On changing seasons

Living in equatorial Singapore, seasons are something I now only encounter on my travels.  But even so, it is clear that that there has been a distinct seasonal shift in the global economy over the past several months: if not summer, then certainly spring.

In the second half of 2016 I wrote several essays and op-eds on the emerging political risks reflected in the Brexit and Trump votes.  Almost a year on, the worst case scenarios of protectionism and populism have not been realised.  With the exceptions of events such as the US withdrawal from the TPP, these structural changes are happening in a gradual way. However, political risks have not gone away – as last week’s German election and proposed US tariffs on Bombardier remind.  Tectonic plates are moving, and meaningful change in a wide range of policies and institutions remains likely over the coming years. But in the meantime, these concerns have been overtaken by a broad-based global economic recovery.

And notably, given the particular exposures of small economies to international economic and political risks, this global recovery is manifesting particularly clearly in small advanced economies.  Small economies are front-running the stronger global growth.  Again, small economies are the canaries in the mine of the global economy.

An encouraging set of Q2 GDP numbers are now in. The average growth rate across the small advanced economy group was 2.9%, which (along with the Q4 2016 GDP growth rate) is the strongest growth performance since 2011. There has been a pronounced acceleration in small economy growth from the second half of 2016.  This small country performance is relatively broad-based, with strong growth from Asia to Europe.  Small economies such as Ireland, Hong Kong, the Netherlands, Finland, and Sweden, are growing at or above 3%.  And there was an encouraging pick-up in growth momentum over the past quarter, which looks to have been continued into Q3.

Large advanced economies are also strengthening, with an average growth rate of 2.2% in the year to Q2.  Most large economies advanced over the quarter, from France and Italy to Japan and Canada.  The UK was a notable exception, down to 1.5% in the year to Q2 from 1.8% in Q1, partly weighed down by Brexit-related issues.  But there is a clear performance gap between small and large advanced economy growth. This small economy out-performance is a useful summary measure of the health of the global economy, and suggests an ongoing global recovery.

This has been supported by stronger world trade growth, to which small economies are heavily exposed.  After a sluggish few years, world trade growth has picked up markedly over the past 12 months (5% in the year to July, the strongest growth since 2011).  This has been reflected in stronger small economy export growth to Q2.  And, although monthly data are volatile, export growth for the year to August looks relatively strong – Singapore (NODX) exports are up 17%, for example.

Small economy equity markets continue to out-perform key global benchmarks through 2017, up 22% year to date in USD terms and 9.5% in euro terms.  This measure also indicates that there is little (near-term) anxiety in small economies about the economic and political outlook.

My assessment of this small economy data is that the global economic recovery should continue, even if the pace of advance is likely to moderate.  The small economy data do not currently provide significant reason for concern about the global economy. Although there are some exceptions – the New Zealand economy is slowing, for example, and Switzerland remains in first gear – there are positive common dynamics across the small economies.

But, of course, risks remain.  First, the potential for a regime change in the global environment remains. Although the prospect of protectionism, populism, and direct geopolitical rivalry are less immediate than feared at the start of 2017, neither is the environment benign: domestic political risks remain in Europe and the US, international commerce is becoming increasingly weaponised (notably by China and the US), and there are several geopolitical flashpoints.  At the moment, these costs are largely localised – Brexit is hurting the UK, Bombardier’s share price is down, and North Korea has had little market impact to date.  But the potential for a marked shift in the international regime should be taken seriously.

Second, the likely start of the unwinding of the monetary accommodation.  This has been well signalled by the Federal Reserve and the ECB, and will likely take place gradually.  And it is positive that economic conditions have made the start of this process possible.  But this is uncharted territory and unintended consequences are quite possible, given the size of central bank balance sheets and valuations in a range of asset markets.

And third, the perennial risks of a China-centred economic or financial shock.

For the moment though, the experience of small economies suggests that a robust economic recovery remains in place. Positive economic surprises seem as likely as negative surprises.  But this improving record of performance – the arrival of spring – should not be over-interpreted as reason for complacency.  New Zealanders are used to unseasonal weather: as Crowded House famously sang, ‘Even when you're feeling warm/The temperature could drop away/Like four seasons in one day’.

Looking forward, it will pay to keep a weather eye on small economies to get a sense of the ongoing strength of the recovery – as well as to calibrate the risks of another seasonal change.