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Global economic review 2015/16: a new mediocre?

The IMF forecasts global economic output to grow by 3.6 percent in 2016, an improvement over world GDP growth rates in 2014 (3.4 percent) and 2015 (3.1 percent).

Most regions of the world economy face modest increases in economic growth from 2015 to 2016: Latin America/Caribbean (-0.3 to 0.8 percent),Middle East/North Africa (2.5 to 3.9 percent),Sub-Saharan Africa (3.8 to 4.3 percent),Former Soviet Union (-2.7 to 0.5 percent).Even the sluggish advanced industrialised economies are expected to register small GDP growth gains in the coming year: Euro zone (1.5 to 1.6 percent),Japan (0.6 to 1.0 percent),United States (2.6 to 2.8 percent).

However, the mildly optimistic IMF forecast for 2016 signals the continued under-performance of the global economy, six years after the 2008–09 crisis. GDP growth rates staged a strong rebound in 2010–12, then tailed off to levels below those of the pre-recession period. Economic growth in Emerging Asia approached 10.0 percent in 2010, then slowed to 6.5 percent at mid-decade – still strong in comparison with the developed economies of Asia, Europe and North America, but well short of expectations during the early post-recession years. The IMF projects Emerging Asian growth to stabilise at that level through 2020, dampening hopes that the East Asian region will serve as the engine of the global economy.

These weak GDP growth numbers heighten fears that the world economy is settling into a ‘new mediocre’ of slow growth, stagnant incomes and pervasive unutilised capacity.

This report analyses five factors hindering global economic growth:

  • Weak recovery of developed market economies
  • Economic slowdown of emerging markets
  • Rising international debt
  • Declining global commodity prices
  • Slow growth of international trade

Weak Recovery of Developed Market Economies

The uptick in Euro area growth in 2016 illustrates (1) the transition from fiscal consolidation to growth-friendly policies, (2) the stimulative effects of the European Central Bank’s quantitative easing programme, (3) the fall in oil and gas prices that benefits energy-dependent Euro zone countries, and (4) shifts in the Euro/USD exchange rate that boost the competitiveness of transatlantic exports.

The improvement in Euro zone growth also reflects the waning threat of financial crisis following the spring 2015 confrontation with Greece. Greece retains its standing as the poorest performing economy in the developed market group (1.3 percent contraction in 2016),and that country’s medium- and long-term prospects remain very guarded.

However, fears of financial collapse in the other PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) have ebbed. Ireland is forecast to grow by 3.8 percent in 2016, the highest GDP growth rate among the developed market economies. Spain is projected to continue its slow, but steady, rebound from the downturn of 2009–13. While Italy and Portugal face weak growth rates in 2016 (1.3 and 1.5 percent respectively),those countries appear to have weathered the fiscal crises of the early decade.

Meanwhile, non-Euro EU countries exhibit solid if unspectacular growth rates: Sweden 3.0 percent, United Kingdom 2.2 percent, Denmark 2.0 percent.

Outside the European Union, developed market growth rates in 2016 range from Israel (3.3 percent) to Japan (1.0 percent). South Korea (3.2 percent),Australia (2.9 percent) and United States (2.8 percent),who are situated in the upper range of the developed market group. Norway (beset by falling hydrocarbon prices) falls near the bottom at 1.3 percent.

Economists have advanced two hypotheses to explain the lagging growth of the developed market economies in the post-recession period:

First, the global economic crisis of 2008–09 (whose depth and magnitude were unmatched since the Great Depression of the 1930s) created lasting structural effects that hinder national economies from resuming pre-recession growth levels. An example of this phenomenon (hysteresis or secular stagnation) is the exit of discouraged unemployed/underemployed workers from the labour force, limiting the economy’s long-term output potential.

Second, weak productivity growth (critical for advanced industrialised countries with low fertility rates and diminishing returns to capital) prevents the developed market countries from achieving robust GDP growth. According to the IMF, the developed market group has experienced lower productivity growth in 2008–14 than in 1995–2007, reflecting: (1) low levels of productivity-enhancing investments following the Great Recession, and (2) the exhaustion of the productivity gains of prior innovations in ICT and other technologies. Notable exceptions to this trend are Singapore, Taiwan and South Korea. The high savings rates and strong education systems of these East Asian economies facilitate investments in technology and human capital. (See David Bartlett,‘Productivity Growth in the Developed Economies’, RSM Talking Points, March 2013.)

Economic Slowdown of Emerging Markets

The emerging market group continues to enjoy an economic growth premium over the advanced industrialised countries (4.5 vs. 2.2 percent). Moreover, long-term structural changes signal the rising importance of emerging markets in the 21st century world economy: expanding shares of world GDP; rising prominence in global finance, trade, and investment; growing capacity for technological innovation; and impressive endowments of human capital.

However, the recent deceleration of emerging economies underscores their increasing vulnerability to adverse shifts in the world economy. China, which reached 10.6 percent growth in 2010, slowed to 6.8 percent in 2015. The IMF forecasts Chinese GDP to stabilise around 6.3 percent in 2016–2020 – a clear indication that the era of double-digit growth in China is over. Some analysts believe that even this downward calibrated GDP growth forecast exaggerates the actual rate of economic growth in China.

China’s economic slowdown reverberates in other emerging markets, depressing Chinese demand for emerging market exports and dampening foreign investor enthusiasm for emerging markets. A number of emerging markets display modest growth rates heading into 2016: Turkey 2.9 percent, Colombia 2.8 percent, Mexico 2.8 percent, Hungary 2.5 percent, South Africa 1.3 percent.

The Russian Federation, Brazil and Venezuela face continuing economic contraction in 2016, demonstrating the impact of falling hydrocarbon and raw materials prices. Other emerging markets less dependent on global commodity trade enjoy stronger growth prospects in 2016 (e.g. Malaysia, Poland, Vietnam).

At 7.5 percent, India has become the growth champion of the emerging market group, reflecting the Modi government’s pro-growth reforms and the windfall of declining oil and gas prices for that energy-import sensitive country.

The slowdown of the emerging markets results from a combination of factors: (1) weak export demand in the European Union, the principal trading partner of China and other emerging markets, (2) falling prices of global commodities, which constitute an out-sized share of the exports of resource-centric economies like Brazil, Russia and Venezuela, and (3) declining external capital flows signalling the foreign investor community’s mounting anxieties about emerging market investments, fears magnified by the August 2015 sell-off on the Shanghai Stock Exchange.

Rising International Debt

Much of the economic analysis of the Great Recession has emphasised the phenomenon of deleveraging, as over-extended households draw down debts accumulated during the pre-recession years. The deleveraging process has continued in many households in Europe and North America even as economic growth resumed in the late 2000s.

However, a recent empirical study by the McKinsey Global Institute (‘Debt and Not Much Deleveraging’, February 2015) shows that global debt has markedly increased in the post-recession period. Between 2007 and 2014, global debt grew by $57 trillion. Government debt and corporate debt exhibited the highest growth levels during this period (CAGR 9.3 and 5.9 percent respectively, against 2.8 percent for household debt).

Equally significant, emerging markets (widely regarded as bastions of stability amid the global financial turmoil of 2008–09) have been major contributors to the international debt expansion, accounting for nearly half of new debt issued globally between 2007 and 2014. From USD 7.4 trillion, debt in China reached USD 28.2 trillion in 2014. By that year, China’s debt:GDP ratio reached 217 percent, surpassing that of Germany and approaching the debt:GDP ratios of other developed economies like the United States and the United Kingdom. Non-financial corporate debt now comprises the largest share of Chinese debt.

Other emerging markets (Hungary, Malaysia, Thailand, Slovakia, Chile, Poland, et al) indulged in a borrowing binge in the easy credit years following the Great Recession. A large share of these emerging market debts are corporate bonds, which have become the world’s fastest growing fixed income class. Approximately 30 percent of emerging market corporate bonds issued in 2014–15 are denominated in hard currency, of which US dollar issues represent more than 80 percent. The Institute of International Finance estimates that USD 375 billion of USD-denominated corporate debt will mature in 2016–18, with another USD 360 billion maturing in 2019–21. (See David Bartlett, ‘Economic Headwinds Facing Emerging Markets’, RSM Talking Points, September 2015.)

The surge in USD-denominated emerging market corporate debt renders borrowers vulnerable to shifts in interest rates and exchange rates. That scenario is now coming to pass: the depreciation of emerging market currencies against the dollar – combined with the impending rise in interest rates as the US Federal Reserve ends its quantitative easing programme – raises the costs of debt service by emerging market borrowers and heightens the international financial community’s concerns about the financial stability of emerging markets.

Declining Global Commodity Prices

The dramatic fall in oil prices is a seminal event with major repercussions for the world economy. From USD 146/barrel in June 2008, the price of crude oil reached USD 46/barrel in October 2015. This development reflects both demand-side factors (reduced consumption following the Great Recession and improved fuel efficiency of motor vehicle fleets) and supply-side factors (increased production of oil in North America resulting from advances in hydraulic fracturing and other recovery techniques).

At the microeconomic level, the decline in oil prices (together with the fall in natural gas prices) has clearly benefited hard-pressed consumers and energy-intensive manufacturers. At the macroeconomic level, the shift in hydrocarbon prices has lifted energy importing developed countries (e.g. Japan) and benefited emerging markets dependent on fossil fuel imports (e.g. India).

But the fall in oil and gas prices has proven disastrous for hydrocarbon-driven economies like Russia and Venezuela. Other oil exporting countries (Kazakhstan, Saudi Arabia) possess fiscal buffers that better enable them to withstand declining hydrocarbon revenues.

The fall in oil and gas prices mirrors broader shifts in global commodity prices. Following a steep plunge during the global downturn of 2008–09, commodity prices staged a recovery in 2010–11. But global commodity prices then softened. All four non-fuel commodity groups (food, beverages, agricultural raw materials, metals) are forecast to register price declines in 2015–16.

Like the drop in oil and gas prices, the fall in global prices of non-fuel commodities benefits hard-pressed households, materials-intensive manufacturers, and natural resource-poor economies. However, the shift in global commodity prices heightens pressure on resource-intensive emerging markets. Food products represent out-sized shares of the exports of a number of countries in Latin America and Sub-Saharan Africa (Honduras 60.0 percent, Ghana 50.2 percent, Ivory Coast 44.7 percent, Nicaragua 42.7 percent, Cameroon 34.7 percent). Similarly, metal products (aluminium, copper, iron ore, nickel) constitute large portions of emerging market exports (Zambia 72.4 percent, Guinea 61.4 percent, Tajikistan 51.6 percent, Mauritania 47.2 percent, Niger 38.0 percent).

Even the advanced emerging markets of South America with well developed manufacturing and service sectors are heavily dependent on commodity exports (Chile 61.2 percent, Peru 60.6 percent, Colombia 58.5 percent, Argentina 49.8 percent, Brazil 45.3 percent). The high exposure of these economies to commodity price shifts is the key factor depressing their GDP growth paths in 2016.

Slow Growth of International Trade

The decline of commodity prices plays a significant role in the recent slowing of international trade. Cross-border trade in goods and services suffered a precipitous decline in 2009, followed by a sharp rebound in 2010–11. But the volume of international trade grew only modestly in 2012–15. Global trade is projected to expand by 4.1 percent in 2016.

Growth in the volume of exports by emerging markets outpaces that of developed markets (4.8 percent vs. 3.4 percent in 2016). However, the emerging markets group has incurred three consecutive years of declining terms of trade, which measures the relative prices of exports and imports. That trend is expected to continue in 2016, with the emerging markets projected to suffer a 1.0 percent decrease in terms of trade – underscoring the continued vulnerability of those countries to fluctuations in global commodity prices.

Amid flagging international trade growth and paralysis of WTO-led multinational trade liberalisation, leading trade countries have turned to mega-regional trade agreements like TPP (Transpacific Partnership) and TTIP (Transatlantic Trade and Investment Partnership).

The 12-member TPP envisages a regional trade zone that would represent 40 percent of global GDP and 26 percent of world trade. Framed as the ‘gold standard’ of regional trade accords, TPP aims to stimulate transpacific trade by lowering tariffs and non-tariff barriers, simplifying rules of origin, and harmonising national regulations. (See David Bartlett, ‘The Transpacific Partnership’, RSM Talking Points, July 2015.)

TTIP would create the world’s largest free trade area. Like TPP, the transatlantic pact would reduce tariffs and non-tariffs barriers to trade, including ‘behind the border’ restrictions on trade stemming from regulatory compliance costs and duplicative administrative procedures. TPP would also spur foreign direct investment between the US and EU by strengthening intellectual property rights, investor protections and dispute resolution procedures. (See David Bartlett, ‘The Transatlantic Trade and Investment Partnership’, RSM Talking Points, November 2014.)

Following five arduous years of negotiation, the TPP members consummated an agreement on 5 October 2015. Implementation of the pact hinges on ratification by member governments, where opposition is strong in some countries (notably the US Congress, which granted fast track trade authority to President Barack Obama after a fierce political battle in spring 2015).

The Obama Administration hopes that ratification of TPP will impart momentum to the TTIP negotiations, leaving the two mega-regional pacts as the bulwarks of a revitalised system of global economic governance to stimulate growth in a world economy whose recovery from the 2008–09 downturn has proven disconcertingly slow.

With the US presidential election looming, the politics of regional trade agreements will be a critical issue in 2016. The outcome of that debate will be a key factor determining whether the world economy settles into a ‘new mediocre’ of slow growth or enjoys a rejuvenation of growth driven by increased foreign trade and investment.

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