority of the population.

Policy debate

According to the report, the related policy debate has been mainly concerned with whether private investment and aggregate demand growth can be best spurred by supply-side-oriented structural reforms or by demand-side-oriented fiscal and incomes policies.

The former approach is based on the belief that product and labour markets that are not sufficiently flexible discourage enterprises from increasing their fixed investments. However, to the extent that secular stagnation results mainly from weak demand, such a policy approach will tend to worsen rather than resolve the problem.

An alternative approach gives a prominent role to incomes policy (e.g., minimum wage legislation, reinforcement of collective bargaining institutions and social transfers) and to public expenditure to address weaknesses both on the demand and the supply sides. This is obviously the case for public investment in infrastructure.

Moreover, said the report, a progressive incomes policy increases demand, as it strengthens the purchasing power of social segments with a high propensity to consume. This in turn creates outlets for private investment, with multiple benefits: higher wage incomes and improvements in formal employment reduce the financial pressure on pension schemes and allow households to increase their consumption spending without adding to household debt. And higher levels of activity and employment are known to foster productivity as well, creating virtuous circles of demand and supply expansion.

Thus, said UNCTAD, fiscal expansion and income growth will increase output and at the same time accelerate potential output growth, thereby animating a virtuous feedback relationship that lays the basis for future sustained, non-inflationary growth. International coordination would multiply these invigorating effects while preserving balance-of-payments sustainability.

The implications of this debate for developing countries are significant, said the report.

A protracted period of stagnation in developed countries would weaken demand for exports from developing countries, affecting both output growth and productivity, and eventually generate balance-of-payments problems in these latter countries.

Furthermore, the choice of monetary expansion as the main instrument for fostering demand, coupled with prevailing unregulated capital movements, generates volatile financial flows to emerging economies of magnitudes that are well above the latter’s absorptive capacities.

“Unless developing countries are able to apply macroeconomic and prudential policies to check such financial shocks, they will enter into a sequence of asset price bubbles and debt-fuelled consumption sprees. The subsequent financial collapse and economic retrenchment could eventually lead to secular stagnation worldwide,” UNCTAD cautioned. (SUNS8107)       

Third World Economics, Issue No. 601/602, 16 September -15 October 2015, pp17-20