What global economic risks do we face?

 

Heather A. Conley

Senior Vice President for Europe, Eurasia,and the Arctic; and Director, Europe Program

Matthew P. Goodman

William E. Simon Chair in Political Economyand Senior Adviser for Asian Economics

 

GLOBAL FORECAST: Eight years after thefinancial crisis, let’s take stock of where we stand. How are the economies inthe developed West, emerging Asia, and other parts of the world performing? Howdo we expect them to perform over the next few years?

MATTHEW P. GOODMAN : The global economy is still not in a good place. Global GDPgrowth has disappointed relative to pre-crisis trends, averaging just above 3percent per year since 2008. Even this modest level of growth has required anexplosion of debt: the global debt-to-GDP ratio has risen almost 10 percentagepoints since the crisis. Trade growth, which used to comfortably outpace GDPgrowth before the crisis, has weakened significantly to just above 2 percentper year. Even in the United States, where job growth has been relativelyrobust, wages have only just passed their 1996 level.

All of this is taking place against abackdrop of enormous political uncertainty and rapid technological change.Either of these could bring further disruption. It’s no surprise that businessinvestment has been stubbornly subdued across the globe.

SCOTT MILLER: Most forecasters estimate global growth will be stuck at around 3percent to 3.5 percent, with the United States delivering the same old 2percent real growth for 2017 and 2018. Essentially, forecasts tell us to“embrace the boredom.” Absent the capacity for a big dose of monetary or fiscalstimulus, slow growth is certainly better than none at all.

GOODMAN :Growth in emerging markets will be more robust, but it is neither strong norlikely to be sustainable. China is continuing its structural slowdown. Even ifIndia maintains growth in the 7 percent range, no single country can driveregional growth.2

The global debt-to-GDP ratio has risenalmost 10 percentage points since the crisis.

HEATHER A. CONLEY : Europe continues to be plagued by high levels of debt, weakgrowth, and a very fragile banking sector, which grows ever weaker fromnegative interest rates and the weight of nonperforming loans. Five Eurozonecountries’ debt-to-GDP ratio exceeded 105 percent at the end of 2015. Surprisescould throw Europe’s “muddle through” strategy off track, but we should alsoprepare for surprises with unanticipated upsides. For now, the economic impactof Brexit has not followed the predicted path of economic Armageddon.

GF: Looking at the current globaleconomic landscape, what do you think are some of the key risks thatpolicymakers need to be alert to? Could we see another downturn on par withwhat we saw in 2008? What about the reverse—do you see any underappreciatedstrengths? And what should policymakers be doing about all of this?

GOODMAN: Thegood news is that the major economies have done a lot to address thevulnerabilities in the global financial system that produced the last crisis.But even as greater resilience has lowered the probability of a 2008-stylefinancial crisis, it would be hard to argue the risks are gone.

One risk is macroeconomic policy error. TheU.S. recovery is still not especially strong, and the Federal Reserve should bewary of raising interest rates too quickly. In Europe and Japan, leaders shouldavoid the temptation to cut government spending too soon.

There are also looming financial risks.Europe needs to deal with a banking sector that is still too weak to withstandan external shock, as we saw when Italian banks wobbled after the Brexit vote.China needs to address mounting corporate debt and industrial overcapacity toavoid its own “lost decade.”

More difficult for policymakers, but noless necessary, will be addressing structural constraints that both inhibitgrowth today and could lead to a crisis down the road.

CONLEY: InEurope, the risks are plenty. There are the anemic French and Italianeconomies, a banking sector too closely linked to government, high sovereigndebt, high unemployment especially among youth, a looming demographic crisis,and increasingly protectionist and nationalistic instincts.

But Europe also has strengths that areunderappreciated. The export-driven German economy continues to perform well,as does the British economy, Brexit notwithstanding. Europe has strong democraticinstitutions and predictable legal systems, globally desirable goods andservices, a highly educated workforce, developed infrastructure, and awelcoming investment climate. This is why both American and Chinese firms findEurope so attractive as an economic destination despite its current economicwoes.

MILLER: TheU.S. and other advanced economies face more downside risks than upside at thispoint in the business cycle. The current U.S. expansion is 90 months old,longer than the post–WWII average of 56 months, and price inflation is headedup slowly. Interest rates remain extraordinarily low worldwide, but areunlikely to stay that way. The end of “free money”—whether it is a result ofmarkets or the action of central banks—is a likely source of instability.Sovereign debt loads have increased dramatically since 2008, and debt serviceobligations will crowd out other fiscal measures.

Here in the United States, tax reform couldprovide incentives for stronger capital formation and productivity growth,which have disappointed since the 2008 recession. Absent real financialleadership, though, status quo politics will likely deliver no better thanstatus quo growth.

GF: Europe was hit particularly hard in2008. What are its prospects for recovery? There’s no denying that its economicwoes are having political implications. Can you give us a sense of how stagnantgrowth might lead to increased populism and nationalism, and how this mightplay out in elections across Europe and in the broader effort to hold Europetogether post-Brexit?

CONLEY :Despite signs of recovery, the perception in Europe remains that the economy isstagnant. This creates palpable anxiety that wreaks political and economichavoc. To give you a sense of the anxiety, the European Central Bank hasmaintained interest rates near zero, but instead of encouraging spending, thenet savings rate of households and businesses actually rose by 40 percent!

Juxtapose this with the fact thatthree-fourths of Eurozone economies will have national elections or referendumsbetween now and the end of 2017. When anxiety meets popular will, the resultscan be unpredictable to say the least. This is what happened with Brexit, whathappened with our elections, what is happening at present with the politicalchaos in Italy, and what could occur in 2017 with elections in France andGermany.

MILLER: Itis a destabilizing brew—slow growth and high unemployment. With little room foradditional monetary or fiscal stimulus.

GOODMAN : Itis a fragile moment right now in Europe. France and Spain are recovering butboth still face high unemployment. The UK faces great uncertainty depending onwhether we see a “hard” or “soft” Brexit. The biggest obstacle to recovery inEurope is probably Germany, even though it continues to enjoy steady growth andrising wages. There will be limits to Europe’s recovery so long as Berlinrefuses to use more expansionary fiscal policy. But it has its own politics toworry about.

GF: Populist forces around the world aretaking aim at trade as being skewed toward big business and fosteringinequality. What is the best chance for rescuing a trade agenda and avoidingtariff wars in the years ahead? What should the G7 be doing?

MILLER: Venturecapitalist and Trump supporter Peter Thiel summed it up in a recent speech atthe National Press Club: “no matter what happens this election, what Trumprepresents isn’t crazy and it’s not going away.” Mainly, the protectionistbacklash evidences a failure of political leadership. But because the forcesbehind the current turbulence are principally technological, it’s important forleaders to recognize that policies that “worked” in a different environment maynot be effective in the future. Technology, not policy, is the prime moverbehind today’s intensified inter-country competitiveness, and yesterday’s tradeor currency deals with advanced economies will not suffice.

Here in the United States, tax reform couldprovide incentives for stronger capital formation and productivity growth,which have disappointed since the 2008 recession.

The sliver of “good news” is that mostAmericans seem to understand that times have changed. Polls show steady supportfor trade and trade agreements despite harsh campaign rhetoric. Withoutquestion, arriving at new policies suited for a new reality will take time andenergy. In the meantime, elected officials in the G7 and elsewhere should workto avoid “vandalism” to the current structure while accelerating an appreciationof how the “new” economy really works and how to address those new challengeswith people, ideas, and effort.

GOODMAN: Tradehas become a scapegoat for an array of grievances relating to rapid changes inthe economy and society. Like technological progress, more open trade bringsbroad and substantial benefits to an economy. However, it is also true thattrade causes real disruption to some workers and companies. Governments havenot done a good enough job on either side of this story: explaining thebenefits of trade or addressing its adjustment costs.

Rebuilding support for trade and tradeagreements begins with making greater investments in the domestic underpinningsof a strong and competitive economy, including infrastructure, education andtraining, and innovation. More assistance for workers disrupted by economicchange—whether caused by trade or technological progress—is also needed.

CONLEY : Oneof the most vocal public expressions of European anxiety and uncertainty is arising revolt against free trade, a catch-all issue for the disruptive natureof globalization. Populists have effectively channeled this fear and anxietyand sought to eliminate any form of compromise between international trade andnational economic policies. As leaders such as France’s far-right leader MarineLe Pen have stated: Are you a patriot or a globalist? According to Ms. Le Penand other nationalists of her ilk, you cannot be both. G7 nations must createthe policy space where “patriots” and “globalists” can claim success, whichwould mean that patriotism is redefined as a nation’s ability to become moresuccessful in a globalized economy and globalists alter how they conductbusiness and negotiate trade agreements to become more responsive to nationaland regional demands and developments. Both sides must change how they havedone business for the past 20 years and find a new middle ground yet both sidesappear to be digging their trenches ever deeper in preparation for a battle ofattrition.

GF: How much does U.S. leadershipmatter? What would you say to someone who says, ‘the U.S. president has littleeffect over the global economy, European politics, or populist forces aroundthe world”?

GOODMAN: TheUnited States remains an “indispensable nation” in global economic affairs. Ourposition as the world’s largest market and a leading source of technology andcapital gives us unparalleled leverage in encouraging pro-growth policies andchampioning an open, rules-based global economic order. You can see this atplay in G20 meetings, where most countries play a passive role and wait for theUnited States to propose a course of action. Of course Washington doesn’talways get what it wants, and needs support to solve most global economicchallenges, but without U.S. leadership the global economic order would be farless stable, predictable, and successful than it has been for the past 75years.

MILLER: Thewave of “globalization” that began in the late-1980s was initiated by U.S.technological, political, and military leadership. Its expansion was supportedby an economic architecture created and sustained by the United States and keyallies. Millions were lifted out of poverty, yet no economy benefited more thanour own, with its relative openness, strong institutions, and adaptive,entrepreneurial people. Globalization has now entered a new phase, but I amconfident that, if anyone can figure out how to make it work in a mutuallybeneficial manner, it is the American people, driven by their ingenuity, senseof fair play, and drive to make things better.

CONLEY: As the largest Western economy, the United States must lead theway to regaining lost confidence. A strong American economy will strengthenEurope’s economy. When political paralysis in the United States finally givesway, this will send a positive and powerful message to other advanced countriesthat they can overcome their crises. Western confidence can be restored, butfor the moment, populism and anxiety are in the ascendancy and Westernconfidence is in retreat.