Five years after the financial crisis which had brought major economies to their knees, the global recovery has only just started.
The outlook for the global economy is brightening, and acceleration in GDP growth in 2014, led by rich countries is becoming a reality. IMF is predicting a growth rate of 3.6% for the world economy compared to 2.9% in 2013. The US economy is picking up with an estimated growth of 2.5% in 2014 whilst Europe is coming out of its debt crisis and Japan is emerging from deflation.
There was much fear that the financial crisis of 2008 would have worse consequences than that of the Great Depression of the 1930s, but the effects have not been as devastating as those in the 1930s. In fact world trade and global output have increased since 2008. Many leading economists believe that what occurred in 2008 was a US crisis that had a contagion effect on Europe because the two financial systems are integrated to a large extent. Whilst many countries in the world were not really affected by this, some emerging economies faced a drop in their exports but did not experience the full impact of the financial turmoil.
According to the IMF the impulse to stronger global growth in 2014 is expected to come mainly from the US, which has long been the main engine driving the global economy, and where activity is predicted to go into a higher gear as the impact of higher taxes and lower spending eases. The Fed, which had injected huge amounts of liquidity into its economy through quantitative easing (QE), is slowly withdrawing its stimulus.
In the Euro zone, business confidence indicators suggest that activity is close to stabilising in the periphery and already recovering in the core economies. For instance, it could be said that the UK is on the road to recovery with the services sector gradually emerging and the manufacturing activity gaining momentum due to a jump in both domestic and export demand. Japan, meanwhile, is showing good progress in its long fight against deflation. Growth has slowed from earlier this year but a solid enough performance in 2014 is still expected.
According to the EIU forecast for 2014, the US, Euro zone and Japan collectively account for close to half of global output, and their combined expansion in 2014 will push overall growth in the OECD to 2.2%, a full percentage point higher than in 2013. It is said that the first synchronised economic expansion in four years in the US, Japan and the euro zone will, in turn, have positive spill-over effects on the rest of the world—and most emerging markets, despite recent problems, should do reasonably well in 2014.
There is no denial that the recovery is underway and this is backed by objective and independent influential economists/renowned institutions from around the world. Further, the buoyant stock markets, positive investors’ sentiments and growing consumer confidence are good signs for improvement in the economy. Leading economists are saying that global recovery could come about through more investment by major corporations, the emergence of a major technological innovation to match the IT revolution of the 1990s and government moves on climate change.
To further support the argument that the world economy is recovering, the U.N. report released during the early part of January 2014, indicates that global trade in goods should pick up in 2014, more than doubling 2013’s sluggish 2.3% growth, as measured by global export volume. Global trade in services has done better and should continue to grow through to 2015, while commodity prices – which include food, energy and base metals prices – are expected to stay flat. Besides the expected growth of 2.5% in 2014 in the US, Western Europe and Japan are expected to grow at 1.5% whilst among BRICs, Brazil is to grow at 3%, India at 5%, China will improve to 7.5% and Russia will reach 2.9%.
Further, the world financial markets look far more stable than they were a year earlier and are expected to remain in that mode during 2014. After the slow but improving economic growth, subdued inflation and good equity performance in 2013, financial markets are surfing on positive mood for 2014. The nearly 15% advance in world equity prices during the second half of 2013, the rise in bond yields (with the 10-year US Treasury hitting 3% in December 2013) and the 28% plunge in gold prices last year have all provided a clear sign that investors expect global economic growth to gather momentum and inflation pressures to remain subdued this year. Wall Street pundits have forecast that equities will continue to outperform fixed income in 2014.
Though the global economy seems to be slowly recovering, such a recovery remains uneven and fragile, with advanced and emerging economies witnessing divergent growth trends. While signs of a recovery in developed economies are stronger, emerging economies are struggling with slower growth. There may also be a multitude of potential shocks. In a changing geopolitical environment with potential political risks in emerging economies and financial risks in developed markets, there are a few macroeconomic scenarios that may not look positive.
Some analysts/political pundits are asking whether the global economy is heading for a crash. They are harping on the fact that the world has not learnt lessons from the 2007-09 financial and economic crises and this means the global economy is heading for another meltdown. The call for unity was played when the world was looking into the economic abyss after the collapse of Lehman Brothers but it did not last long. Many problems, including too-big-to-fail banks and the growth of a largely unregulated shadow banking system, have not been adequately addressed. Central banks are unclear about how and when to remove the colossal stimulus they have provided for their economies over the past five years. These core weaknesses mean it would be unwise to rule out another financial crisis in 2014.
Emerging markets are looking risky too. If there were to be a seismic shock to the global economy next year, the hot money would be coming from the emerging world. Developing countries have seen large flows of hot money courtesy of the QE activities of the west’s central banks. With interest rates low in the developed world, investors have parked their cash in the higher-yielding currencies of the emerging economies. Now that the Fed has started to reduce the amount of stimulus it is providing each month, the risk is that the hot money will leave emerging markets as quickly as it arrived, having a negative impact on their currencies. The most vulnerable emerging markets look to be those with big current-account deficits, because they are likely to be the first targets for currency speculators. Brazil, South Africa, Turkey and India are cited as those most likely to be affected.
The biggest risk of all, however, is China. Foreign investors have been impressed by the economic reforms announced by the communist leadership but, in the short term, China is slowing down after its debt-fuelled recovery from the last recession. The implementation of structural reforms will be critical in driving the Chinese economy towards sustainable development and helping it grow beyond the middle-income range.
As regards the Euro zone, one may ask whether it is over the worst of its predicaments. Four big legacy problems from the last crisis may hold Europe back over the coming 12 months: growth, unemployment, deflation and the soundness of banks. Unlike the US, the Euro zone (except Germany and lately the UK) has yet to recover from the recession of 2008-09. A double-dip recession ended in 2013 but growth is still barely positive and not nearly strong enough to bring down an unemployment rate of more than 12%. Deflation is already a reality in Greece and Cyprus, while in Portugal inflation is only just above zero. Falling prices increase the real value of debt, making it harder for countries to repay what they owe. The two potential flashpoints for 2014 are the European Central Bank’s asset quality review of Europe’s banks, and the need for fresh bailouts for the two most vulnerable countries: Greece and Portugal.
As for the Japanese economy, will Abenomics succeed in redynamising the economy? The drastic attempt by Japanese Prime Minister, Shinzo Abe, to bring the declining economy to life has already sown positive signs. Since he took power a year ago, growth has picked up to an annual rate of 3%, and deflation of -0.1% year on year in December 2012 has given way to inflation of 1.1%. But the burning question for 2014 is whether the first two of his three policy “arrows” – a spending surge and quantitative easing on a massive scale – will be followed by the promised third arrow: economic reform. Among other things, the Abe administration is creating large scale facilities for childcare and focusing on a number of overseas trade deals that are also likely to lead to the opening-up of new sectors of Japanese industry to competition. But these are long-term reforms, and investors are expecting Abenomics to bring quick results. There is a risk that markets will lose faith with the debt-burdened Japanese government in the meantime (ratio of debt to GDP: 246%). By the end of 2014, there will be a clearer idea whether Shinzo Abe’s policies are sound.
Without dismissing the downside risks, it can realistically be said that 2014 will be a good year overall as the consensus of recovery is really based on positive signs – whether it be in the US or the Euro zone or Japan. These economies will drive the world this year with encouraging results provided that the fundamentals are kept within control against the backdrop of sound economic and financial policies. Mistakes are made in market-based economies but lessons learned from them are among the most effective ways to manage scarce resources and restore resilience in the economy in a financially sustainable way especially now that the debate has moved to the isuue of “secular stagnation” in which sluggish growth and output, and employment levels are well below potential.
Undergraduate Yr 1, Desautels Faculty of Management
McGill University – Canada
Source: IMF World Economic Outlook October 2013, The Economist & Financial publications.
* Published in print edition on 7 February 2014