After the first month of 2024, the consensus on the forecast for the global economy remains cautiously optimistic. Most central banks and analysts predict either a soft landing or even no landing at all. Well, my colleague Nouriel Roubini, known for his alarm calls, thinks that the worst case scenario is the least likely
Business leaders and policymakers I spoke to at the World Economic Forum in Davos last month echoed this sentiment. The fact that the world economy did not enter recession in 2023, despite a sharp rise in interest rates, has allowed many experts to be optimistic about the outlook for 2024. To explain their optimism, they cite the better-than-expected performance of the US economy or predict that artificial intelligence will catalyze the increase productivity, which many hope for. As one finance minister remarked: "If you're not naturally optimistic, you shouldn't be finance minister".
Economists around the world seem to share this opinion. The VEF survey, "Chief Economists' Forecasts for January 2024", found that while most respondents expect a slight global slowdown in 2024, most are not overly concerned and see the expected slowdown as a healthy correction to inflationary pressures caused by excess demand.
The mood of analysts and business leaders was not affected by the disruptions in global trade caused by attacks by the Yemeni Houthis on commercial ships in the Red Sea, as well as the ongoing wars in Ukraine and Gaza. The US stock market is at record highs, and even the proverbially conservative IMF has revised its growth forecast upwards. In its latest overview of the world economy, it describes the risks to global growth as "broadly balanced". This characterization marks a significant departure from the cautious tone the IMF usually uses to discourage finance ministers from engaging in unsustainable spending.
In this crucial election year, when voters in dozens of countries - representing half the world's population - go to the polls, public spending is already expected to rise sharply. In macroeconomics, this phenomenon is known as the "political budget cycle": politicians in power want to stimulate the economy to improve their chances of re-election, so they increase public spending and run budgets with larger deficits.
Despite the relatively optimistic consensus, recent events suggest that risks remain for global growth to take a negative turn. To begin with, I am deeply skeptical of the Chinese government's announcement that the country's economy will grow by 5,2% in 2023.
GDP growth numbers have long been a politically sensitive issue in China, especially over the past year when President Xi Jinping consolidated his one-man rule by firing a number of top officials, including the defense and foreign ministers. As China's economy faces deflation, falling property prices and weak demand, it is increasingly clear that its problems are far from over and that Xi is determined to control information.
The combination of a prolonged economic slowdown and the collapse of the real estate sector could bring China to the brink of a Japanese-style "lost decade." The obvious Keynesian solution to the slow collapse of the real estate sector and the indebtedness of local authorities is the establishment of direct money transfers to households. But given that Chinese consumers are more thrifty (unlike their spendthrift American counterparts), and that public debt is already growing at a rapid pace, a debt deflationary spiral looks increasingly likely.
Despite avoiding a recession in 2023, European economic growth is expected to remain weak this year. The persistent reluctance of European countries to invest in their own defense suggests that former US President Donald Trump's potential return to the White House in 2025 could force a painful adjustment. Worryingly, European leaders do not seem to be preparing for such a scenario, even as the war in Ukraine depletes their ammunition stocks faster than they can be replenished.
Europe is also facing negative economic effects from US President Joe Biden's Inflation Reduction Act (IRA), which uses tax breaks to attract European companies to America. Although the Act is ostensibly intended to accelerate the transition to green energy in the United States, it is essentially a protectionist trade measure. It may have provided a short-term boost to the US economy, but its long-term consequence could be a repeat of the effects of the Smoot-Hawley Tariff Act of 1930, which set off an international trade war and worsened the Great Depression.
Still, Biden's trade protectionism looks moderate compared to Trump's plans: a 10% tariff on almost all imported goods. The move could wreak havoc on the global trading system. European countries are understandably hoping for the re-election of Biden, who, unlike Trump, has repeatedly confirmed his commitment to curbing Russian expansionism.
It is also alarming that American Democrats and Republicans seem not interested in reducing public spending, let alone reducing the budget deficit. Regardless of which party wins control of Congress after the November elections, it is almost certain that the deficit will be fueled by heavy spending. If real interest rates remain high, as many expect, the government may be forced to choose between deeply unpopular fiscal tightening and pressure on the Federal Reserve to allow another rise in inflation.
Despite the widespread belief that the global economy is headed for a soft landing, recent trends give little cause for optimism. As the world faces another year of turbulence, policymakers and analysts must remember that a soft landing means little if the landing strip is in a turbulent area.
The author is a professor of economics and public policy at Harvard University; he is the winner of the Deutsche Bank Prize for Financial Economics 2011; he was the chief economist of the IMF (2001 - 2003)
Copyright: Project Syndicate, 2024. (translation: NR)
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