The surprising resilience of global economic growth

01.06.19 Publication:

This was supposed to be the year of the global economic slowdown, led by the United
States and Europe. More than 10 years after those regions’ recovery from the 2008 financial
crisis began, it looked to be time for a recession or slowdown, especially with a trade war
under way between the world’s two largest economies, the United States and China. So the
big surprise of 2019 is that the slowdown has not really happened.

One main reason for the surprise is that a central part of the logic behind the idea
that a slowdown or recession must be imminent was mistaken. It was based on the
experience of other slowdowns and recessions during the postwar era. But conditions today
are different, because the 2008 financial crisis has made them different.

Previous postwar slowdowns took place when rising price inflation forced central
banks to raise interest rates sharply. This raised borrowing costs for the private sector,
including households, and sometimes caused difficulties for banks as default rates by their
borrowers typically rose. Thus, an economy that had been over-heating, with demand
growing more rapidly than the productive capacity of the economy could cope with, had to
be cooled down, deliberately. Sometimes this happened in a smooth way, sometimes not.

Admittedly, last year the Federal Reserve Board in the United States has been raising
its interest rates and its counterpart in Europe’s euro zone, the European Central Bank, has
announced that it is ending its programme of direct expansion of the supply of money
through quantitative easing. So some cooling down has been taking place.

Yet these actions have not been made in response to rising price inflation, unlike in
the past. In America’s case, the Fed’s interest rate rises during 2018 were a response to a
tightening labour market but there had been no evidence of upward pressure on wages. In
Europe’s case, unemployment has fallen but is still high at 6% in the euro zone, with levels
of 10% or higher in France, Italy, Spain and Greece.

In truth, these moves to tighten monetary policy slightly represent efforts to begin a
process of normalisation of financial conditions. Low and often negative interest rates have
produced considerable distortions in financial markets, a problem with which Japan and
Japanese corporations are highly familiar. But such moderate efforts at normalisation can
easily be paused or even reversed. That is what the Federal Reserve is doing now.

In both Europe and the United States, there remains quite a lot of slack in the
economy and so plenty of scope for further growth. Labour-force participation rates in the
United States, which have been fluctuating around 65% of 15-64-year-olds, are far below
levels in Japan or Western Europe. High unemployment in Europe is also accompanied by
unusually large numbers of workers on part-time and short-term contracts. So the likelihood
of inflation is low. Brexit is a source of uncertainty, but most firms have made their
preparations for it already.

This abundance of spare capacity is the likely explanation for why economic activity
on both sides of the Atlantic has been stronger in the first four months of 2019 than many
forecasters had expected. Moreover, the Chinese economy, which has a noticeable effect
on manufacturing and capital-goods exporters such as Germany and Italy, has also                                                      rebounded in recent months, thanks to the relaxation of Chinese government restrictions                                                          and some new stimulus to lending.

The question, of course, is what these rebounds mean for the rest of 2019 and for
2020. What they in particular mean is that neither of the big negative factors of rising
central bank interest rates or the US-China trade war has proved powerful enough to cause
a proper recession or stagnation.

Even though new, more aggressive tariff hostilities have now broken out between the US
and China, we can expect the trade war to remain an important but marginal factor in the
global economy. It is and has been a negative force, but not decisively so. Official interest
rates will likewise have a marginal influence.

Higher oil prices are another potential source of difficulty. America’s decision to
tighten sanctions on Iran have led to a new rise in international crude oil prices. But at
around $70 per barrel for Brent crude, they remain well below the $85 level seen during
late 2018. If they rise back to $85 or more, this will have a contractionary effect on oil-
consuming countries such as Japan and Europe and may dampen US growth as well. Yet
there is no known reason to believe that a new jump in oil prices is likely.

Consequently, I think we can say that the economic outlook for 2019 and 2020 is
quite benign. There will not be spectacular, exciting growth. But neither will there be a
recession. The outlook for business is for quite steady, quite stable growth.