Regional Analysis 2018 Global

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The global economy ten years after the financial crisis - section updated Sept 2018

Many commentators, including the World Bank, the World Economic Forum and the International Monetary Fund (IMF), are in agreement that for the first time since the global financial crisis, all major regions of the world are experiencing an upturn in economic growth. This global growth is broad based across both advanced and emerging economies.

Commentators are referring to a ‘Goldilocks’ global economy, whereby conditions are “neither too hot nor too cold”; that is not too hot to drive up inflation nor so cold that it triggers a recession. The rise in productivity results in limited spare capacity, and this will need to be balanced with the rise in inflation in order to maintain this equilibrium. Inflation remains relatively low, given the sizeable gap in pricing to be made up since the global financial crisis. However, in the coming year it is expected that inflation will gradually rise, and as this happens central banks and governments will have to take action to prevent overheating.

This continued global growth has resulted in central banks beginning to withdraw their economic stimuli. The US Federal Reserve commenced reducing its bond portfolio in Q4 2017, the ECB halved its monthly bond buying stimulus from January 2018, while the Bank of England has yet to announce a reduction in its bond buying. While the current, broad-based growth acceleration in the global economy is a welcome trend, growth in investment and total factor productivity (TFP) has been declining over the past number of years. Due to demographic trends, labor force growth has also been slowing in many parts of the world, meaning that potential output (the amount the economy can produce if labor and capital were fully employed) will grow at a slower rate in the future, and the current demand-led recovery is likely to run up against supply constraints. The decline in productivity growth is particularly worrying, since this is seen as a key source of improved living standards in many countries in the past. However, the current economic growth provides an ideal opportunity for reform.

In the coming year it is expected that inflation will gradually rise, and as this happens central banks and governments will have to take action to prevent overheating.

Above trend performance for the US economy

The US economy is experiencing above-trend growth, with the currently low inflation levels expected to rise in 2018. The Federal Reserve policy is expected to continue gradual interest rate increases. Although inflation levels are below target, the government is keeping a close eye on the labor market, where unemployment is declining to unsustainable levels.

The recently enacted US tax reform is expected to cut tax by US$1.5 trillion over the next ten years. It is generally accepted that corporations and the wealthy will benefit most from the reform, with a significant reduction in the corporation tax rate from 35% to 21% . It is expected that the lower rate will result in greater economic activity, which will not only boost the economy, but in turn will result in an increase in wages, resulting in greater real household incomes. If Apple’s announcement that it would pay US$38 billion in taxes as it repatriates its cash to the US is any indication, it looks like a win for the US economy.

President Trump’s position on the North American Free Trade Agreement (NAFTA) seems to have mellowed recently. While the US, Canada and Mexico continue talks to renegotiate the Fair Trade agreement, President Trump has stated in recent interviews that he is in no hurry to renegotiate, particularly as Mexico has presidential elections coming up in 2018. However, there is concern amongst companies on the stock market whose profits are closely tied to the NAFTA.

The main risk to the US economy is the divisive political environment, and in particular, the mid-term elections, which are to be held in November. There are also significant changes taking place in terms of the senior fiscal policymakers, with Jerome Powell taking over from Janet Yellen in February 2018, as Chair of the Federal Reserve. Ms. Yellen was not afforded the opportunity of a second term, as is the norm, and while this new appointment is not expected to cause major change in policy, it may bring about some uncertainty. US policy makers will need to maintain the focus on securing steady growth in the economy.

Varying growth across Europe’s economies

Europe’s economy is experiencing its best growth in a decade; steady growth with continued momentum is generally expected. Drivers of this are the continuing revival of the global economy, and the positive consumer and business sentiment in the euro area. Despite this strong growth, rapid erosion of economic slack and reduction in unemployment, inflation is set to remain low generally, with persistent easing of monetary policy and the ECB expected to keep rates at low levels until the second half of 2019.

The UK is experiencing moderate growth from below-trend rates; it struggles with high inflation arising from the depreciation of sterling after the Brexit vote and higher import prices. High inflation and stagnancy in wage levels are eating into real household incomes, and discouraging consumer spending. The UK economy continues to function under the cloud of Brexit, and while negotiations are continuing to dominate the horizon, the full implications of Brexit are not yet known.

Italy and Spain are still experiencing slow growth and continue to have high levels of unemployment, with Spain continuing to struggle with tensions relating to Catalonia. Meanwhile Ireland is expected to have the fastest growing economy in Europe for the fourth year in a row, showing an increase in tax revenues and retail sales, alongside falling unemployment.

As the largest economy in Europe, Germany continues to grow, hitting a six-year high in 2017. With rising wages, historically low unemployment and modest inflation growth, Germany now faces key decisions on how best to manage its economy to continue its positive performance into the future. Some commentators note that wage growth is being kept in check as a result of an influx of central European workers, which is keeping a cap on wages, while the threat of international price competition is forcing manufacturers to curtail cost inflation. Political unrest is the biggest threat to the economy at present, with the failure to form a coalition following last year’s elections.

The year 2017 marked the French economy’s best performance since 2011. The reform program being rolled out by President Macron to improve competitiveness and productivity, as well as a more positive outlook from both business and personal consumers, resulted in increased spending, all of which are pointing to continued growth.

Inflation rises in Asia

Looking to Asia, the geopolitical situation in the region, and in particular the Korean Peninusla, is an area for concern. Inflation is set to rise, pushing many central banks to raise interest rates. This is not expected to be a problem in 2018, as the positive outlook for growth coupled with the interest rate rise are set to slow growth to a steady pace in the region. Taiwan, Korea and Thailand, which are export-led economies, are experiencing continued growth on the back of the strength of the global economy. However, inflation is expected to rise as a result of policymakers increasing interest rates. Large domestic and lower income economies like India, Indonesia and Phillipines have young populations, and hold the potential for very high growth. This potential has not always been realised, due to poor structural reform, but the outlook is particlarly optimistic for India, given recently implemented reforms, aimed at stimulating growth.

China’s economy is also benefitting from strong global demand. However, its economy is expected to decelerate due to a cooling housing market, following the potential housing bubble that loomed last year. This is further compounded by policymakers’ desire to address environmental issues, which may result in a slowdown in infrastructure investment. This deceleration in growth could spill over into other countries in the region.

The GCC introduces VAT

The GCC’s general economic outlook remains strong, with higher oil prices, strong global growth and positive financial conditions. Particular concerns arise from security threats, political unrest and the oil production cuts that continue to weigh on oil-producing economies. Interestingly, VAT has been introduced in the region, with Saudi Arabia and the UAE recently implementing the tax in order to broaden their collection base, and Bahrain, Kuwait, Oman and Qatar pledging to do the same in the coming years. 

Qatar’s GDP continues to grow, despite the economic blockade enforced by its neighbors. Despite the impact of the reduced oil output, Bahrain has seen growth, primarily due to strong infrastructure spending.

Saudi Arabia contracted on the back of the oil production cut and reduced government support. In an effort to diversify the economy away from oil, the government has announced a budget that introduces VAT and prioritizes capital expenditure. The planned floatation of a 5% stake in its national oil company, Saudi Aramco has received widespread publicity for being the largest IPO in history and is set to yield in excess of US$10 billion. A number of mega projects, including the US$ 500billion NEOM Project are initiatives seeking to reduce the country’s dependence on oil. However, it is not expected that the budget will balance until 2023.

Advanced economies need to use the current period of growth to build buffers into their economies in order to be better prepared for the next downturn.

The United Arab Emirates (UAE) is currently experiencing subdued employment and wage growth, which is likely to impact on private consumption in 2018. The UAE government has published a budget which includes significant increases in infrastructure spending in preparation for the 2020 World Expo, so it is expected that growth will pick up in 2018 on the back of government policy, and as the oil sector slowly recovers.

Ultimately, advanced economies need to use the current period of growth to build buffers into their economies, develop defenses against financial instability and invest in structural reforms in order to be better prepared for the next downturn.

Emerging markets and developing economies need to accelerate investment in both physical and human capital, including investment in infrastructure and education, health, and other human skills and well-being, as well as initiatives to promote economic diversification and liberalize trade. Investment in these areas will boost long-term growth prospects and improve standards of living.

Contributors:Kim Hegarty, Derry Scully, Niall Doran