This article first appeared in Forum, The Edge Malaysia Weekly on October 23, 2017 - October 29, 2017
The world economy is humming along at its best pace since around 2011. Not only has growth picked up but inflation remains under control, external imbalances are contained and global financial conditions continue to be benign enough to push stock markets up. Yet, caution prevails. Most forecasters remain wary, with the likes of the International Monetary Fund (IMF) and the World Bank highlighting downside risks such as possible geopolitical flashpoints and threats to trade.
Our view is that global economic growth could continue to surprise positively in the near term and that East and Southeast Asia will be major winners from this rebound. Yes, there are developments that pose unquantifiable or unpredictable challenges, but these are likely to unfold over the longer term, not imminently — developments such as new technologies, financial imbalances and geopolitical risks. There is, though, one exception to this nice scenario and that is the very real threat to maintaining the global trading regime that Asia has benefited from so much.
Upside surprises likely to global demand for Asian exports
The data supports a positive view of near-term growth. The most recent OECD Composite Leading Indicator points to continued, above-trend growth. The CLIs were upbeat for most of the major economies — both the G3 advanced economies and the large emerging economies. Putting all this together, it looks like virtually every part of the world economy is progressing and will continue to do well, except for a handful of countries that are embroiled in conflicts or gross economic mismanagement. We have not had it this good in the world economy for many years.
Surveys of purchasing managers show that new orders continue to rise, suggesting that there is enough demand in the pipeline to sustain this recovery. Moreover, new export orders are also performing well, meaning that the recovery in individual countries is increasingly spilling over into export demand, which Asian economies thrive on.
Going beyond just data, it is really important to understand the underlying processes that drive the world economy and whether they are supportive of further growth. The answer is a resounding yes.
In essence, let us not forget that the global economy sustained a whole series of shocks of unusual scale and intensity in recent years — the global financial crisis (GFC), several bouts of crises in the eurozone, China’s abrupt growth deceleration and the collapse of commodity prices. Mercifully, these shocks have receded and the world economy is now able to normalise. Credit markets are reviving, along with labour and housing markets. Business confidence is also higher, as seen in the recovery in capital spending since end-2016, which has been a boon for export-oriented Asia.
The beauty of this “normalisation” is that it creates a couple of positive dynamics:
- One is that if virtually every part of the world economy is growing, each country’s recovery feeds into that of its trading partners, stimulating each other until we get an upward spiral and upside surprises to forecasts.
- Perhaps more controversially, we believe that as the world economy normalises, old relationships will reassert themselves so that the currently low levels of inflation give way to more normal inflation, global trade goes back to its old habit of growing in line with, or faster than, world output and businesses recover their animal spirits and step up capital spending, which then raises productivity and wages.
- And finally, this return to more “normal” times allows the long-standing drivers of growth to reassert themselves — labour force growth, urbanisation and other changes in developing economies that spur infrastructure construction, application of productivity-enhancing new technologies, and competition that stimulates new products and business processes.
Second, the global economy will not go back to exactly how it operated in the past for the simple reason that technological changes are multiplying across many areas of activity, with the pace of change likely to accelerate. While it is true that sectors such as traditional media, hotels and taxi services have been disrupted, we do not think the net effects will be negative in the near term. In fact, we see a powerful pickup in capital spending as businesses invest in new technology so as to remain competitive and relevant to their consumers. For example, advances in composite materials and engine technology have produced a class of super-efficient new airplanes whose operating economics are so good that airlines have to invest in new planes even where their existing aircraft are still operational.
Those who worry about the impact of technology rightly point to risks such as how accelerating automation might displace less skilled workers or make developed economies more competitive in manufacturing activities that have moved offshore to countries with low labour costs. These are indeed real risks, but it is premature to rush into a judgement that these advances in technology will have net bad consequences. After all, we do know from history that the downside risks of new technologies tend to be more evident than the upside potential. That was the case with previous phases of automation, but in the end, the impact has been net positive. Very few people will complain that mass production with moving assembly lines in automobile manufacturing or automated spinning and weaving in textile manufacturing are bad things.
So, where are the risks?
There is much concern about political risks. Will North Korea’s pursuit of nuclear weapons end in conflict? In Europe, will Brexit be followed by even more struggles for separation in places such as Catalonia? Will the multitude of seething tensions in the Middle East cause more explosions? Unfortunately, even the most astute analysts with the best available intelligence are struggling with these questions, so the impact of politics on the global economy is essentially unquantifiable. However, an analysis of possible scenarios based on reasonable assumptions suggests that extreme outcomes are not likely: The most probable scenario is occasional outbreaks of turbulence, which the global economy can deal with.
Another concern is the build-up of financial imbalances because of the excessive monetary policy responses to the GFC and its aftermath. This applies to the developed economies as well as to China. Consequently, as the IMF points out in its recent assessment of financial risks, asset markets are priced too richly, leverage is now higher than before the GFC, and investors have moved into asset classes that they are not familiar with in a desperate search for yield. If the right policies are not followed, these financial distortions could potentially lead to a major shock that the IMF estimates would hit global economic growth and cause US$100 billion of capital to flow out abruptly from emerging markets. Nevertheless, despite these concerns, the IMF’s baseline assessment is that the recovery in the global economy combined with enhanced regulation and still-supportive monetary conditions all reduce the likelihood of a big shock.
The big risk to us is trade
That leaves us with the one risk that really could keep us awake at night — the growing threat posed by the Trump administration to the global trading regime. In recent months as the new administration’s trade team was confirmed in office and began to staff up its departments, its strategy has become clearer.
- At one level, the administration is unilaterally investigating allegedly unfair trade practices even before US companies complain about them. The result has been a 48% rise in trade sanctions deployed by it against exporters, many of whom are from Asia. We think this can only get worse.
- More worryingly, the administration seems to be trying to undermine the effectiveness of the World Trade Organization. The US has blocked the appointment of appellate judges to WTO’s dispute settlement system. At the rate that judges’ terms end and need to be renewed, this vital dispute settlement system will collapse by late 2018. In other words, while not mounting a frontal attack on the global trading regime, the administration seems to be neutering it from within.
- Just last week, as the renegotiation of the North American Free Trade Agreement got underway, US trade negotiators offered Canada and Mexico, the US’ partners in Nafta, a set of proposals that they could not possibly accept, for political and practical reasons. President Donald Trump has repeated his desire to withdraw from Nafta and replace it with bilateral deals which he thinks will be more favourable to the US. Most analysts we speak to believe that such a withdrawal will have a disastrous effect on manufacturing supply chains in North America. Worse still, it could potentially cause an anti-US backlash in Mexico, which could allow radical candidates to win power in Mexico.
Trade-oriented Asian nations should be very worried. The protectionist inclinations of the Trump administration threaten to upend the global trade regime that has served the economic development of Asian economies so well. If the US moves from being the defender of a rules-based global trading regime to promoting a global free-for-all in trade, the biggest losers will be the major Asian exporters.
Two countervailing forces give us some degree of hope. One is that the US business community is mobilising strongly to prevent Nafta from collapsing and to preserve the open trading system. The other is that Asian countries are not sitting still. One set of countries is trying to salvage the Trans-Pacific Partnership agreement that Trump pulled the US out of. It is likely that some form of TPP minus the US will be agreed in the coming year. Asian nations are also working hard to finalise the Regional Comprehensive Economic Partnership, which will help support trading arrangements in a large part of Asia.
Conclusion
The interplay of all these complex forces suggests the following outcomes. First, global growth should surprise positively in the coming quarters. Second, as this higher growth reduces slack in the economy and interacts with rising oil prices, inflationary pressures could rise faster than expected. This will spur somewhat faster monetary policy normalisation, which may increase the turbulence in financial markets. But we expect policymakers to err on the side of caution, so we do not expect a financial shock. Finally, the risks to the global trade regime could worsen, necessitating a massive effort by the beneficiaries of world trade to mobilise support against potentially disastrous actions by the current US administration.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
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