By David Dapice*
As the year that saw the world’s strongest economy brought to the precipice of a default comes to a close, and many wonder if 2014 promises more stability? Judging by most forecasts, including that of the International Monetary Fund, the global economy may grow about 3.5 percent, but confidence in that forecast is subject to more than usual hedging due to several policy unknowns and uncertainties.
As unemployment in the developed world remains steady and growth in the emerging economies dependent on lackluster performance of the industrialized economies, a question mark hangs over economic prospects worldwide.
Start in the United States. The gradual start to tapering by the Federal Reserve – the slowing of massive purchases of mortgages and government bonds to increase liquidity and hold down interest rates – was announced middle of December and could have worldwide impacts. A suggestion by Federal Reserve Chairman Ben Bernanke in May 2013 that a slowdown was imminent caused bond yields to jump and credit flows to several debt-prone emerging economies to reverse. Purchases will now be reduced from $85 billion monthly to $75 billion.
While Janet Yellen, nominated as Fed chief, may be more concerned than Bernanke with unemployment, it’s unclear what the impact of tapering will be. Demand for investment is slack, caused in part by fiscal restraint and, perhaps, the incentives for CEOs to maximize their stock prices quickly through buybacks rather than through longer-term investments. It will be difficult to slow and end this ongoing policy without creating global financial instability.
Liquidity vs. financial instability
In addition to monetary uncertainty, the U.S. fiscal battle to reduce the deficit or implement constructive spending could face partisan gridlock. Yes, Congress approved a two-year budget in December. But government spending is still hamstrung. Congress resists infrastructure investment to repair rusting bridges and approves large corporate farming subsidies while cutting unemployment benefits and food stamps, to list just a few examples.
The rocky health-care rollout has thrown a sixth of the U.S. economy into turmoil, and the risk of a default on U.S. debt, while reduced, is not removed. This uncertainty reduces corporate confidence and depresses investment, as low-cost debt and corporate cash flow buy up shares rather than build new factories.
Five years after the initial downturn, growth remains subdued, though higher than Europe’s, and job creation is stubbornly low. Hopes of stronger export growth are fading due to economic weakness among major trading partners. Government spending will remain weak but because the cuts will be reduced, it will not diminish overall demand so much as in 2013. Most states are no longer cutting budgets, and this will partly offset the federal restraint.
Both the Eurozone and Japan are expected to grow about 1 to 1.5 percent next year, and both face policy challenges. European banks remain loaded with shaky government and private debt supported by extraordinary measures of the European Central Bank, while Japan must cut back on its expansionary monetary and fiscal policies and implement politically difficult structural reforms in its rapidly aging society. Political turmoil in Europe’s Mediterranean economies could cause further problems, but so long as the Germans allow the ECB to continue preventing collapse, slow progress is likely.
China remains a major question mark. Its growth of 7 to 8 percent has been a factor in keeping global demand relatively buoyant and helped raw material exporters in the Americas, Africa and Australia. However, weak banks, growing social expenditures and tapering of excessive investment along with slowing to zero labor force growth should mean somewhat slower growth in the medium term. Most expect 7 percent growth to continue in the next few years, but anti-pollution measures could restrict energy use or increase costs.
Consequences of sustainable growth in USA and China
Many major emerging economies, such as India, Brazil and Indonesia, rely on borrowing and the latter two on raw material exports. If the Fed tapering and Chinese transition to more sustainable growth happen together, these economies would slow more than the modest growth gains currently projected. This is a downside risk. While Indonesia recently cut fuel subsidies, the approaching election could slow policy responses; political scandals in Brazil could also impair strong responses to policy challenges. India remains in a slowing mode due to a weak currency, inflation and policy paralysis facing outsize budget deficits. Whatever reforms were attempted, implementation remains frozen pending the spring 2014 election.
Other developing nations rely either on manufactured or raw material exports. Both are likely to be somewhat subdued due to China’s switching its growth away from resource-heavy investment to consumption as well as the slow growth and aging of rich nations. However, somewhat higher growth is expected next year for most less developed countries.
If forecasts work out and the rich countries average 2 percent growth in 2014 while the emerging economies average 5 percent, the expected 3.5 percent growth would be realized – a rate similar to what the world experienced from 1995 to 2004, except the 3.5 percent is reached by the higher weight of the emerging economies offsetting slower growth of rich nations. So, the world is back to normal despite problems in half of its GDP!
Slowdown in global trade
This change shows up clearly in the slower growth of trade. From 1995 to 2004, the volume of rich country exports grew at 6.4 percent a year, while from 2012 to 2014 the growth falls to 2.9 percent. Nonfuel emerging economies once grew at 10.2 percent a year, but their exports grow only half as much from 2012 to14. Imports follow broadly similar patterns. It’s true that 2014 shows improvement – 4.7 percent for rich exports and 6.7 percent for the emerging countries. Still, global trade has slowed dramatically, in total and relative even to slower GDP growth. This slowdown is part of the reason for sluggish job growth in many parts of the world, along with lingering credit problems, aging populations and overall weak demand.
If unexpected monetary or fiscal shocks occur, the downside risks the IMF refers to would appear. Because of excess capacity and unemployment, there is scant fear of inflation despite trillions of dollars of excess liquidity and negative real interest rates. Some opine that bubbles are forming in financial markets – at least on a price/sales basis if not a price/earnings metric. Profit/GDP ratios are at all-time highs.
A sharp decline in stock prices would likely depress global growth, although ownership of financial equity wealth is so concentrated, it’s not clear that significant direct pain would be widely felt. The Fed must continue to weigh, should interest rates rise and allow positive returns for savers or should owners of equities, fewer in number than holders of bank savings accounts, be pampered with special liquidity programs, which also benefit highly leveraged banks and other big investors, but may not boost jobs much?
Economists and others debate whether the world’s sustainable growth rate is falling or not. Putting aside hugely relevant environmental concerns, the answer may be that aging populations, slower technical change as expressed in productivity and structural transfer problems suggest that growth is slower for now. Perhaps the rich world will grow more slowly than it did even a decade or two ago, while China and perhaps India also slow. That leaves many billions of workers and consumers who may still outstrip their recent past, but their weight in total GDP is modest. Unless the rich find ways to grow faster, the world will probably face modest growth for a while until the weight of the faster growing emerging economies finally starts to be felt more.
David Dapice is associate professor of economics at Tufts University and the economist of the Vietnam Program at Harvard University’s Kennedy School of Government. This article was first published on December 20, 2013 with the headline Worries About the World Economy for 2014 on Yale Global.