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Earlier this month the International Monetary Fund (IMF) revised up its outlook for the global economy. It now expects global growth at 3.6% in 2017, slightly up from its previous forecast of 3.5% and higher than realised growth of 3.2% in 2016. Rebounding trade, higher commodity prices and an accommodative monetary policy environment are among the main factors driving what’s now expected to be the highest global growth outturn since 2014.
But is the pickup in global growth sustainable? The IMF appears to believe so, forecasting global growth to average 3.7% until 2020. We are less optimistic. Despite the recent material improvements in the global economy, there are still major headwinds to global growth which are unlikely to fade easily. Two in particular stand out: the secular decline in productivity and elevated financial stability risks.
Productivity growth in advanced economies has been on a downward trend since before the financial crisis and has slowed dramatically in recent years. In the US for instance, growth in real output per person, the main measure of productivity, averaged just 0.5% over 2012-2016 compared to 2.8% from 2000-2007. Population ageing, sluggish investment, less technological disruption and a slower pace of global trade growth are among the main explanations for the declining trend. While investment and trade have picked up in 2017, they remain below historical growth rates and the levels needed to spur higher productivity growth.
Irrespective of its causes, the productivity decline has important implications for the future of global growth. If output per worker does not accelerate, production will slow, which in turn will have further knock on effects on growth by dragging on wages and consumption. At present, it is not clear how this trend will be arrested without heavily incentivising greater investment, technological adoption and specialisation. Government efforts to prop up growth through higher spending and tax breaks have been insufficient in size and scope, as they have lacked the fiscal space and know-how to effectively target specific sectors to correct the productivity downtrend.
The second area of concern for the sustainability of global growth is the elevated risks to financial stability which have made the world economy vulnerable to an unexpected shock. Specifically, the large accumulation of leverage since the financial crisis. G20 countries collectively have a non-financial debt stock of over 220% of GDP, an increase of 40 percentage points since 2007. This high leverage leaves the global economy highly vulnerable to a demand shock, such as a banking crisis in Europe or a major geopolitical disaster. This could squeeze debt repayment, push up bond yields and result in a major deterioration in sentiment, bringing global growth down. But more importantly, what’s different this time around and what would prevent a quick recovery is that governments and central banks will be significantly constrained in their ability to respond. Fiscal space remains limited in the aftermath of the crisis and interest rates continue to hover close to the zero lower bound, providing authorities little room to manoeuvre. Hence, even if the shock is not as deep as the financial crisis of 2008-09, engineering a recovery to trend growth would be more challenging.
However, even if a major crisis fails to materialise, its likely that policy makers around the world will continue to enact measures to curtail financial stability risks and these measures themselves will pose a headwind to global growth. The gradual and choreographed policy tightening currently taking place in the US is one example. Eventually, higher interest rates will reduce the incentive to accumulate debt, but they will also reduce the incentive for firms to expand output.
Unfortunately there are no easy fixes and we are not optimistic that global growth will be sustained at its current rate over the medium term due to the force of these headwinds. Declining productivity requires deeper labour market reforms and substantially higher investment. Actual implementation of the large fiscal stimulus promised last year by some advanced economies would be helpful. In terms of financial stability, the onerous task of deleveraging is the only real solution, but avoiding a hit to global growth in the meantime could be difficult.