The global economy is now projected to grow at 3.3% in 2019, down from 3.6% in 2018, according to the April 2019 edition of the IMF’s World Economic Outlook (IMF 2019). The IMF points out several developments that have prompted the downward revision of the global economy. This includes the escalation of US–China trade tensions, the need for credit tightening in China, economic stress in countries such as Argentina and Turkey, and disruptions to the auto sector in Germany caused by the introduction of new emissions standards.

Behind all the different reasons for the downward revision of global growth, there is one thing in common: rising uncertainty. Chapter 1 of the World Economic Outlook – which focuses on the prospects and policies for the global economy – mentions the word “uncertain” and its variants 36 times. Some of the references discuss the impact of uncertainty on global economic growth. For instance, the report notes that “amid high policy uncertainty and weakening prospects for global demand, industrial production decelerated… The slowdown was broad based, notably across advanced economies”. The report also points out that political uncertainties “add downside risk to global investment and growth. These include policy uncertainty about the agenda of new administrations or surrounding elections, geo-political conflict in the Middle East, and tensions in east Asia”. On the impact of uncertainty and trade tensions, the report notes that “higher trade policy uncertainty and concerns of escalation and retaliation would reduce business investment, disrupt supply chains, and slow productivity growth”.

Similarly, the IMF’s report also discusses the impact of uncertainty on economic growth for specific countries. For instance, the report points out that a downward revision for growth in the UK partly reflects the “negative effect of prolonged uncertainty about the Brexit outcome”. And for South Africa, the downward revision for growth reflects “continued policy uncertainty”.

Rising uncertainty – here, there, and everywhere

These references are line with the latest reading of the World Uncertainty Index (WUI). The WUI’s latest data shows a sharp increase in global uncertainty in the first quarter of 2019 (Figure 1).

 Figure 1 World Uncertainty Index (1996Q1 to 2019Q1, GDP weighted average)
Image: WUI

Uncertainty is rising in many parts of the world – in advanced, emerging, and low-income countries alike (Figure 2). Examples include uncertainty in Ireland regarding the outcome of Brexit, in Gabon related to President Ali Bongo Ondimba being admitted to the hospital after reportedly suffering a stroke, in South Africa around key policies, especially land reform, and in the Democratic Republic of Congo regarding the recent elections.

 Figure 2 Uncertainty in Democratic Republic of Congo, Gabon, Ireland, and South Africa (World Uncertainty Index 1996Q3 to 2019Q1)
Image: WUI

Implications of higher uncertainty

Higher uncertainty matters because it has serious consequences for the economy. For instance, in times of high uncertainty, companies may reduce investment and delay projects (Bloom et al. 2018, Dixit and Pindyck 1994). They do this because it is costly to reverse investment. So, they prefer to ‘wait and see’. Similarly, households reduce consumption as they wait for less uncertain times (Carrol 1997). Rising uncertainty also affects all sectors of the economy. It can increase the cost of credit to households and firms (Kelly et al. 2014, Gilchrist et al. 2010).

In our work, we find that increases in uncertainty foreshadow significant output declines. Based on our estimate, the increase in uncertainty observed in the first quarter could be enough to knock up to 0.5% of global growth over the course of the year. This average effect, however, masks significant heterogeneity within and across countries. Within countries, we find larger effects for sectors with higher financial constraints. Across countries, the effect is estimated to be larger and more persistent in countries with lower institutional quality (Figure 3).

Image: Panel B. Countries with above-median rule of law