The International Monetary Fund and others have recently revised down their forecasts for global growth – yet again. Little wonder: the world economy has few bright spots – and even those are dimming rapidly.
Among advanced economies, the US has experienced two quarters of growth averaging 1%. Further monetary easing has boosted a cyclical recovery in the eurozone, though potential growth in most countries remains well below 1%. In Japan, so-called Abenomics is running out of steam, with the economy slowing since mid-2015 and edging close to recession. In the UK, uncertainty surrounding the June referendum on continued EU membership is leading firms to keep hiring and capital spending on hold. And other advanced economies – such as Canada, Australia and Norway – face headwinds from low commodity prices.
Things are not much better in most emerging economies. Among the five Brics countries, two (Brazil and Russia) are in recession, one (South Africa) is barely growing, another (China) is experiencing a sharp structural slowdown, and India is doing well only because – in the words of its central bank governor, Raghuram Rajan – in the kingdom of the blind, the one-eyed man is king. Many other emerging markets have slowed since 2013 as well, owing to weak external conditions, economic fragility (stemming from loose monetary, fiscal, and credit policies in the good years), and, often, a move away from market-oriented reforms and toward variants of state capitalism.
Worse, potential growth has also fallen in advanced and emerging economies. For starters, high levels of private and public debt are constraining spending – especially growth-enhancing capital spending, which fell (as a share of GDP) after the global financial crisis and has not recovered to pre-crisis levels. That decline in investment implies slower productivity growth, while ageing populations in developed countries – and in an increasing number of emerging markets (for example, China, Russia, and South Korea) – reduce the labour input in production.
The rise in income and wealth inequality exacerbates the global saving glut, which is the counterpart of the global investment slump. As income is redistributed from labour to capital, it flows from those who have a higher marginal propensity to spend (low- and middle-income households) to those who have a higher marginal propensity to save (high-income households and corporations).
Moreover, a protracted cyclical slump can lead to lower-trend growth. Economists call this “hysteresis”: long-term unemployment erodes workers’ skills and human capital; and, because innovation is embedded in new capital goods, low investment leads to permanently lower productivity growth.
Finally, with so many factors dragging down potential growth, structural changes are needed to boost potential growth. But such an overhaul is occurring at a suboptimal rate in advanced and emerging economies, because all of the costs and dislocations are front loaded, while the benefits occur over the medium and long term. This gives opponents of reform a political advantage.
Meanwhile, growth remains below the diminished potential. A painful de-leveraging process implies that private and public spending need to fall, and that savings must rise, to reduce high deficits and debts. This process started in the US after the housing bust, then spread to Europe, and is ongoing in emerging markets that spent the past decade on a borrowing binge.
At the same time, the policy mix has not been ideal. With most advanced economies pivoting too quickly to fiscal retrenchment, the burden of reviving growth was placed almost entirely on unconventional monetary policies, which have diminishing returns (if not counterproductive effects).
