NOVEMBER’S terrorist attack in Paris and the influx of refugees into Europe are but the latest symptoms of political and economic tensions in North Africa and the Middle East. Conflicts are raging elsewhere, and there are 60m displaced people worldwide.
2015 is the hottest year on record. An extremely strong El Niño has spawned weather-related calamities across the Pacific. The prospect of rising interest rates in the United States and China’s slowdown are contributing to economic volatility worldwide. There has been a sharp deceleration in the growth of global trade, with the drop in commodity prices problematic for resource-based economies.
The global economy is sluggish, because, seven years after the collapse of Lehman Brothers, financial stability is not yet assured. Financial-sector weaknesses linger in many countries — and financial risks are growing in emerging markets.
With all of these taken together, global growth in 2016 will be disappointing and uneven. The global economy’s medium-term growth prospects have weakened, because potential is being held back by low productivity, aging populations, and the legacies of the global financial crisis. High debt, low investment, and weak banks are burdening some advanced economies, especially in Europe; and many emerging economies face adjustments after their post-crisis credit-and-investment boom. This outlook is heavily affected by major economic transitions. These are creating global spill-overs and spill-backs, particularly China’s changeover to a new growth model and the approaching normalisation of US monetary policy. Both shifts are necessary. They are good for China, good for the US, and good for the world. The challenge is to manage them efficiently.
China has implemented deep structural reforms to lift incomes and living standards, seeking a ‘new normal’ of slower, safer, sustainable growth that relies more on services and consumption and less on commodity intensive investment and manufacturing. But China’s policymakers must do this while preserving demand and financial stability.
But, this past summer, investors’ fears about the pace of the Chinese economy’s slowdown put further pressure on commodity markets and triggered sizeable currency depreciations among commodity exporters who rely on Chinese demand. As it invests less, China’s appetite for commodities — it consumes 60% of the world’s iron ore, for example — will decline. This will contribute to what could be a prolonged period of low commodity prices, which policymakers — particularly in large commodity exporters, like Australia and Brazil — will need to manage carefully.
The second major transition is the Federal Reserve’s determination to raise interest rates. Although rates are expected to remain low for now, the transition reflects better economic conditions in the US, which is also good, because the global low interest rates contributed to a search for yield by investors. That supported financial risk-taking and higher valuations for equities, sovereign bonds, and corporate credit. So the Fed also faces a delicate balancing act: to normalise interest rates while minimising the risk of financial-market disruption.
But the prospect of rising US rates has contributed to higher financing costs for some borrowers, including emerging and developing economies. This is part of a necessary adjustment, but the process could be complicated by structural changes in fixed-income markets, which have become less liquid and more fragile — a recipe for market overreactions and disruptions.
Outside the advanced economies, countries are better-prepared for higher interest rates. And yet I am concerned about their capacity to buffer shocks. Many emerging economies responded to the global financial crisis with bold, countercyclical fiscal and monetary measures. Via these policy buffers, they led the global economy in its time of need. Over the past five years, they have accounted for 80% of global growth.
But these policy initiatives were accompanied by an increase in financial leverage in the private sector, and many countries have incurred more debt — much of it in US dollars. So rising US interest rates and a stronger dollar could reveal currency mismatches, leading to corporate defaults — and a vicious contagion that spreads to banks and sovereigns.
And yet these transitional risks can be managed, by supporting demand, preserving financial stability, and implementing reforms. Most advanced economies, except the US and possibly the United Kingdom, will require accommodative monetary policies. All advanced economies, however, should incorporate spill-over risks in their decision-making. The eurozone can upgrade its prospects by tackling non-performing loans of €900bn. This would enable banks to increase the supply of credit to companies and households, thereby enhancing the potency of monetary accommodation, improving the outlook for growth, and bolstering markets. Emerging economies need to improve the monitoring of major companies’ foreign currency exposures. They should also ensure financial stability by using macro-prudential tools to strengthen banks’ resilience to the build-up of corporate leverage and foreign debt.
Globally, there is a pressing need to complete regulatory reform — with a focus on the transparency of nonbanks, or shadow banks. And we have another major task ahead: upgrading the inadequate resolution framework for systemic, globally active financial institutions.
On the fiscal side, countries should use policies that are growth friendly. The International Monetary Fund recommends that advanced economies with room for fiscal stimulus use it to boost public investment, especially in infrastructure. Medium-term fiscal plans also remain a priority, especially for the US and Japan.
Commodity-exporting countries that have room for fiscal-policy manoeuvre should smooth their adjustment to lower prices. Others should rely on growth-friendly fiscal rebalancing — by, for example, implementing tax and energy price reforms and re-prioritising spending, including to protect the most vulnerable.
Commodity exporters used the commodity boom to strengthen their fiscal frameworks against shocks. This has given them greater control over the pace of fiscal adjustment, enabling them to preserve growth. This is a useful lesson for others.
Finally, all countries need to upgrade their economic structures by reforming their labour and product markets, infrastructure, education and healthcare systems, and trade policies.
Implementation requires savvy policymaking, especially in this phase of lower growth and higher uncertainty. Given the collective nature of the issues — like climate change, trade, migration, and the global financial safety net — international co-operation is urgent.
This spirit came through in the adoption of the Sustainable Development Goals, in September, and again at the United Nations Climate Change Conference, in Paris, in December.
Likewise, the refugee crisis in the Middle East and Europe is not just a humanitarian issue; it is an economic one that affects us all. We must all help.
Copyright: Project Syndicate, 2015.