Living in interesting times
This time last year, I argued that the Goldilocks economic recovery of strengthening, broad-based global growth was likely to be joined by lurking, hungry bears. These economic and political bears have increasingly made their presence felt through 2018: trade tensions, the end of central bank balance sheet expansion, geopolitical competition, and so on.
The coordinated global recovery is fading. Outside the (fiscally-supported) US, world GDP growth has slowed through 2018, from the Eurozone and Japan to China. And the higher frequency data into Q4 suggests ongoing loss of global economic momentum. My small economy lead indicator measure shows that growth in economic activity is back to levels at the end of 2016; the surge in global growth over the past two years has come to an end.
Global growth is not falling off a cliff, but will be slower. The IMF and the OECD have downgraded forecast 2019 GDP growth to 3.7% and 3.5% respectively. I am a little more cautious on the outlook for 2019 given the recent weak data flow, but I don’t see a high probability of a major growth shock in 2019. And several governments, from China to France and Italy, are preparing more expansionary fiscal policy settings to offset slowing growth (and political anger), which will provide a buffer.
What I think is more likely – and more material – than an economic shock in 2019 is an institutional shock; a regime change in the institutions that have governed the global economy for decades. This is a slow motion process, but with the potential for jump-shifts – as institutional arrangements designed for one context are stressed by the emergence of new dynamics. This process picked up force in 2018.
The US/China trade tensions are broadening into strategic economic and geopolitical competition. Despite the tactical truce at the G20 meetings, there are strong dynamics that will drive greater economic and political frictions between these two powers (increasingly apparent in the technology sector). China’s amorphous and expansive Belt & Road Initiative is confronting many countries in Eurasia with hard strategic choices. And from the WTO to the G20 and OPEC, international institutions are facing significant stress as a multipolar system emerges. However, there are some positive developments in this multipolar world, such as the EU/Japan FTA approved by the European Parliament last week.
In domestic policy, pressures continue to mount on central bank independence (India is the latest example). And the protests in France over the past few weeks are the latest reminder at the anger against political elites and the appetite for different policy approaches. From Brexit, to the rise of populist parties, and the difficulties of forming stable governments, many Western countries are facing political challenges. There is growing demand to ‘take back control’.
But these events are just a prelude to what is likely through 2019 and beyond, as political and institutional arrangements come under increasing stress (exacerbated by slowing GDP growth). Consider the following areas where I think institutional stress is likely.
First, increasing politicisation of central bank decision-making is likely – 30 years on from New Zealand’s path-breaking 1989 Reserve Bank Act. The unwinding of QE in the context of slowing growth (and asset prices) will be a combustible mix. Weakening political support for independent central bank decision-making will create new challenges, with the potential for loose global monetary policy for longer.
Second, policy and institutional tension is likely in Europe due to different fiscal preferences of countries like France and Italy and the disciplined preferences of the increasingly structured Hanseatic League 2.0 (and friends). It seems likely that (again) large countries will breach the fiscal rules as they respond to economic and political pressures. This will place European institutions under significant stress, with the potential for a schism as was threatened in the Eurozone crisis.
Third, there will be greater strategic economic and regulatory competition between the big economies, and growing constraints on the operations of global firms. Already, there is increasing use of discretionary, unilateral sanctions and deal-making: the weaponisation of economic policy. President Trump’s apparent willingness to do a deal over the Huawei CFO’s detention is just the latest evidence that rules-based globalisation is being supplemented by big power politics. We are moving from hyper-globalisation to managed, multi-polar globalisation.
And fourth, expect change in exchange rate arrangements, an institutional choice that sits at the intersection between these domestic and international pressures. From the sustainability of the Eurozone (and other pegs, such as the HKD) to the potential for currency tensions between the US and China (in a manner similar to the US/Japan currency tensions in the 1980s), expect exchange rate arrangements to become an increasing focus of political attention in 2019 and beyond.
These (and other) changes will have meaningful economic and market impacts. Some will be positive for short-term growth (loose macro policy), others may be negative. But as the way in which policy decisions are made changes, firms and economies will face new risks and opportunities, creating winners and losers. The impact of the Brexit process on the GBP and on UK GDP growth shows the importance of politics for market and economic outcomes. More broadly, the 1970s provides guidance for the type of outcomes that can be expected in a fluid, uncertain policy and institutional environment.
In the immediate aftermath of the global financial crisis, there was much commentary about the emergence of new policy approaches. In the event, no new policy consensus emerged – apart perhaps from unconventional monetary policy. But a decade on, we may be seeing something new arrive.
Focusing only on the state of the global business cycle is likely to underplay the potential for disruptive change in the global economy. 2019 will not simply be about the evolution of the business cycle and some specific risks around trade wars, but will be a story about disruptive change to the rules of the game of the global economy.
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Dr David Skilling
Director, Landfall Strategy Group