On these days, a large proportion of the content of traditional and on-line media are summaries of what 2018 brought and predictions of what 2019 will entail. This will go in crescendo towards the end of the year. Here and there, of course, recipes of delicious dishes, suggestions of the most stylish outfits for New Year Eve and recommendations to avoid controversies and quarrels in the family gatherings that are inexorably waiting for us.
Let’s contribute to this seasonal trend by trying to figure out what 2019 is going to be like. Terms like Brexit, trade and protectionism come to mind quickly. Oh, wait, do these words raise a feeling of déjà vu? Absolutely. After all, twelve months ago were talking about them. Then, should we conclude that nothing has varied since one year ago? Not really. Actually, the scenario did change to some extent.
A general deceleration in growth
The economy of most of the countries was advancing at a sound pace since 2017, when the world growth rate was 3.7%. A year ago, international institutions like IMF or OECD were pretty optimistic about the new momentum in the world economy. The IMF, for example, projected that world growth would be 3.9% in 2018 and 2019.
Now forecasts have been adjusted downwards. Some drops of pessimism are creeping in. According to both IMF and OECD, world growth has reached a maximum (or a plateau, in IMF terms) in 2018, and the future does not look so promising any longer. Why? To start with, lower levels of trade and higher levels of uncertainty are causing a detrimental impact in the actual and expected rate of change of GDP. World growth will be 3.7% in 2018 and 2019, and 3.6% in 2023 (IMF). The difference in terms of figures may seem meagre; the bottom line is that some fears have materialized and are blurring the current scenario.
The new setting
In recent years a good number of countries have recovered from the 2007-2008 crisis (although not completely). Extremely expansionary monetary and fiscal policies have helped, no doubt. Fears of deflation vanished. Many economies are enjoying full employment. Unemployment in OECD has reached the lowest level since 1980 and is expected to be around 5% in 2020. Conditions in financial markets are sound. Financial reforms undertaken after the crisis have worked and the financial architecture has improved (again, there is no room for complacency: risks could be lurking in that rather unexplored and mysterious galaxy of the shadow banking). Living standards, by and large, are not at the pre-crisis level yet, since the crisis has proved to be quite persistent, but we are getting there gradually.
The scenario is changing, however:
- First, there is no room for further accommodative demand policies. Fiscal policies will probably turn from expansive to neutral in most OECD countries. The ECB has announced the end of its program of massive asset purchases. In simpler terms, the monetary policy designed in Frankfurt is modifying its stance from very lax to less expansionary. Interest rates in the euro zone will have to increase at some point in the future. Incidentally, they have already increased in the US.
- There is already a noticeable impact on trade and output of the escalation in tariffs between US and China. The effect is larger in those countries but not confined to them; negative spillovers are coming about.
- Oil prices have hiked, and further increases cannot be ruled out. The combination of mounting production costs (due to tariffs or energy) and the lack of spare capacity (there is a shortage of highly skilled labour) in many developed countries is waking up inflation.
What is happening to oil?
Oil prices have increased over 30% with respect to 2017. Production has risen in the US and Russia, but not enough to offset the supply reductions in some OPEC members, notably Venezuela. There is a lot of uncertainty about prospects in Iran. Other potential disruptions in the near future can not be ruled out. It is true that OPEC has eased restrictions, but the industry does not have spare capacity. Prices are quite volatile and further increases are indeed possible.
Inflation and wages
Wages are beginning to increase in OECD. It is good news, but has a downside: the risk of a passing through to prices if there are no gains in productivity. Compounded with the negative effect of tariffs, oil prices will entail higher inflation. This phenomenon is crucial for the Euro zone: as recent research has shown, the area has a large propensity to second round effects of oil price shocks and potential wage-price spirals, probably because of the rigidities in the labour markets. This confronts monetary authorities with a trade-off: After a (supply side) oil shock, inflation goes up and output falls. Here is the dilemma: is it better to tackle inflation by restrictive measures or to avoid a dismal behaviour of output via monetary expansions? The choice is especially painful in the Eurozone, where an adverse- to-inflation ECB (in accordance with its mandate) coexists with lethargic activity in some areas.
These facts suggest that, since many developed countries are close to their potential capacity, it is imperative to help expand the supply side and rise productivity growth. In other words, the possibilities production frontier has to shift outwards. Or, using a very familiar and repeated expression, structural reforms are necessary, although governments are generally reluctant to tackle them, as I discuss here. Which kind of reforms? Everything conducive to more competitive and efficient markets (of both good and services and labour) such as lower taxes or less red tape.
Trade and protectionism
In 2018 tariffs increased primarily among US and China. Their impact on trade and GDP is already apparent, not only in these countries, but also in others areas as Europe or Japan, inextricably connected to global trade by regional supply chains.
Perspectives are dismal: a further reduction of trade will entail a dip in productivity because of less competition, less specialization and less diffusion of ideas. Therefore a key issue now is what happens next regarding US-China trade conversations.
There are also other fronts. In Europe, it is impossible yet to make conjectures about the outcome of the Brexit enigma, since it is closely linked to domestic policy in the UK. However, it is clear that maintaining the current status quo of no tariffs when trading with the EU is in the best economic interest of everyone.
The U.S.‑Mexico‑Canada new trade agreement still has to work. Trade experts also wonder if the new government in Brazil will support Mercosur instead of boycotting it (allegedly because of conflicts with Argentina) as previous ones did. A more dynamic Mercosur will positively impact almost all Latin America, not only in terms of fostered trade but also creating incentives and confidence for Foreign Direct Investment.
A closer look at growth in some areas
US growth has been buoyant due to expansionary fiscal and monetary policies but those effects are decaying. Long term interest rates are starting to rise. The increase in tariffs on imports from China and the subsequent retaliation of the Asian country have fuelled uncertainty, discouraged investment and hurt growth. One year ago, the IMF projected a 2,7% and 2.5% growth rate for 2018 and 2019, which has ever since been adjusted to 2.4 and 2.1%, respectively, while the forecast for 2023 is 1.5%.
The Euro zone, whose GDP rate of change achieved a healthy 2.4% in 2017, will grow only 2% in 2018, 1.9% in 2019 and around 1.4% in 2023. Some of the most dynamic countries in the area are Slovenia, Malta, Cyprus, the Baltic Republics and Finland. Several of the least, Italy and France. The situation of Italy and its public deficit is worrisome; the performance of France is disappointing. Macron announced ambitious and much-needed reforms for the French economy but his agenda seems to be stalled.
Emerging and developing economies
The emerging economies as a whole will maintain a favourable rate of 4.7% throughout 2018 and 2019. As usual, the most dynamic area is East Asia.
Some emerging and developing economies have been and will be negatively affected by higher interest rates in developed countries and mounting uncertainty regarding trade. Some of the effects are already taking place: currency depreciation against the dollar, pressures on inflation and interest rates, higher risks in heavily indebted countries, decreasing capital inflows. A few oil exporting countries, though, as Nigeria and Kazakhstan, could benefit from the surge in oil prices.
China will moderate its growth from 6.9% in 2017 to 6.6% in 2018 and 6.2% in 2019. It grew very fast in the first half of 2018, but since then it has been negatively affected by the trade conflicts with the US. A more prudent, restrictive and reasonable approach to lending could have had some influence, too, but this was to be expected, since Chinese firms and local governments are too leveraged. The country is facing an important challenge in the medium term since working age population is declining.
India continues to display strong growth, above 7%, thanks to the structural reforms implemented in the recent past. Forecasts suggest that future rates will be in the neighbourhood of 7.5%.
In Latin America, Brazil will probably increase its growth to 2-2.25% in the next two years. The country is in desperate need of structural reforms, notably in the realm of security system and pensions, to restore confidence of agents. Its high level of public debt should not be overlooked, either.
In Mexico there are still risks associated to the implementation of the new trade treaty with Canada and US. It could certainly be negatively affected by slower growth in the US. The new government has to show commitment to further reforms and sound fiscal and monetary policy frameworks. The fight against crime and corruption, and the promotion of stability and confidence, are also essential.
The future looks troubled for Argentina and very bleak for Venezuela. Bolivia, Chile, Colombia, Panama, Peru and Paraguay will continue exhibiting solid growth.
In Sub-Sahara Africa average growth will be close to 4%. The region comprises a good number of excellent performers: Kenya, Uganda, Rwanda, Tanzania, Ghana and Senegal, among others, although the largest economies in the continent, as Nigeria or South Africa, are not doing very well.
2019 is bringing more uncertainty and inflation, less trade and less growth.
It is not a surprise that the IMF and OECD have urged policymakers to implement growth enhancing reforms and abandon dangerous or reckless measures.
Following these facts and ideas, in my view remedies are associated to two main avenues:
- It is essential to reverse or at least stop the increase in tariffs. Future events in US vs China and UK vs EU are therefore crucial.
- Structural reforms capable of triggering increases in productivity are urgent. We have heard this so many times…Nonetheless, the oil shock is an extremely good occasion to increase capacity in the supply side of the economies, especially when the possibilities of demand policies are exhausted. As recent history has shown, the best way to fight inflation is to increase productivity growth. Action in this field could, at least partially, offset the decline in trade and the increase in uncertainty.