The current state of the global economy resembles that of a sailor whose boat was caught on a sandbar but is now freed by the rising tide. The sailor is naturally relieved to be able to set sail. But this relief must be tempered by the urgency to pilot toward deeper seas before the receding waters beach the ship again.
As the June 2018 Global Economic Prospects report documents, the global economy seems to be leaving the legacy of the global financial crisis of the past decade behind. About half the world’s countries are experiencing an increase in growth. This synchronized recovery may lead to even faster growth in the near term, as stronger growth in, say, China or the United States spills over to other parts of the world. All the consensus forecasts for 2018 and 2019 reflect optimism. And this growth is occurring for the right reasons—investment and trade growth, which had been declining, have risen. Furthermore, in the United States, Europe and Japan, unemployment has declined, while inflation has not picked up much, suggesting that policymakers may have found that “sweet spot “in the tradeoff between unemployment and inflation. The confidence indicators also remain elevated.
But, as the report points out, the medium-term prospects tell a different story. Protectionist threats cast a dark cloud over future growth. If these threats lead to trade wars, the consequences could be devastating. Even if they do not, uncertainty about economic policy dampens investor sentiment. Secondly, a credit event in a major emerging market or a sudden tightening of monetary policy in the United States leading to a spike in interest rates could roil financial markets, causing a slowdown especially in highly indebted countries. From the 1975 oil crisis, to the Latin American debt crisis of the 1980s, to the Asian financial crisis of the 1990s, to the 2007-09global financial crisis, there has been a financial market crisis every ten years or so. It is now ten years since the last crisis.
Moreover, as the analytical sections of the report show, increasing corporate debt in some emerging market economies has left them especially vulnerable to interest rate and exchange rate shocks. And the prospects for commodity exporters will be limited as the major commodity-importing countries, especially China, shift their demand away from oil and other commodities.
These ominous signs reinforce the finding from the January 2018 edition of the Global Economic Prospects report, namely, that while current growth appears robust, potential growth will be lower. Underlying factors such as demographics (declining labor supply in many, large countries) and the legacy of low investment growth in the past contribute to this limited potential growth. The risks described above mean that actual growth may be even lower.
The implication is that policy and institutional reforms that build human capital (to make labor more productive) and improve the business climate (to increase investment) are needed now more than ever. De still robust pace of growth provides political space to implement these reforms. Now is the time to act.