Nariman Behravesh, Chief Economist at IHS Global Insight, on the causes for optimism – and caution – in the economic outlook.
The causes of the ongoing global malaise are well known: an addiction to debt (in developed economies) and to exports (in emerging markets), followed by a painful period of deleveraging that has been made far worse by policy mistakes. The extreme uncertainty brought on by the political paralysis in the United States, Europe and (to a lesser extent) China is, arguably, the single biggest drag on growth now. The good news is that the underlying dynamics of economic recovery are in place in many parts of the world and will reignite growth once these high levels of uncertainty diminish and economic confidence is restored.
United States: Strong Recovery Forces Waiting to Be Unleashed
While US growth remains sluggish, there are many reasons to be confident that growth will rebound, once there is more clarity on the future course of macro and micro policies, especially vis-à-vis deficit reduction.
Growing evidence suggests that pent-up demand is finally being released. Vehicle sales and housing are the bright spots in the economy, as more households have decided to replace ageing cars and to take the risk of buying a house. One of the most promising recent trends is the sharp rise in household formation – the rate at which young people get married or leave their parents’ homes. Household formation is closely correlated with housing activity. In the aftermath of the Great Recession, household formation fell to around half a million a year (roughly one-third of its long-term trend value). It has recently jumped to a 1.2-million annual rate.
The US household and financial sectors have been aggressively reducing their debt levels over the past four years. This process of deleveraging will ease in the next two years, resulting in stronger growth in consumer spending and more bank lending.
The burgeoning energy boom (natural gas and liquids) has already created hundreds of thousands of new jobs in both the upstream (exploration and drilling) and downstream (petrochemicals) industries. This boom is likely to go on for some time.
Europe: Crisis Resolution Is Increasingly on Track
While the eurozone sovereign-debt crisis seems to drag on, recent developments offer the hope that there may be light at the end of the tunnel.
The European Central Bank’s (ECB) decision to backstop Italian and Spanish bonds has significantly reduced the risk of a Greek debt write-down and/or a Spanish request for a bailout from spiralling out of control and dragging down Italy and the rest of the eurozone. Once the Greek and Spanish crises are resolved (one way or another), the level of uncertainty in Europe will diminish.
The ECB is expected to support growth in the eurozone, while a weaker Euro will help many of the region’s export-led economies (Germany, most notably).
One very bright spot for Europe is the UK economy, which has emerged from recession. Among other things, this suggests to the rest of Europe that there may be “life after austerity,” especially if the central bank is committed to supporting growth. This has certainly been true of the Bank of England, but now appears to be true of the ECB as well.
Other Key Economies: More Stimulus and (Mostly) Weaker Currencies
In light of the troubles in the United States and Europe and the damage to exports, many countries in Asia and Latin America have put in place additional monetary and fiscal stimuli. These measures have been easier to justify, given the downward drift in inflation rates (despite recent increases in food and fuel prices).
Central banks in many of the world’s key economies have jumped on the monetary stimulus bandwagon – some, like Brazil, more aggressively than others. A few (Brazil, Japan and Turkey) have also initiated more unorthodox stimulus measures.
Some countries have also tried to prime the pump with targeted (and, so far, limited) fiscal stimuli, including Brazil, China, Hong Kong SAR, Malaysia, South Korea and Thailand. Most of these countries are trying not to overdo the stimulus, hoping not to reigniting inflation.
Another potential plus for many emerging markets is the recent decline in their currencies relative to the US dollar. This has been most pronounced for those countries that have aggressively lowered their interest rates, and will help boost their exports.
Finally, anxiety over the apparent unwillingness or inability of China’s leadership to aggressively promote growth during its leadership transition has now diminished considerably. More stimuli can be expected, especially if growth weakens any further.
The “Window of Maximum Uncertainty”
These positive global dynamics and the impact of additional stimuli (both announced and expected) will help to boost growth in the near term. Nevertheless, the restraining effect of the current levels of uncertainty on businesses cannot be overestimated. A recent study by the Federal Reserve Bank of San Francisco suggests that the lack of confidence in the future course of the US economy and US policy may have added as much as one percentage point to the American unemployment rate. The impact could be even larger in Europe. Unfortunately, these high levels of uncertainty are likely to remain with us through the middle of this year, and possibly longer.
The good news is that once this uncertainty diminishes, consumer and business confidence can be rebuilt and economic dynamism can be restored.
Nariman Behravesh is Chief Economist at IHS Global Insight. He is participating in the World Economic Forum’s Annual Meeting 2013.