Why has growth been so sluggish for so long? While it is easy to blame the 2008–09 financial crisis for all the current economic woes, global growth has been on a downward trend since 2000. The world economy is being dragged down both by supply-side and demand-side constraints.
The deceleration in long-term trend growth has been caused by two supply-side limitations: the big slowdown in labour force growth (in some cases into negative territory) and a sharp falloff in productivity growth. Since 2007, demand-side constraints have also been a problem. These include: debt and deleveraging in the developed world; the rapid decline in the pace of world trade; the excess-capacity-driven struggles in China’s construction, heavy manufacturing, and mining sectors; and distress in commodity-linked emerging markets and commodity industries.
Unfortunately, in this environment, there is limited scope for further demand-boosting policies—fiscal policy is hampered by past profligacy and limited tolerance for further fiscal reform, while monetary stimulus may be losing some of its potency, even though some central banks, such as the ECB, may provide more.
On the other hand, there could be a big payoff from supply-enhancing policies—sensible immigration policies that, for example, allow more skilled workers from overseas to enter the labour force; targeted investment policies that boost investment in new technologies and productivity; structural reforms that increase economic efficiency; the easing of regulatory costs and burdens; and the reduction of restrictions that inhibit provision of credit to smaller firms.
There is nothing inevitable about slow growth; however, it requires governments to enact sensible long-term policies rather than succumb to short-term political expediency.
Have the risks of another recession risen recently?
Lackluster growth increases the vulnerability to a shock—this is less of a problem for countries with solid growth in their domestic economies, including the United States, the United Kingdom, Germany, and India.
Perhaps one of the most surprising aspects of the current global picture is the stability of growth (2.5–2.7% since 2012) in the face of multiple shocks, including the Eurozone sovereign debt crisis, China’s rapid growth deceleration, collapsing commodity prices, and recessions in some large emerging markets.
The good news is that the usual “recovery killers” are a distant threat. First, with a few exceptions, policy tightening is not a danger to recoveries in most parts of the world—in fact, from a global perspective, monetary policy may become a little more stimulative in 2016. Second, the net effect of the commodity rout on global growth is still positive, albeit smaller than before. Third, asset bubbles (and the potential for them bursting) are not a significant hazard. Finally, while the risk of even slower growth in China is high, the impacts on the developed world and commodity-importing emerging markets is limited.
The one risk that could derail global growth in the near term is a big oil shock, triggered by an escalation of the Middle East conflicts—fortunately, the probability of such an event in 2016 is relatively low.
The bottom line is that the risks of even a mild global recession in 2016 are not especially high—no more than 20%.
Implications of a world stuck in low gear
The “rolling routs” in foreign exchange markets (beginning in 2013), commodity markets (beginning in 2014), and stock markets (beginning in 2015) are consequences of weak growth in the developed world and decelerating growth in the emerging world. These convulsions have exacerbated the problems facing emerging markets.
The severe problems in China’s heavy manufacturing and mining sectors have had an especially damaging impact on commodity markets and the economies of commodity-exporting countries, including Australia and Canada.
Attempts by commodity producers to cut production have had little impact on prices, as demand growth has been even weaker.
Anemic growth in global trade has added to the woes of export-led economies— a state of affairs that is unlikely to change much in the next few years.
The next year or two are likely to see a continuation of the trends we have seen since 2012, with developed economies doing a little better and most emerging markets continuing to struggle.
The risk in 2016 is that growth will remain stuck in low gear—between 2.5% and 3.0%.