Nine economics lessons from 2017

With Christmas rapidly approaching, and 2018 just round the corner, it is time to down tools and consider some lessons from the world of economics this year. You might spend your Christmas eve watching the Festival of Nine Lessons and Carols at King’s College, Cambridge. To keep it seasonal, I’ve gone for nine lessons here, too.

So how did the economy perform, and what are the takeaways?

1. Global growth was more solid and synchronised than expected

The world economy had a decent year. Global economic growth developed stronger sea-legs, and spread to important countries that had previously been plagued by recession and/or scandal, for example Brazil, South Africa and Russia. For the first time since the financial crisis, no major country or region experienced an economic contraction. The most welcome surprise, perhaps, was the build-up in cyclical economic expansion in the eurozone. The most predictable disappointment was the UK.

The International Monetary Fund’s October forecasts suggested that after 3.6 per cent in 2017—roughly the same as the average from 1990-2007—global growth momentum will roll over into 2018. But watch out. We normally have a business cycle downturn every 10 years or so, and the last one was in 2009. Don’t say you weren’t warned.

 

1. The US expansion is going for gold

December marks the 102nd month of expansion in the US economy. If it keeps going to April 2018, it’ll rival the 2nd longest US expansion (Feb 1961—Nov 1970), and if it keeps going to July 2019, it will break the 120 month record (Mar 1991—Nov 2001). The Trump White House has mercifully had little impact on the economy so far, and with the economy growing at over 3 per cent at an annualised rate since the spring, the new proposal to cut taxes for firms and the better off will give the US economy a further lift going into 2018.

The consequences for the fiscal deficit—possibly over $1 trillion of lost tax revenues over the coming decade—inflation, interest rates, and eventually welfare when the tax cuts have to be paid for, are for another day. Will that day come before July 2019? Stay tuned.

 

1. China’s acid test is coming

After an economically turbulent 2015-16, China slipped off most people’s radar screens in 2017. Officially, the economy grew by about 6.8 per cent, thanks to the prior build-up of fiscal, infrastructure spending and credit stimulus programmes. More stable growth allowed the authorities to embark on a significant financial crackdown on debt accumulation, egregious forms of financial risk-taking, and over-heating in big city property markets. But as this year ends, we can already see early signs of the next economic slowdown.

The acid test will come in 2018 when we shall see if the government has the stomach to sustain tighter financial conditions in the face of slower and perhaps more volatile growth. Now that President Xi Jinping has been more or less deified by the Communist Party and the centralisation of power around him is stifling the institutions of government, constraint and consensus, the risks and consequences of policy errors are significantly higher.

 

1. Brexit: fear turned into fantasy

The dire outcomes predicted for the UK in the wake of the Brexit referendum didn’t happen, but the consequences were always likely to be more corrosive than abrupt. In 2017, we learned the UK’s potential growth is not only lower than we thought, but liable to be downgraded further as we leave the biggest free trade area in the world. This will have huge consequences for budgetary policies and tax revenues, among other things.

Now, instead of fear, we have fantasy—of “Global Britain,” or a 19th century throwback to when England ruled the world and trade was on terms we largely dictated. Brexiteers in all parties still think we can “have our cake and it eat it.” It’s not possible, as recognised in the recent agreement reached by the UK and the EU. Yet the fantasy lives on. By Autumn 2018—a few months before we are due to leave the EU according to Article 50—we should know if the fantasy has been appropriately bottled, or not.

 

1. Politics didn’t rock the economics

The politics of anger that erupted in the Brexit referendum and the US election in 2016 came to dominate our lives, and were reflected also in European populism. But the impact on the way the world economy works has so far been relatively minor. Brexit, America First, North Korea, Sino-US relations... nothing has rocked the world’s economic equilibrium.

Yet complacency would be wrong. We are in a fight involving concentrations of wealth, income and industrial power at home, and a vacuum in global power politics. Stanford-based historian, Walter Scheidel argues that extremes of income and wealth distribution have been unwound by war, revolution, state collapse, or pandemics. This may be unduly alarmist, but few would say he’s completely wrong.

 

1. Investors had a good year

2017 has been a good year for investors. The 17-fold rise in Bitcoin eclipses all, but global equities on average rose 19 percent, and emerging market equities were up nearly 30 per cent. Even out-of-fashion bonds and gold both returned about 7-8 per cent.

Can this continue into 2018? Professional investors are anxious about elevated valuations, and it might not take much bad news to lead to a big downturn in asset prices. It does all look bubbly, and the trick, as always, is to get out before the rush if you are able.

 

1. Trump is bad for trade

Having said politics hasn’t rocked the economic balance, one thing could soon change that. Early on this year, Trump withdrew the US from the Trans Pacific Trade Partnership, started a controversial renegotiation of the North American Free Trade Agreement with Canada and Mexico, and threatened everyone else with his America First thinking on trade. Although the White House soft-pedalled anti-China trade measures for a while—mostly to get China to pressure North Korea—they are likely to get an airing and cause trouble before long.

The Administration is considering implementing tariffs against Chinese steel and aluminium exports, as well as measures against China related to abuse of intellectual property rights. More generally, Trump has vacated the leadership role when it comes to world trade and investment governance, and allowed the US to distance itself from the World Trade Organisation and its core dispute settlement procedure.

We will be lucky if 2018 comes and goes without a deterioration in both US-China trade and global trade relationships.

 

1. Austerity is over. Long live austerity

In 2017, in the UK, US and Europe, the rhetoric and policies of austerity changed. Higher economic growth has helped, but a decade of austerity has made us weary, or angry when inequalities are pervasive. With wages and salaries in real terms for most people still stagnant, the option of additional falls in the share of public spending in GDP are now off the agenda. For these reasons, austerity may be over.

But if instead we still want to lower fiscal deficits in better economic times, and lower the burden of debt in the economy in the future when demographics, for example, are pushing it up, austerity will continue. Governments will need new tax revenues, and a broader tax base. Expect more on this in 2018.

 

1. Productivity matters

In the UK, if the pre-2007 productivity growth trend had continued, today’s productivity level would be over 21 per cent higher than it is. The 10-year moving average hasn’t been this low since the 1820s. It’s worse in the UK than in most other rich nations, but all have experienced the same problem, as have many important emerging countries, including China.

We all know that productivity matters, and wages, living standards and tax revenues all depend on it, but the reasons for low productivity, and what to do about it remain opaque. We are talking about a potpourri of causes including investment, over-regulation, the need to upgrade education and skill attainment, the lingering effects of credit booms that stifle productivity growth and misallocate resources, and possibly even a mismeasurement of productivity.

Knowing why productivity is in a funk is an important step in trying to re-energise it. The politicians that listen to the best advice and grasp the nettle on how to solve the problem will probably inherit the earth.

… And on that note, a very happy Christmas to everyone.