Beneath the calm surface

calm surface.jpg

The IMF updated its global outlook last week, holding its GDP growth forecasts steady at 3.5% for 2017 and 3.6% for 2018. But beneath this calm surface, these updated forecasts provide insights on a changing global economic environment.  There are three aspects of the revised IMF forecasts that are of particular relevance.

First, the IMF forecasts a continuation of the global economic recovery.  The 2017 and 2018 forecasts are up from 3.4% and 3.2% in 2015 and 2016 respectively, on the back of stronger growth in both advanced economies as well as emerging and developing markets.  The IMF also sees an ongoing recovery in trade, running at about 4% over the next couple of years.  This is a marked improvement over much of the post-crisis period, when world trade growth has been close to zero.  And estimates from CPB show that world trade growth in the year to May is back at levels not seen since 2011, at around 5%.  This is a particular benefit for small open economies.

Indeed, after a relatively weak 2014 and 2015, in which slow world GDP and trade growth weighed on small economies, small economy growth returned strongly from mid-2016.  Small advanced economy growth rates were 3.0% in the year to Q4 2016, and 2.8% in the year to Q1 2017.  This is well ahead of the large advanced economies group, suggesting that the international economic and political environment remains broadly supportive of small economy performance.

Relative to the economic concerns of a few years ago, these global outcomes are a positive surprise: several of the key economic risks have not materialised.  Of course, these forecast global growth rates remain well below their pre-crisis levels, productivity growth remains low, and unemployment is worryingly high in many countries.  But the global economy is firming.

The second notable feature in the IMF’s Outlook was the major change in several country-specific forecasts.  The growth outlook for the US was marked down sharply by 0.2% and 0.4% for 2017 and 2018 respectively.  In contrast, the euro area was upgraded (by 0.2% and 0.1%) with all of the large euro area economies being marked up (France, Germany, Italy and Spain), while the UK was marked down by 0.3% for 2017. Emerging Asia was also marked up; and on the back of its strong Q1 GDP numbers, the IMF now expect China to grow at 6.7% and 6.4% in 2017 and 2018.

It is striking that the IMF can downgrade the US markedly without altering the overall global growth forecasts.  This update provides evidence that the US can now sneeze without the rest of the world catching a cold.  
These growth revisions may not be large, but they provide a powerful reminder that the global growth rebalancing continues.  Indeed, the pattern of these updates reinforces the shift in the global centre of economic gravity from advanced economies to emerging markets.

Although there are some advantages to the global economy being less reliant on the US, there are some risks associated with this rebalancing.  China and other emerging Asian markets, which are increasingly at the centre of the global system, have a higher economic and political risk profile. The risk profile of global growth will increase steadily as China and other emerging markets account for a larger share of global GDP.

Third, this IMF update shows that politics do matter for economic performance.  At the core of several of the country growth forecast revisions were domestic political factors.  In the US, the inability to pass legislation on tax reform and infrastructure has led the IMF to reduce its estimate of the fiscal impulse.  The weaker than expected economic data in the UK – in large measure Brexit-related – has contributed to the UK downgrade.  And the reduced political profile in the Eurozone is helping with the growth outlook.

The apparent disconnect between political events and rhetoric and economic and market performance has been a puzzle over the past year: the risks associated with populist, protectionist policies have not had an obvious impact on the global economy, despite many concerns.

But we are now beginning to see an impact of domestic politics on the economic outlook of the involved countries.  So far, this is relatively contained: the chaos in Washington is hurting the US; and Brexit has damaged the UK outlook (and its close neighbours, such as Ireland) but has not had a material impact on the European economy as a whole.  And these effects will likely persist: the full impacts of the Trump Administration and of Brexit will become more apparent over the coming period.

It is clearly encouraging that the global economic recovery is taking hold, and that world trade growth is returning.   But this remains a gradual recovery process, and risks remain: most notably a China shock, the continuing potential for protectionist activity that could easily spread into trade and currency tensions around the world, and the risks around the normalisation process.  Even if all looks calm on the surface, this IMF update gives a sense of the powerful tides and currents at work in the global economy.  Do not over-interpret the constant headline growth number.

David Skilling