This article first appeared in The Edge Financial Daily on February 8, 2018

KUALA LUMPUR: The narrowing gap between real and potential output, pointing to slowing potential growth, is a significant concern for most countries around the world, and the gap is closing faster for export-oriented emerging markets and developed economies (EMDEs) compared with their import-oriented peers, according to the World Bank.

“We used to think excess capacity was present in EMDEs, but it is not there anymore,” said World Bank director for development prospects Ayhan Kose at the launch of the Global Economic Prospects report here yesterday.

The slowdown in potential growth is the result of years of softening productivity growth, weak investments and an ageing global labour force, the report noted.

On the decline in potential growth prospects for emerging markets (EMs), the factors include the slowdown of economic activities in China, less favourable demographic changes, and a lack of productivity gains seen in the sectoral shift from manufacturing to services, said Kose.

This could result in faster-than-expected inflationary pressures as excess supply disappears in the near future, which could prompt a quicker tightening in monetary policy by the central banks of advanced economies’, Kose added.

Investors’ failure to price in further rate hikes, which leads to a sudden repricing of risk, as well as a possible overvaluation in US equity markets (see chart), could add to financial stress, he said.

This is one of the nearest term risks to strong economic growth forecasts, while protectionism, geopolitical tensions and policy uncertainty could threaten to derail global growth as well.

As a solution to the closing gap, the report recommends that policymakers focus on introducing measures to boost long-term potential, including improvements in the education and healthcare systems, stronger governance, and business climate reforms.

“With the anticipated further withdrawal of monetary stimulus by advanced economies, EMDEs’ policymakers need to remain alert to the potential for adverse spillovers and pursue policies to lift long-term growth,” the report said.

Meanwhile, Khazanah Research Institute research director Allen Ng, also present at the launch event, said it remained to be seen whether the recent strong global economic growth was resilient and sustainable.

“We’ll have to wait and see if the real economy will be affected,” he said, alluding to recent volatility that rocked the financial markets.

In an email sent to The Edge Financial Daily, he added: “For the longest time, there has been much slack in many economies. Now that the slack is closing, there’s potential for greater demand-side inflationary pressure.”

Ng said as Malaysia has seen its manufacturing industry peaked in the early 2000s, measures such as moving up the manufacturing value chain and providing more modern-day services can be considered to ensure productivity growth does not slow down.