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Despite IMF’s rosy headlines, world economy in for bumpy ride

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The International Monetary Fund’s recent World Economic Outlook brought some welcome good news about a global economy that has massively underperformed since the Great Recession.

By forecasting somewhat higher growth rates in the 3.6-3.7-percent range for 2017-2018, the fund was trying valiantly to put a positive face on a global economy that may see a cyclical uptick but faces many significant headwinds.

{mosads}The WEO says as much in its title, “Short-term Recovery, Long-term Challenges” and in its assessment of medium risk factors that threaten to make the recovery short-lived. Managing Director Christine Lagarde added a pithy comment that a “good recovery should not be wasted.”

 

So, what really ails the global economy and what clouds the landscape? Major concerns include generally weak investment levels, financial markets that have not regained their pre-crisis vigor and trade growth volumes that are forecast to fall significantly below GDP growth.

Much of current growth is a rebound from significant output gaps in the advanced economies and the result of an artificially promoted growth rate in China.

Nevertheless, plant and equipment investment has been below trend, perhaps due to global uncertainty, the specter of disruptive technologies or because capital can be used more effectively in financial markets. It certainly cannot be the case that interest rates are the constraint inasmuch as they have been at historic lows for 8 years.

Cross-border flows are well below their peaks and are now at the level compared to GDP that prevailed in the year 2000. There are ample pools of liquidity earning low returns, while there are massive needs in infrastructure and climate finance.

Those flows will be affected by reversals of quantitative easing in the U.S. that will raise interest rates and affect both exchange rates and debt repayment profiles in emerging market economies (EMEs).

The IMF notes the tightening of financial conditions as the first and possibly largest threat to a sustained recovery as well as the biggest problem for EMEs to contend with in addition to prevailing low commodity prices. 

Pundits such as Nobel Laureate Paul Krugman have noted as recently as the IMF-World Bank Annual Meetings last week that the glory days of robust trade are in the “rearview mirror” and that Global Value Chains (GVCs) have most likely plateaued.

This slowdown in world trade growth has many possible causes, including China’s rebalancing, new technologies that are less import dependent, a peaking of past advances in logistics and possible concerns about protectionism and demands for on-shoring.

This shift, regardless of cause, won’t be easily reversed and it will predictably put a drag on global growth.

In a world of slower growth, governments will need to use domestic policy levers to boost economic activity. However, there is a legitimate concern that public policy is currently under-equipped to do so. In the first place, many countries have failed to use fiscal policy instruments effectively or have chosen a low-growth policy mix favoring consumption over investment.

At last week’s Peterson Institute for International Economic conference, it was reported that former policy officials were pessimistic that governments had either the fiscal or the monetary tools in their arsenals to deal with a new economic slowdown.

Why? First, debt levels are high and there is little fiscal space. Second, after massive amounts of quantitative easing (QE), there is little ability to create more liquidity. In fact, QE is being reversed, which will drive up rates. Overall, even if there were political consensus in the U.S. or Europe or Japan, policymakers might not be able to prevent another significant downturn. 

More worrying, indeed, is the lack of any consensus. In the case of the U.S., still the world’s largest economy and the harbinger for others, the heightened skewing of incomes at the top, the high cost of health care and the fascination with military spending means that there is little room to spend on infrastructure, much less deal with impending problems of future job displacement due to disruptive technologies.

Even in Europe, where there may be more appetite for universal basic incomes, a notion now actively discussed in the IMF’s just released Fiscal Monitor, a combination of demographics, poor debt dynamics and resurgent nationalism may derail coordinated pro-growth efforts.

The condition of the world’s second-largest economy, China, is open to interpretation. There is significant evidence that growth is being pushed through excessively lax credit, and the IMF has warned that the levels of corporate debt in China are worrying.

The prevalence of weak state enterprises, ill-advised local and provincial borrowing and burgeoning shadow banking create a risk profile that would worry most policy officials in other countries. The spillovers of an adverse future financial event are potentially serious, even if the domestic impact is contained.

In this iffy environment, it is perhaps not surprising that productivity performance globally has been so weak. Most analysts discount the measurement issue and point to other reasons for the slowdown.

One fact is clear, however, and that is that the global economy is in for some rough patches, spurred on by new and disruptive technologies, threats to globalization, poor domestic policy choices and weaknesses of global management. In this picture, the IMF’s rosier outlook for 2017-2018 has to be taken with a grain of salt! 

Danny Leipziger is professor of international business and international affairs at George Washington University and managing director of the Growth Dialogue and the Growth Dialogue Institute. He is former vice president for poverty reduction and economic management at the World Bank and he was vice chair of the Spence Commission on Growth and Development.

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