Economics

Are we flirting with another global recession?

The economies of emerging countries are most at risk

October 12, 2015
International Monetary Fund chief Christine Lagarde spoke at the meeting of the world's finance ministers ministers and central bankers in Lima last weekend (AP Photo/Rodrigo Abd)
International Monetary Fund chief Christine Lagarde spoke at the meeting of the world's finance ministers ministers and central bankers in Lima last weekend (AP Photo/Rodrigo Abd)

The IMF didn’t say it as such at its annual meeting, held last week in Lima, Peru. Yet a rather sober economic outlook, accompanied by warnings of a greater likelihood of downside risks gave substance to a widely expressed fear that another global recession is lurking. The biggest concerns centre around emerging countries in general, and China in particular. Another global recession in a world of heightened political volatility, especially in the Middle East and on Europe’s borders, might have us running for the hills, but how likely is this?

The short answer is "very", simply because we should expect cyclical downturns every now and again. The abolition of boom and bust, to borrow from Gordon Brown, is simply a fantasy. But the world is still working itself out in the aftermath of a monster financial shock, and past rules-of-thumb such as "recessions happen every six or seven years" may count for little. Moreover, it makes a big difference whether the next recession arrives in 2016, or not until much later. There’s no question the world economy is going through a rough patch, but a global recession in which there is no or negative growth doesn’t seem the most likely outcome as things stand.

Global recessions don’t happen that often, and the four that have happened all followed substantial increases in oil prices. In 1975, oil prices quintupled (in 2013 prices), and GDP in advanced economies fell sharply. In 1982, in the wake of a doubling of oil prices in 1979, global growth was a mere 0.5 per cent. In 1991-92 after a more moderate 50 per cent rise in oil prices, global GDP rose by just 1.8 per cent, and in 2009, after another near-doubling of oil prices and with a full-blown financial crisis to boot, global GDP fell by two per cent. Even though oil prices have picked up a bit in recent days, they are still less than 50 per cent of what they were in June 2014. If past oil price performance is anything to go by, we should skirt by a global recession, even though the outlook for commodity producing countries, such as Brazil, Russia and Saudi Arabia is poor.

Avoiding a global recession though doesn’t mean plain sailing. The IMF reminds us in its latest research that most recessions that have happened in the last 50 years have left lasting negative effects on economic growth. Putting this into the perspective of our recent experience, a changed regulatory and behavioural legacy has dulled bank and business practices and is stifling growth; cutbacks in investment have lowered R&D, and productivity growth; and a debt hangover in both the public and private sectors is also weighing for the time being on growth prospects. There’s no doubt that these conditions are keeping our economic condition fragile, dampening growth, and fair to say, making us vulnerable to shocks that haven’t happened yet. But this isn’t a global recession.

Neither the US, nor the UK look as though they are on the cusp of a contraction. People worry about America’s performance over the summer and growth may have dropped to about one per cent. But beneath this gloomy headline, underlying domestic demand in an economy that has almost full employment was still increasing at close to three per cent. In the UK, we have had some disappointing readings about the momentum in services and manufacturing, but  employment levels are at record levels, and wages after inflation are rising at the fastest level for many years. The economy is probably still expanding at about 2.25-2.5 per cent, though the coming fiscal squeeze may well temper this momentum. Even in the beleaguered eurozone, growth and lending are picking up, and analysts are still fairly optimistic about the scope for company earnings to rise over the coming year.

It is in emerging countries that the bigger fears lie. Emerging markets in general are facing a growth crisis that few saw coming five years ago. Before the financial crisis, they were chalking up annual growth of 5.5 per cent, but now it is more like 3.5-4 per cent. And if you express this growth in terms of US dollars, which is relevant for companies, profits and local incomes, growth is actually falling because of the strong rise in the US currency against emerging currencies. Brazil and Russia are already in recession, with little prospect of significant relief in 2016. Turkey is facing the prospect of an onslaught of economic and political disruption. 

Several major emerging countries are suffering because slowing growth has exposed the unsustainability of high levels of debt, especially among companies. According to the IMF, company debt has grown by four times in the last 10 years, and a high proportion of the rise has been denominated in now much more expensive US dollars. Emerging countries that are more commodity-oriented are doing significantly worse than those focused on manufacturing, because of the sharp decline in commodity trade, exports, and prices. These countries desperately need commodity prices to stabilise—as a first step, at least. And this is primarily about China.

The events of August, when China eventually succeeded in stabilising its rapidly falling equity markets, and engineered a cumbersome and poorly communicated mini-currency devaluation left many people feeling confused—and anxious about the government’s capacity to manage the economy and markets. These shortcomings may reflect political volatility that could become more important as China navigates a complicated economic transition to a destination, whose outlines are still blurred. For the moment, though, we can say with reasonable confidence that China’s economy is neither collapsing as some fear, nor a source of confidence, as other still assert. Economic rebalancing to a more consumer-led growth model is slow, the anti-corruption campaign is stifling important economic reforms, and China has quite significant debt, and over-capacity problems to manage. 

China reached the end of extrapolation in 2011, and everything changed. Growth has slowed from 12 per cent to about seven per cent, or most likely a bit lower, and this process is likely to continue over the next few years.  Eventually, it should settle at a sustainable growth rate of about four per cent. The main questions for China are how this process is managed, and its consequences. The prospects for emerging markets, and by implication the rest of us will certainly depend to an extent on the answers.