Last year, three key trends underpinned the fortunes of the global economy: the return to weak growth in the advanced economies, the decline of the emerging markets, and geopolitical uncertainty associated with a range of regional conflicts threatening to spill over into major global risk flash points. In that, 2016 is shaping to be just a repeat of the year passed.
The reason for this rather bleak conjecture is simple: the main global catalysts for growth are currently experiencing deep structural crises that are unlikely to be resolved in the short term. Any hopes for a stronger recovery in world GDP will require serious efforts to boost private sector demand across a number of countries, both at policy level and on the ground – in the real economy. In turn, this means reducing the unsustainable levels of public spending in the U.S., and Europe, as well as an expansion in the domestic demand in the key Emerging Markets – an exactly the opposite course to the one pursued in recent decades.
Latest IMF projections put global growth forecast for 2016 at 3.56 percent, down from 4.04 percent forecast a year ago. At the peak of post-crisis recovery in October 2012, IMF expected 2016 growth to come in at 4.51 percent. All in, over 2013-2015, the global economy lost some USD3.5 trillion in growth terms compared to the post-crisis forecasts.
The table below summarizes the downside trends in the recent forecasts across the Advanced Economies, including the Euro area, as well as the emerging markets. See table 1
US: From internal to external deleveraging
Analysts’ consensus view throughout 2015 has been that of the strengthening recovery in the U.S. economy. This consensus ignored the fact that U.S. GDP estimates reported a number of highly volatile prints.
For example, the first estimate of 3Q 2015 GDP growth of 1.5 percent was subsequently revised up to 2.1 percent on unexpected increases in business inventories. Similarly, 2Q 2015 growth was revised up from the initial estimate of 2.3 percent to 3.7 percent on weather effects and inventories. 1Q 2015 growth estimates ranged between -0.7 percent and 0.2 percent with upside provided by domestic demand. All indicators are, with full year growth estimates in 2.4 percent range with 2016 outlook for 2.7 percent expansion.
This compares poorly to the historical averages: for example, 1995-2007 average rate of growth in the U.S. stood at 3.2 percent per annum. Meanwhile, volatility in growth is not abating. In 2015, Bloomberg Economic Surprise index for 2015 is stuck at the lowest level in 16 years of the index history.
The poor performance comes on foot of an unprecedented monetary and fiscal expansion since the mid-20th century. Take a look at the key numbers. Back in 2008, U.S. Fed balance sheet was around US$900 billion. By the end of October this year, the balance sheet swelled to US$4.5 trillion. Between June 2006 and August 2007, U.S. Federal Funds rate stood at 5.25 percent. Today it is set within 0-0.25 percent range. Meanwhile, in 2008, U.S. Federal Government debt held by the private sector stood at US$5.8 trillion. Today it stands at US$12.8 trillion. The U.S. economy received roughly US$10.5 trillion between the end of 2008 and the end of 2015. Over the same period, average annual increase in the U.S. nominal GDP stands at US$464.3 billion or just about a quarter of the average annual stimulus expended.
The reasons for this massive failure of the monetary and fiscal stimuli to raise the U.S. growth off the downward trend are structural: high debt, and private demand and supply stagnation.
I wrote previously in this column about the thesis that U.S. economic growth is now permanently lower because of demographic and demand-driven imbalances between savings and investment; and the supply side drag on growth stemming from flattening returns to technological innovation. However, what is worth stressing here is that the threat to the global growth from the U.S. growth weaknesses over the next few years will be coming via the external deleveraging of the U.S. economy.
Take a look at a simple fact presented in the Table 2 below: since 1983, there has been only one year (1991) when the U.S. did not run a current account deficit. The leveraging of the U.S. economy, including through trade, household demand and corporate tax “optimizations” was a consistent driving force behind the miracle of global growth for a good part of the last three decades. See table 2
However, if in 2004-2008, U.S. current account deficits averaged 5.3 percent of GDP, over 2014-2016 the average deficit is expected to average less than 2.6 percent of GDP.
The need for external deleveraging via reduced current account deficits is amplified by the public sector expansion in the U.S. over recent decades. Since the beginning of the century, accumulation of public and private debt in the U.S. has been associated with increasing share of government spending in the economy and rising rates of tax extraction, depressing potential for private investment and savings growth. Thus, in 2000 – at the cusp of the previous business cycle – government spending amounted to roughly 31 percent of the total economic activity in the U.S. In 2015, this figure stands at closer to 36 percent and it expected to remain above 35 percent through 2020.
In other words, the U.S. economy’s ability to carry the weight of global growth on its shoulders has been diminished severely.
Europe: Life on perpetual life support
With the U.S. growth engine running on fumes, the European economy still remains on life support of ECB interventions and creative accounting dressage. Year on year, Euro area’s GDP expanded at 1.6 percent in 3Q 2015, prompting analysts to cheer acceleration in growth. However, in quarterly real GDP, growth has steadily declined throughout 2015 from 1Q 2015 0.5 percent to 2Q 2015 0.4 percent and to 3Q 2015 0.3 percent. In 3Q 2015, quarterly rate of growth was above 2Q 2015 levels in only six out of 21 European countries reporting. Meanwhile, domestic demand remains below pre-crisis levels.
The uneven pace of European recovery is now translating into continued disparity in policy responses by the member states. While Germany and so-called Euro area “core” states continue the course of internal devaluations, the rest of the Euro area member states are busy scheming to engineer relief from fiscal austerity. The ECB is accommodating this by superficially depressing the cost of government debt and propping up the demand for state bonds.
The result? In 2005-2006, state spending averaged 45.2 percent of GDP in Germany, 47.4 percent in Italy and 52.7 percent in France. In 2015-2016, this is forecast to average 43.7 percent in Germany, 50.3 percent in Italy and 56.7 percent in France. While Germans are saving, French and Italians are spending in a repeat of the pre-crisis scenario. In line with this, investment as a share of GDP, having averaged 22.4 percent across the Euro area in 1995-2007 will fall to an average of 19.3 percent over 2015-2017.
As in the U.S., European government spending appears to be crowding out private activity.
Meanwhile, global economy’s slowdown is hitting hard at the heart of the EU’s exports-led recovery strategy. Over 1995-2007, Euro area exports of goods and services grew on average 6.81 percent per annum. In 2016, the IMF forecasts growth of 4.57 percent. Which means that just as the U.S., Europe is heading into external deleveraging. Over 12 years prior to 2008, the Euro area ran an average current account deficit of 0.33 percent of GDP per annum. In 2015-2017, it is expected to run an annual average current account surplus of 3 percent.
The only way Europe can square shrinking exports growth and rising current account surpluses is by keeping domestic demand low for years to come. In other words, Europe will be beggaring its neighbors in the global economy.
Worse, sustained high unemployment, economic and social disenfranchisement of younger voters, lack of prospects for the recovery – all are now translating into political turmoil brewing within European electorates. Europe’s response to this? Attempts to reignite territorial expansionism (in Ukraine and Turkey), whilst promoting greater integration within the EU. The former efforts are running across geopolitical faultiness exposed by conflicts with Russia and the ongoing migration crisis. The latter are running across deep divisions between the “core” and the “periphery” on such issues as risk sharing, financial and economic cooperation and faster regulatory harmonization.
The end result is that Europe has spent the last eight years lumbering from one existential crisis to the next, from the Global Financial Crisis, to the Great Recession, to the Sovereign Debt Crisis, to the latest Migration Crisis. The EU’s response to the latest crisis is to attempt to shore up the external borders of the neighboring states. This was illustrated in November by the EU deal with Turkey. Judging by the Italian and Greek expenditures on attempting to control their own borders and taking this cost across other border countries that act as a major conduit for passage of refugees, Europe is looking at spending a good part of one-fifth of the entire EU budget on “securing” the borders. The funds will have to be taken out of the private economy, further raising taxation and lowering the economy’s productive capacity.
Emerging markets: An engine that choked
Which brings us to the last bastion of hope for global growth jump start: the core Emerging economies. Alas, these too are now firmly in the grip of a downturn.
Russian economy is shrinking at a rate of 3.7 percent (January-September 2015) in its first recession since 2009. Forecasts for 2016 growth are ranging from -1 percent to +0.7 percent, so even at an optimistic end of these figures, the economy looks more like a stagnation giant than a growth engine.
Brazil is in its third quarter of continued recession with 3Q 2015 output down 4.5 percent year on year. Collapse in commodity prices and ongoing fiscal contraction on foot of a massive overspend by the government in recent years have turned one of the world’s more dynamic economies into a proverbial basket case. Still, government deficit is set to hit 9.5 percent of GDP by the year end, and the country’s growth pipeline is now narrower than in the 2009-2011 period.
Much has been written about the slowdown in China, but Chinese economic growth now looks set to fall to 3.8-4 percent in 2015, based on independent analysts estimates, instead of reaching the official target of 7 percent. What 2016 might hold for the world’s second largest economy is anyone’s guess. However, given financial and real estate market imbalances accumulated over the recent decade of debt-fuelled growth, the prospect of a robust recovery seems less likely than the prospect of a deeper slowdown.
India – the brightest star on the BRICS horizon is also stalling, for now unnoticed by many analysts. Going into 2016, India Business Outlook survey collected by Markit, posted “the weakest degree of optimism among private sector companies since composite data were first available in October 2009.” India’s PMIs are now skirting the dreaded zero growth line and have posted consecutive monthly declines since the local peak in December 2014. This is especially worrying, given that the previous spurt of growth came on foot of large-scale monetary and fiscal expansions. The former is now feeling inflationary concerns that will most likely cap any future monetary stimuli. The latter has just run into the brick wall of high deficits, with government net borrowing in 2015-2017 expected to average some 7 percent of GDP.
In November, S&P put the government of South Africa on notice that the country is on an unsustainable economic policy path. The South African economy has been narrowly avoiding an official recession over the last couple of years. 3Q 2015 GDP print came in at a disappointing 0.7 percent, undershooting markets consensus forecast for a 1.1 percent expansion. This growth comes on top of 1.3 percent contraction in 2Q 2015. In line with this, full year growth forecasts have been cut from 2 percent back in February to 1.5 percent in November.
Meanwhile, Africa’s largest economy, Nigeria, is doing fine on the surface with 2.84 percent GDP expansion in 3Q 2015, having posted 2.35 percent growth in 2Q. Which is the glass-half-full story. The glass-half-empty bit is that this growth rate was a massive 3.4 percentage points below 3Q 2014 print. Excluding oil production, Nigerian growth over 3Q 2015 was 4.45 percentage points below 3Q 2014 and underperformed 2Q 2015 figures. In other words, Nigeria is facing a risk of growth slowdown both in terms of oil revenues and non-oil activities.
The world without a growth axis
In simple terms, heading into 2016, global economy lacks catalysts for growth. No matter how we spin the data, neither the traditional drivers (the U.S. and the emerging economies), nor the previous laggards (the Euro area) are capable of lifting global growth off the historically low growth trend. As the chart below highlights, this dilemma is well-reflected in the historical forecast revisions. See figure 1
The core point of concern here is that under the “normal recovery” projections, world economic growth should have been at around 3.5-3.6 percent some two years ago. The latest projection put this benchmark out to the end of 2016.
Much of the global growth gap is made of weaknesses in the private sector spending and investment present across the advanced economies – the very same spending and investment activities that are the key drivers for global trade and demand for goods and services supplied by the emerging markets. In contrast to the prevalent Western anti-austerity narrative, these weaknesses are driven by the over-taxing of the real economy by the public sectors. If political leaders want 2016 to be a year of real change in the global economy, they might consider replacing rosy forecasts from captive analysts with lower tax burden on entrepreneurs and savers.