August 2016 Issue
Since the onset of the financial crisis, the global economy has been beset with problems. Macroeconomic and geopolitical issues have impacted growth and commodity crashes have been damaging. Emerging markets, once hailed as the next global growth areas, have also failed, mired in economic and political chaos.
Over the last eight years, the state of national economies and the global economy has been at the heart of considerable debate and uncertainty. Governments and central banks have employed a number of measures to return economies to growth. Such measures have met varied levels of success and failure. Governments in many developed nations faced with economic hardship unleashed wave after wave of austerity measures, slashing public spending budgets in the process. Banks and financial institutions were subjected to greater fiscal regulation amid calls for improved responsibility and accountability.
However, the wisdom of the widespread austerity movement is increasingly called into question by a number of organisations, including the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD). As the OECD lowers global growth outlook predictions, it has warned that the global economy is in danger of being sucked into a “self-fulfilling low-growth trap”. Accordingly, the global economy will continue to stagger along at its slowest pace since the financial crisis for a second year in a row in 2016, the OECD claims in its biannual Economic Outlook report.
According to the OECD’s predictions, the reticence of businesses to invest, and the considerable caution being demonstrated by consumer spending, will likely cause the global economy to grow by just 3 percent this year. Growth may pick up modestly to reach 3.3 percent next year, the OECD notes, though it is still due to be down 0.3 percent for both 2016 and 2017 compared to the OECD’s November 2015 Outlook report. Growth levels of that magnitude can be detrimental, according to the OECD, as they would not only deprive young people of job opportunities, but also restrict access to healthcare and pension benefits for the elderly.
GDP growth in OECD countries is projected to be under 2 percent on average over 2016-17, according to the report. Growth of this nature would be broadly in line with outcomes in the previous two years. With the use of supportive macroeconomic policies and with the continuation of the low commodity prices that have impacted the global economy for some time, a modest recovery in advanced economies should persist. Though the OECD’s prediction is also contingent on the growth of both wages and business investment, projected growth is reliant on the tension which has punctuated the financial markets of late being replaced by a period of relative calm – something which in light of the UK’s Brexit vote, now appears unlikely.
“The aftershocks of Brexit will be felt across Europe and the wider world, but the leave vote may not be the end of the story.”
Regardless of the relative optimism surrounding some of the more advanced economies, there are still a number of forces likely to drag back advanced growth. Weakness in external demand in emerging and developing markets will, according to the OECD, continue to slow the expansion of advanced economies.
Brexit
On a national level, the OECD cut its US growth figure for 2016 to 1.8 percent from its previous prediction of 2.0 percent. This is due to potential weak foreign demand and a dearth of investment in the oil & mining sector. The spectre of ‘Brexit’ also caused the OECD to lower expected growth in the UK, issuing a strong warning over the potential damage caused by opting to leave the EU. This became a startling reality in late June, with a 52-48 percent majority in favour of leaving the EU opening ‘pandora’s box’ economically, politically and socially. With both major British political parties in disarray, the pound tumbling and global markets in a tailspin, the outlook for the UK’s economy appears gloomy.
The aftershocks of Brexit will be felt across Europe and the wider world, but the leave vote may not be the end of the story. The confusion and consternation that surrounds the UK’s decision may rumble on regardless, with David Cameron’s unwillingness to trigger Article 50 of the Lisbon Treaty, which which will fire the starter pistol on the UK’s formal exit from the European Union. With mixed signals emerging from within the European bloc about the timetable for the exit, the debate over the UK’s place in the European economy looks far from over. Millions have pushed for a second referendum and debate among parliamentary circles over whether Article 50 will ever actually be invoked, means Brexit could continue to be the ‘ghost at the feast’ for years to come.
According to the OECD’s report, Britain would likely face a considerable slowdown in a Brexit world. Based on the notion that Britain remained in the EU, the OECD cut its forecast for 2016 British growth to 1.7 percent from 2.1 percent previously. Leaving the EU could see growth figures lose half a percentage point in the years ahead.
In recent months, the outlook for Europe in general has improved, according to the OECD, which raised its growth estimate to 1.6 percent this year from 1.4 percent in February on an improved outlook for the French and German economies. Brexit, however, will be hugely detrimental to the wider European economy. The high level of exposure to the UK markets, in terms of trade and investment, for countries such as Ireland, Luxembourg and the Netherlands, will see the impact spill into their economies.
On a broader scale, Brexit poses a greater threat to the European bloc. The leave vote has undermined confidence – and could potentially impact security – across the EU. According to the OECD’s pre-referendum report, Brexit had the potential to impact equity prices in the region, causing them to drop markedly. Furthermore, risk premiums on bonds would also rise. This would add to pressures on private and public finances and potentially compound political tensions in the EU.
Though the report notes that some improvements have been made in the global economy in recent years, and the global unemployment rate is expected to fall to 6.2 percent in 2017, these improvements must be taken in context. There will likely still be 39 million people unemployed next year; around 6.5 million more than were unemployed prior to the onset of the crisis.
In light of the data presented by the report the OECD, like the IMF before it, is calling on governments to do more to stimulate growth, particularly as the global economy is locked in a “negative feedback-loop” which is currently affecting capital stock in the market. The OECD has called on governments to quickly “make good on promises to current and future generations”, however the method of achieving this goal remains a point of contention.
“The need is urgent. The longer the global economy remains in the low-growth trap, the more difficult it will be to break the negative feedback loops, revive market forces, and boost economies to the high-growth path. As it is, a negative shock could tip the world back into another deep downturn. Even now, the consequences of policy inaction have damaged prospects for today’s youth with 15 per cent of them in the OECD not in education, employment, or training; have drastically reduced the retirement incomes people are likely to get from pension funds compared to those who retired in 2000; and have left us on a carbon path that will leave us vulnerable to climatic disruption”, notes the report.
Spend, spend, spend
Fiscal, monetary and structural policies are in need of an overhaul. Though some central banks in Europe, the US and Japan have opted to utilise quantitative easing (QE) to help dig their economies out of difficulty, the status quo of QE means that countries and the global economy itself will be unable to find a route out of the low growth loop. While QE has played a vital role in recent years, it is a risky process in and of itself. Accordingly, there have been growing calls for governments to move away from cuts and austerity and to embrace measures which will promote better financial health.
The need to reverse the prevalent economic outlook is particularly pressing given that, eight years after the financial crisis, the global recovery remains alarmingly weak. Investment has remained lacklustre and wage gains too have been poor for some time. According to the OECD, growth rates have been the inevitable outcome of stagnant growth and wider volatility in the financial services space, remaining below pre-crisis levels. As a result of this protracted period of slow growth, the longer-run supply-side potential of global economies has been damaged by longer than anticipated periods of unemployment.
Should global economies remain on their current trajectory, the global recovery will likely remain slow for the foreseeable future. With subdued aggregate demand, poor underlying supply-side developments, as well as weak investment, trade and productivity growth, and diminished reform momentum, the global economy is set to languish.
Bright spots
But all is not lost, according to the OECD. In the US, for example, though growth rates have been downgraded in the latest economic outlook, the country is likely to avoid a significant slowdown in the second half of the year. The OECD’s leading indicator for the US was unchanged for the third straight month at 98.9, showing “signs of stabilisation” in economic growth. A reading below 100.0 points to growth that is slower than normal. As recently as March, the leading indicator was pointing to “easing growth” in the US.
A number of the world’s other larger economies may see more significant growth than previously suggested. Brazil, Russia, Germany and Japan will see more steady growth. That said, in Japan GDP growth is likely to remain modest, with the tightening labour market having only a limited impact on nominal wage growth and sizeable fiscal consolidation projected in 2017.
After considerable uncertainty, the Chinese economy too is beginning to show signs of much needed stabilisation. The indicator for China rose to 98.41 in April from 98.38 in March, its second consecutive monthly increase since the reading first dropped below the 100 mark in October 2014. “Growth is flat in the advanced economies and has slowed in many of the emerging economies that have been the global locomotive since the crisis,” OECD Secretary-General Angel Gurría said while launching the Outlook during the Organisation’s annual Ministerial Council Meeting and Forum in Paris. “Slower productivity growth and rising inequality pose further challenges. Comprehensive policy action is urgently needed to ensure that we get off this disappointing growth path and propel our economies to levels that will safeguard living standards for all.”
Conclusion
Confusion reigns in the post-Brexit world. While some key economic and financial indicators worldwide had been trending, somewhat tentatively, upwards, the decision taken on 23 June has threatened the UK’s economy and taken a sizeable chunk out of global optimism.
© Financier Worldwide
BY
Richard Summerfield