Five Factors That Could Mess Up Global Growth
Brexit, tariffs, currency meltdowns in Argentina and Turkey, a China growth scare, and a financial near-implosion in Italy—to name just a few events—have surprised many policymakers, companies, and investors in the past two years. The inclination is to treat each as the product of the particular circumstances of each country; and the implication is to play a game of whack-a-mole with each.
There’s validity to such a case-by-case approach. But it risks overlooking that something deeper is going on here—a common thread, if you like. And the ramifications will be accentuated by what are now widening inequalities brought about by differing growth rates and policies in advanced economies as the U.S. increasingly outpaces other economies.
The more this is understood, the better the world will be able to navigate surprises. And if politicians and companies step up more forcefully, the higher the probability of avoiding most of them altogether.
It wasn’t supposed to be like this. In the 10 years since a global financial crisis damaged many lives and almost tipped the world into a multiyear depression, efforts have been made to strengthen the banking system and reduce its risk of contaminating the real economy. Years of experimental, unconventional measures by central banks to keep interest rates down and inject liquidity have bought time to heal. Awareness has spread that too many years of low and insufficiently inclusive growth does more than undermine economic performance and potential—it tears at the fabric of society, erodes trust in key institutions, and fuels the politics of anger. Finally, an unusual consensus has emerged among economists as to the critical mass of policies needed to break out of the “new normal” of disappointing growth.
The sense of economic optimism associated with all this has been reinforced by 2017, a truly exceptional year when financial markets and corporate profitability thrived, seemingly in defiance of political and geopolitical challenges.
Building on what was already an impressive multiyear rally, world stock markets surged more than 20 percent. Investors also made money in virtually every other asset class, including government bonds that usually are negatively correlated to stocks. And all this occurred in the context of extremely low volatility. Meanwhile, corporate profits rose from one record to another, leaving many companies ample cash on their balance sheets to buy back stock, boost dividend payments, pursue mergers and acquisitions, and enlarge investment programs.
The growing sense of optimism was amplified by the emergence in 2017 of an exceptionally broad pickup in growth around the world. Hailed as a synchronized and self-perpetuating phenomenon, it’s been expected to establish a more accommodating environment for new pro-growth policies on the part of individual countries and for the type of global policy coordination that can make the whole much larger than the sum of the parts—or, to paraphrase Christine Lagarde, managing director of the International Monetary Fund, an environment to fix the roof while the sun is shining.
Yet recent developments have exposed cracks in this seemingly happy configuration. Many elements of the surge are strained, stretched, and vulnerable to sudden disruptions. While some of the particular manifestation of these cracks may come as a surprise, the overall phenomenon shouldn’t—especially if you consider the following five factors:
It takes time to restore trust. Despite the improvements, a significant trust deficit remains. The most visible display is in the continued vibrancy of anti-establishment movements and causes—from the elections of Donald Trump in the U.S. and Emmanuel Macron in France to the new government in Italy and the Brexit saga in the U.K.—and the related erosion in the standing of “expert opinion.” These all reflect voters choosing to disrupt a system viewed as having served them poorly and lacking credibility.
The less trust there is, the harder it is to win political consensus on even the most bipartisan economic issues, such as infrastructure modernization in the U.S. In some cases, such as in the Brexit-focused U.K., and in Italy, where negotiations over a new government led to questions about the country’s commitment to the euro zone, national attention risks being held hostage by one issue, making it hard to deal with the challenges of an unusually fluid world. With that, political anger remains.
Lack of policy action makes everything bumpier. The resulting policy paralysis has been visible in economic areas. Among the most systemically important economies, the U.S. is virtually the only one to have embarked on multiple reforms that can sustain higher growth rates. U.S. companies have welcomed deregulation and tax cuts, with some signs that their greater willingness to boost spending adds to the strength of the labor market. But, apart from the U.S., policy efforts lag realities on the ground. As a result, the synchronized global economic pickup is starting to sputter.
Europe’s recent economic bounce is turning out to be more the result of a natural healing process than policies. As such, it will be hard to sustain—especially worrisome when you consider that countries such as Greece and Italy are operating at gross domestic products still below the levels that prevailed before the financial crisis and barely above those when they joined the euro zone and adopted its single currency.
In some large emerging economies, the recent growth spurt may turn out to be a temporary phenomenon rather than a true breakout. Witness Brazil (where the surge after the impeachment of Dilma Rousseff may be fading away) and Russia (where economic improvement is tied to higher oil prices). Even in India, the jury is out on how the recovery from the demonetization shock can be sustained at a high level.
Some issues remain poorly understood. The political constraints on decisive policy action are compounded by some economic puzzles, the biggest being persistently sluggish productivity. Add the breakdown in historical relationships—such as that between unemployment and wages and inflation—and you get legitimate questions about how quickly, if at all, it will be possible to arrest and reverse a notable increase in the inequality of income, wealth, and opportunity.
The resulting sense of analytical unanchoring is accentuated by the general impact of technological change and, specifically, the growing influence of artificial intelligence, big data, and mobility. This trio is changing not only what we do but also, more fundamentally, how we do things. The massive expansion in possible activities, including a much larger scope for the empowerment of the individual, comes with a greater risk of marginalization, alienation, and radicalization.
The gradual withdrawal of the financial safety net creates risk. All this comes at a time when central banks are slowly getting out of the business of suppressing financial volatility. Unlike in past bouts of financial instability, none of the systemically important central banks has attempted to repress volatility this year, be it the Federal Reserve refraining from countering the February spike or, more recently, the European Central Bank saying little and doing nothing to calm disrupted Italian bond markets.
Many have realized this is part of a general withdrawal of central banks from carrying, almost single-handedly, the bulk of the economic and policy responsibilities in the wake of the Great Recession. The process is most advanced in the U.S. As such, markets are comfortable with the Fed maintaining its rate-hiking cycle. It’s just a matter of time until the ECB and Bank of Japan embark on the Fed’s path—first stopping the exceptional purchase of securities, then announcing a timetable for a reduction in balance sheets and initiating a multihike rate cycle. And while the Fed has shown that a “beautiful normalization” is indeed possible, it remains to be seen whether all three central banks can deliver this simultaneously.
Growth differentials are the thing to watch. With the latest U.S. jobs report showing the economy maintaining a healthy momentum, including an impressive pace of job creation and rising wages, growth differentials will continue to favor the U.S. With the Fed continuing to hike this year, the U.S. will also maintain considerably higher interest rates, another factor that will support the dollar. And if the world slips into a trade war, the damage to the U.S.—which, given the size and diversity of its domestic resources, remains a relatively less open economy overall, and therefore less sensitive to trade disruptions—would likely be less than that suffered by other advanced countries.
Both scenarios involve risks for emerging economies. If local conditions are already vulnerable, as in Argentina and Turkey, a stronger dollar and higher U.S. interest rates increase the threat of a local currency slide that destabilizes other segments of financial markets, forces major increases in domestic rates, and dampens economic activity. And if trade wars break out, the less favorable global trading environment will increase the threat of financial instability.
The probability of disruption isn’t limited to poorly managed economies and/or those lacking strong balance sheets. Even the healthiest can be affected, especially in the short term, adding to the potential surprises for policymakers and investors. As illustrated by the recent tremors, technical factors can help spread distress across borders—the most important being the disruptive sway of “crossover” financing (that is, from opportunistic investors seeking quick profits) over less flighty, “dedicated” capital flows from established institutions. Indeed, you need only look at the generalized sell-off in emerging-market assets in May across countries and investment segments to get a sense of the forces in play.
The good news is that the intensification of these trends isn’t inevitable. Policymakers have the knowledge and ability to counter disruptive forces. What they need is the political will to implement a comprehensive approach, one that’s based on experience and able to course-correct as needed.
The longer it takes for policymakers to move in earnest, the more important it is for individual companies to take action. Strengthening balance sheets, reducing exposure to currency swings, enhancing trust, and lessening reliance on short-term financing can play important roles in building resilience. More open mindsets and a willingness to invest in people and technology can help increase agility.
This mix of resilience and agility is also what investors need to navigate a fluid global environment. They should focus on solid balance-sheet investments, avoid being chased out of the markets by the occasional volatility spike, and stand ready to exploit temporary mispricings that volatility often creates. They should favor U.S. investments relative to the rest of the world and, if they feel trade tensions will indeed lead to big trade wars (which I think can be avoided), tilt their risk exposures further in the direction of domestically oriented opportunities.
As important as individual country factors have been, all those recent surprises reflect some bigger forces in the global economy. Absent a comprehensive multicountry effort to create and sustain higher and more inclusive growth, they’ll prove just part of a bigger set of actual and potential surprises for policymakers—ones that could even come together to seriously undermine the prospects for healthy growth and genuine financial stability over the medium term.
Companies and investors should hope that governments will step up to their growth policy responsibilities. Remember, it’s much less a question of what’s technically desirable and more one of what’s politically feasible. There’s still low-hanging fruit to harvest. But in waiting and continuing the game of whack-a-mole, they would be wise to do what they can now to increase resilience and agility. Absent policies that unleash the considerable potential of the global economy, the surprises they’ve seen so far could risk being just the beginning of a truly global economic slowdown and more intense financial instability.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include The Only Game in Town and When Markets Collide.