ISPI ( Italian Instıtute for International Political Studies ) THE FUTURE OF GLOBAL ECONOMY: LOW GROWTH, NEW NORMAL? 1 Aug 2023 Nicola Nobile

 

ISPI ( Italian Instıtute for International Political Studies ) 

THE FUTURE OF GLOBAL ECONOMY: LOW GROWTH, NEW NORMAL?

1 Aug 2023

Nicola Nobile

The Future of Global Economy: Low Growth, New Normal?

Despite the outlook of moderate growth this year, we think policy rates are set to remain high given lingering concerns about sustained high inflation. This is likely to temper growth next year.

COMMENTARY GEOECONOMICS

Oxford Economics forecasts see a relative subdued economic outlook for 2023 and 2024, as global GDP for both years is projected at around 2%, below the average of the five years pre-covid. The road is expected to be bumpy in the quarters ahead. Despite the outlook of moderate growth this year, we think policy rates are set to remain high given lingering concerns about sustained high inflation. This is likely to temper growth next year.

Looking more closely at the very short term, recent activity data suggest that world GDP growth in Q2 is likely to have eased only modestly after a strong Q1. The US is expected to enter in a recession at the end of this year and monthly data in other areas, such as the Eurozone, have started to signal weakening economic momentum going ahead. For instance, available data both for Germany and Italy point at best to a stagnation in Q2. 

Inflation, which was in the double digits in most advanced economies over the winter, has started to decrease, but the annual rates remain still well above that of the central banks’ targets. For instance, eurozone inflation fell to 5.5% y/y in June, 0.6ppts lower than the previous month while inflation in the US was at 3% in June. In both cases, core inflation remains higher than the headline number and is falling much more slowly. 

Due to lingering concerns within central banks about the pace at which underlying inflation pressures will ease, and some ongoing resilience in labour markets, we believe policy rates will remain higher for longer. This means that over the summer we will likely see further rate increases in both the US and the euro area. However, this does not mean that rates will continue to increase also after the winter, but we see a slower dynamic toward the normalization of interest rates.  

This is set to impact next year, with 2024 calendar year growth broadly in line with this year. Growth is expected to pick up only from 2025 to around 3%, as the impact of policy rate cuts seeps through to the real economy. 

And what about the medium term?

Our view for the medium term is that of relatively mediocre growth. Indeed, our forecast for world GDP growth (at PPP) of around 3% per year from 2022-2031 is not a meaningful improvement from the 2.9% per year growth during 2012-2021 which was a period that included the very deep recession associated with the global financial crisis.

All the major areas will see a deceleration or stabilization of growth rates around subdued levels with respect to the previous decades. For instance, growth in the US is expected at just around 1.5% per year, down further from an already weak 2% rate of expansion in 2012-2021 and well below the 2.5% per year average since 1990. 

With growth in the Eurozone and Japan also expected to remain low (albeit relatively steady) in the 2022-2031 decade, the burden of lifting world growth will fall on emerging economies. 

China, which over the previous decade has grown on average by around 7% per year is seen entering a period of sub 5% growth, with its economy impacted by a combination of high debt, lower return on investments and declining working age population. India will remain fast-growing but will only represent 4% of world GDP at the end of the forecast period. Africa is starting from an even lower base and its growth won’t match India’s.

Demographic factors, as in the case of China, play an important part in our expectations of low long-term world growth and are unlikely to shift much. For instance, in most of all eurozone countries (including Italy), we expect the labour force to barely grow, severely denting the potential output of the area in the upcoming decades. 

This means that growth will have to come from other factors, such as capital accumulation, via government or private investment, and productivity gains. And while the accelerated green transition will boost investment, the lift to the capital stock will be offset by lower investment in the fossil-based technologies and a higher depreciation rate, as stranded assets are written off and investment shifts towards services. Furthermore, the subdued dynamic of productivity growth and the high level of debt, both at the private and public level, are seen as factors limiting potential output in the medium to long term at a global level. 

Factors to watch over the coming years 

What we described so far represent our baseline case. However, in recent years we have moved towards a period of high instability and higher ‘complexity‘. The factors below are the main three risks that we believe could impact our central scenario and therefore our views over the coming years. 

Volatility and higher inflation could impact monetary policy decisions.  

At the start of this cycle, central banks were late to tighten, partly because they were too confident that inflation expectations would remain low and stable. But in a world of more common adverse supply shocks, the risk that inflation expectations may dislodge further is a real threat. 

Over the longer term, inflation could end up being higher than the target despite policymakers’ best intentions. For instance, regionalization of global trade and energy transition might push inflation up marginally over the medium term.

If policymakers remain vigilant to expectations, then early and aggressive rate-hiking cycles will prevail. If they don’t, then delayed and ultimately even bigger hiking cycles with persistently higher rates will become the norm. Ultimately, a world of persistently higher interest rates will imply less room for manoeuvre for fiscal policy, clearly impacting more the countries with a high debt burden, such as Italy, for which the debt to GDP ratio in our baseline case over the coming years is expected to float around a high ratio of 140%. 

A halt in globalization? 

Pandemic and war have exacerbated the slowdown of growth rates of globalisation and have spurred companies to ponder if their current supply-chains would be appropriate for a world that could end up more fragmented than before. 

It is however difficult to assess the macroeconomic impacts of corporate decisions regarding supply chains. The most recent data do not support the hypothesis that globalization has come to an end, but we could clearly see a different structure in the directions of trade, with potentially a series of ripple effects (from prices to protectionism to politics, etc) that could impact the way we thought about global trade over the last two decades.

Productivity boost or a continuation of sluggish productivity growth? 

The best chance of better-than-expected GDP growth over the medium-term comes from a step up in productivity growth. This could come from new technologies in areas like artificial intelligence, robotics, biosciences, and autonomous vehicles. 

Moreover, in some countries that have seen some very sluggish growth over the last couple of decades such as Italy, structural reforms might offer an improvement to the country’s potential. But this is something very difficult to achieve from a political point of view. 

For instance, while we expect the fiscal spending Next Generation EU plan to marginally affect Italy’s growth potential via direct spending on investments, we are doubtful that this will be accompanied by all the promised structural reforms that could intensify the impact of the investment boost.

Nicola Nobile

Oxford Economics