A gloomy outlook for the global economy

David Lipton, the first deputy managing director of the International Monetary Fund (IMF), told the Financial Times, on the sidelines of the recently concluded annual conference of the American Economic Association, "The next recession is somewhere over the horizon, and we are less prepared to deal with that than we should be . . . [and] less prepared than in the last [crisis in 2008]."

Lipton essentially summarises the global economic situation and prospects. Although in its most recent forecasts in October, the IMF projected 3.7 per cent growth in the global economy for 2019, Lipton's comment is an indication that the IMF is most likely going to revise its 2019 growth forecast substantially downward when it releases updates.

In light of the uncertainty caused by the US-China trade war, the IMF expects the US economy to slow from a three-year high of 2.9 per cent in 2018 to 2.5 per cent in 2019, while China's economy has already slowed.

EUROPEAN RECESSION: The European Central Bank is expecting growth in that region to come in at a more sluggish 1.7 per cent in 2019. Europe is likely already in recession with the collapse of industrial production in Germany, France, UK and Italy. Germany's gross domestic product (GDP) fell by 0.2 per cent in the 3rd quarter of 2018, and Italy recorded a negative GDP growth of 0.1 per cent due to weaker domestic demand.

Germany's industrial output fell by 1.9 per cent month-on-month in November 2018 and was down in five of the six months before December 2018. France's industrial production fell 1.3 per cent in November 2018, reversing a recovery of 1.3 per cent growth in October from a 1.7 decline in September.

While the UK remains mired in the Brexit mess, its GDP growth has been dragged down to 0.3 per cent in the three months to November, as its car manufacturing reversed amidst the broadest drop in industrial production since 2012. The final quarter GDP growth is expected to be 0.1 per cent, almost halting the economy.

TRUMP STIMULUS DISSIPATES: Trump and the GOP [Republican] Congress have tried to breathe a new life into the US economy with large tax cuts. Those tax changes were focused too narrowly; nonetheless the tax cuts goosed business investment and overall growth in 2018. The impact however was not only modest, but also fast disappearing. As average families gained little from the tax changes, their purchases of houses and consumer durable continued to slide through 2018. Instead of investing in the expansion of productive capacity, companies have spent much of their tax savings on a stock buy-back spree totalling some $1.1 trillion in 2018.

Furthermore, because the Trump tax-cuts and spendings were poorly timed, the US economy is now overheating, with inflation rising above target. Therefore, the US Federal Reserve will continue to raise the federal funds rate in an attempt to dampen demand.

A survey of 500 chief financial officers, including 226 in the United States, by the Duke University's Fuqua School of Business reveals that nearly half of the US executives believe the US will enter a recession by the end of 2019, with 82 per cent believing that it will have begun by the end of 2020. Wall Street's biggest banks, JP Morgan and Bank of America, are also sniffing a slowdown of the US economy in 2019. Both the Dow Jones Industrial Average and the S&P 500 were bracing for their worst December performance since 1931, when stocks were battered during the Great Depression.

NOT PREPARED: David Lipton has rightly warned about the lack of preparedness. First is the concern with the potency of monetary policy after it has exhausted all its manoeuvring capacity with the unconventional approach since the 2008-2009 global financial crisis (GFC). Second, countries now have less fiscal space than in the wake of the GFC; public debt has risen and, in many countries, deficits remain too high to stabilise or reduce debt. Third, the world is now less united; the solidarity that helped co-ordinated actions to prevent the great recession from turning into another great depression has not just waned, but major countries are now into outright antagonism.

Domestic political environments are also more hostile. For example, in Europe, the rise of ethno-populist parties is making it harder to pursue EU-level policies and create the institutions necessary to combat the next financial crisis and downturn. There will certainly be a backlash against any large bail-outs of financial institutions.

THE ORIGINAL SIN: Lipton, however, did not mention the root cause of policy paralysis - that is, the policy blunders since the GFC. First was the premature withdrawal of fiscal stimulus and an ideologically driven emphasis on fiscal consolidation, arguing that it would boost investor confidence for a robust recovery. Despite the unearthing of fatal errors in the much cited empirical studies backing the arguments for fiscal consolidation, and the IMF's admission that its earlier advice for fiscal consolidation was based on faulty calculations, there was no change of policy course. Governments failed to take advantage of historically low interest rates (negative real interest rates in most cases) to borrow and invest in education, health, science & technology and much needed infrastructure to boost productive capacity.

Second, this placed all the responsibility for engineering a robust recovery on the monetary authorities which then began experimenting with an unconventional monetary policy, known as quantitative easing (QE). However, the global economic recovery remained tepid and vulnerable to a back-slide. Extra liquidity, made available by QE, found its way to speculative activities and to emerging economies amplifying the vulnerability of their financial sector, which experienced increased volatility.

Third, the QE benefited financial asset holders, thus contributing to growing wealth inequality. At the same time, cuts in public services and social spending exacerbated rising income inequality. Tax cuts at the top, while failing to generate much claimed investment and jobs growth, added to unprecedented concentration of income and wealth in the hands of the few.

Fourth, the failure to engineer a robust recovery not only made the debt situation worse, but also made lives of the ordinary people harder. The growing inequality also created resentments and led to the erosion of trust in the political and economic system.

DEMOCRACY AND MULTILATERALISM IN RETREAT: The end result is the rise of populist ultra-nationalist politicians in Europe and decline of democratic polities elsewhere. The "new sovereigntists" and false prophets of American exceptionalism are undermining multilateral cooperation when needed most. Thus, a recession in 2019 may well elevate geo-political tensions, exacerbating the negative feedback loop for a 'perfect storm'.

Anis Chowdhury, Adjunct Professor at Western Sydney University and the University of New South Wales (Australia), held senior United Nations positions in New York and Bangkok.

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