Outlook 2017: The global economy in the Trump era
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- The global economy is expected to grow at a rate of around three per cent in 2017
- The election of Trump has increased uncertainty worldwide
- There is uncertainty regarding both his proposals for a protectionist trade policy and the geopolitical effect of his plans
- Europe is also entering a period of political uncertainty and faces serious challenges
- The Chinese economy appears to be stabilising but still has its problems
The global economy has been growing at a moderate pace of around 3% for several years now. We expect growth of around this rate to continue in the coming years as well. But it should be clear that the choice of the American people to elect Donald Trump as their president has enormously increased the degree of uncertainty. This uncertainty concerns both his economic policy proposals and the geopolitical impact of his plans. We therefore begin this contribution with an analysis of the economic developments to be expected in the United States. We then turn to a general discussion of the developments in China, Japan and certain emerging markets. This will be followed by a more detailed analysis of the situation in Europe, because our continent also faces huge challenges, and, like the US, serious political uncertainties in the near future. We end by offering some conclusions.
A dissatisfied world
Both the vote for Brexit in the UK and the choice of the US electorate for Trump as president can be seen as a protest vote against the establishment and against free trade, at least against the distribution of the prosperity generated by free trade. There are high levels of dissatisfaction in Europe too, as evidenced by the rise of nationalist political parties. Unfortunately, people tend to focus mostly on what has gone wrong and ignore the many good things that have been achieved in recent decades. Although the Great Financial Crisis (GFC) and the subsequent euro crisis in Europe caused much damage and misery, global poverty has significantly declined in recent decades, mainly as a result of developments in China and more recently in India.
Even today, there are still reasons for a degree of optimism. The eurozone has now posted several years of steady economic growth. There has been a gradual decline in unemployment across the board. In the United States, the economy is generating its eighth consecutive year of positive economic growth, although the rate of growth has slowed here as well. US policymakers have succeeded in bringing unemployment down to more acceptable levels. The volume of GDP is now at or above the level seen in 2008 in both the US and most European countries.
Of course, this positive picture needs some qualification. Unemployment is still very high, especially in the eurozone Member States hit hardest by the crisis, and mainly amongst young people. The current growth rate and the slowness of the decline in unemployment in southern Europe are contributing to anti-Europe sentiment. In the United States, large parts of the population have been excluded from the increase in prosperity. Their income has lagged behind that of the small group of super-rich in recent decades. Their support for Trump is most of all a vote against the establishment. It is one of the challenges facing President Trump to reduce the enormous gulf between rich and poor without further worsening the government’s financial position. Today, government debt in the US is already more than 100% of GDP.
President Trump and the economy
If the plans he presented during the presidential campaign are anything to go by, the new President Trump will stir things up drastically in a number of respects right from the start. US budgetary policy will be eased significantly, with increased spending on infrastructure and defence. This is good for the US economy and could also positively affect the potential for growth. A large tax cut for high income groups and business could provide some support for business investment, but it will make little contribution to economic growth. Any positive effects will in any case take some time to become evident. Against this additional spending, there will be efforts to make cuts in other areas of government expenditure, but we expect the net effect to be a quite drastic worsening of the general government balance and a sharp rise in the already excessive level of government debt. This could lead to higher capital market interest rates and over time to a weaker dollar. We also expect the current Fed chair Yellen to be replaced at the end of her term in early 2018 by someone to whom Trump is more favourably disposed. This could undermine confidence in the Fed’s independence and put further pressure on the dollar (see US Special, The Trump Timeline).
Another negative point is that Trump favours a protectionist policy on trade. During the campaign, he gave notice that he intended to immediately confront China in the area of trade politics, accusing the country of currency manipulation. The probability that the US will sign new trade treaties such as TTIP in the coming years is – based on Trump’s election promises – nil. He will also be looking to amend existing trade treaties. If these policy proposals are turned into action, the negative effect will not only be felt in the growth of world trade, but also in the US itself. Free trade is on balance good for economic growth, although there are also losers. But the losers are not helped by trade restrictions. If Trump actually enters into trade conflicts with major trade partners, the US will face countermeasures. This could significantly harm the American economy and reverse the initial boost to growth. Protectionism is not the answer to today’s problems - not in the US, and not elsewhere in the world. Nevertheless, there is a danger that free trade will be damaged in the coming years.
Whether things will actually take such a course is difficult to say in advance. Trump has to get Congress on his side in order to turn his policy proposals into action. The Republicans now hold a majority in both the House of Representatives and the Senate, which can significantly increase the potential effectiveness of the president. This means that measures like tax cuts for the most wealthy, investments in infrastructure and defence, more scope for the extraction of shale gas and cancellation of the climate treaty can probably be effected quickly. The climate will be one of the first victims. At the same time, the members of Congress will be looking out for the interests of American business, and these interests are not generally served by a hard protectionist stance. Although we think that the US will take a more protectionist direction, the stance may turn out to be less extreme as one might infer from the election campaign.
For now, we expect the US to still generate economic growth of 1.7 per cent in 2017. In subsequent years, we expect the negative effects of a more protectionist policy increasingly to overshadow any positive effects of a more expansive budgetary policy, taking the economy to a lower growth trajectory. Over time, a sharp worsening in the US debt position will damage confidence in the US as a safe haven and put downward pressure on the dollar.
Until recently, China was the main engine driving the global economy. With annual growth of more than 8% over many years, the country has been largely responsible for the increase in world trade. China is now the largest economy in the world in terms of purchasing power, and has undergone a rapid increase in income. Hundreds of millions of Chinese people have now escaped poverty, and the country now has a large and still fast-growing middle class. An impressive performance by any standards. However economic growth suffered a clear setback in 2015, mainly due to the government’s policy of reining in unbridled credit growth. According to our own estimate, economic growth is currently around 4½ per cent, significantly lower than the more than 6¾ per cent officially reported (see figure 1). The situation appears to have stabilised for now, but there are obvious risks. One example is the overstrained housing market, which is not limited to the major cities (known as the tier 1 cities) such as Shanghai and Shenzhen (figure 2, see How serious is China’s housing market bubble?). In the slightly smaller cities as well (known as tier 2 and tier 3 cities), we see that prices are rising much faster than would be expected on the basis of fundamental factors. The strong rally in house prices is mainly due to the fact that the housing market is seen as the only profitable and relatively risk-free investment opportunity, especially since the stock market collapsed in September last year.
The original and highly successful export-led growth formula has to be gradually converted into growth driven by domestic demand. This is happening, in fits and starts. Chinese policymakers are currently involved in a balancing act whereby they have the difficult task of reforming the economy without causing economic activity to slow too much.
Slower growth is a problem for Chinese policymakers. Many new jobs have still to be created in the market sector, while many government businesses in traditional sectors such as steel and coal are undergoing reorganisation. Growth of 4½% per cent is too low for this transition, but the question remains whether they can maintain even this current lower growth rate. There is a threat of serious trade frictions with the US in the near future (see above). In the longer term, Chinese growth will be undermined by a problematic demographic structure. Due to its long-maintained one-child policy, China has one of the fastest ageing and contracting populations anywhere in the world. The transition to a market economy is meanwhile far from complete. The upshot is that China will be a source of uncertainty in the coming years and will certainly not be a driver of the global economy.
The Japanese economy will continue to show sluggish growth in 2017 and the years beyond, with very low inflation and government finances that are seriously out of balance, despite vigorous efforts by the Bank of Japan in particular to stimulate both growth and inflation. The Japanese government’s debt is largely in the hands of Japanese financial institutions, including the central bank. As a country, Japan still has a savings surplus as shown by its current account balance and sizeable positive net international capital position. Despite the unusual monetary situation and government debt running out of control, an acute financial crisis does not really appear to be likely.
For the emerging markets, the picture is mixed. Some of the larger economies, such as Brazil and Russia, are emerging from a long and deep recession. Slight positive growth is expected in 2017, for the first time in several years. Brazil is coming to the end of a period of political turbulence and can now focus on the future again. Although the economy is in poor shape after years of mismanagement by the deposed President Rousseff, the first signs are hopeful. Russia has benefited from a modest recovery in the oil price, although this will probably fall again due to the effects of the policy to be initiated under Trump. Russia is also still suffering from the sanctions imposed by the EU in 2014, but can hope that these will be eased under pressure from President Trump. But the longer term outlook for Russia is not really positive. The country has a poorly developed business structure and very poor demographic prospects. For the rest of Latin America, see our LATAM regional study published in October 2016. Regarding the other emerging markets, we should mention India, which is one of the fastest-growing economies in the world, and Turkey, which on the other hand is going through a difficult period in the wake of the attempted coup in July 2016. India has a rapidly growing and to some extent a very highly educated population, and still has huge upside potential if it succeeds in pursuing the course of liberalisation it has embarked upon. Turkey, which traditionally features a weak balance of payments with a high current account deficit, has now been downgraded by several rating agencies to junk status, which makes funding its deficits more difficult. At the same time, Turkey has huge geopolitical importance, so that it is difficult to imagine that the EU and the US would allow it to fall into financial chaos as well as political turbulence.
Europe faces big challenges in the coming years. Some of these are external, but the EU itself is also a source of uncertainty. We begin this paragraph with a look at the state of affairs regarding the proposed Brexit. We then look at the future of European integration and the economic consequences in more detail.
The UK is on the way to Brexit
The United Kingdom will increasingly be faced with the consequences of the vote to leave the EU, known as Brexit, in the referendum of 23 June this year. A weak pound in combination with what at the moment looks like full British access to the internal market will form a strong buffer in the coming years, and the direct effects of the referendum on economic growth would appear to be not too serious. The depreciation of the pound will however lead to a sharp increase in inflationary pressure. While it is still unclear what the UK’s future trade relationships with the EU and the rest of the world will look like, uncertainty will prevail (see: Brexit: Q and A). Our base scenario (figure 3) assumes a smooth Brexit which, despite all the rhetoric, will ultimately not cause unnecessary damage. One focus of attention in the coming years will be the inflow of direct foreign investment. The UK has traditionally been an important base for foreign companies and financial institutions and is therefore exposed to a potential loss of confidence. In the worst case, the UK could lose its unlimited access to the internal market, which would be bad news for the country. Foreign banks in the City could lose their ‘European passport’ and leave London, and British industry would have more difficulty in exporting to the EU. However, one cannot entirely rule out the possibility that the UK will ultimately not turn its back on the EU, if for example sufficient concessions with respect to migration of labour can be obtained. There is also a court case in progress to decide the issue of whether the UK government is entitled to trigger Article 50, which deals with the starting of the exit procedure, without having obtained the approval of the parliament.
The European Union is at a crossroads
Our base estimate for the eurozone is shown in table 4. It shows continuing but rather weak economic growth of varying degrees between the individual Member States. The average unemployment rate shows a slight downtrend and government finances are modestly recovering. However this situation, which will probably continue to dominate in 2017, is not likely to continue in the somewhat longer term. Not only is there reasonable doubt that the current monetary policy will still be sustainable (see Outlook 2017: Financial Markets), the expected growth rate is too low to resolve the major problems. As a result of the crisis, unemployment has risen to very high levels in a number of countries, especially among young people. In every southern European country, youth unemployment (people under 25 years of age) is higher than 25%; in France, this figure stands at around 20% (see figure 3). Even in a country such as Spain, which has made huge progress in policy in recent years, the current rate of growth is not enough to offer hope of real improvement. Large countries such as Italy and France are well behind the curve with structural reforms, and this is reducing their growth potential and standing in the way of a properly functioning labour market.
Politically, there will soon be elections in many European countries and big changes may be on the way. There is already widespread dissatisfaction with the effects of ‘Europe’ in many countries. There is a big chance that this dissatisfaction with weak development will be expressed in a protest vote, to some extent encouraged by the US elections and the Brexit referendum. How Europe will develop further in the coming years therefore depends on political choices, and this is therefore by definition unpredictable. These choices may work to the benefit of the economy, or not.
In an article soon to be published we will further develop various potential future scenarios for the eurozone and analyse the effects of these scenarios for the economies of the countries concerned.
The options for European policy
One important area of uncertainty concerns what policy Europe will adopt.
In a positive outcome, we could see a grand bargain, in which the financially stronger countries such as the Netherlands and Germany ease budgetary policy while the weaker Member States that are still lagging with regard to financial reforms can catch up and introduce economic reforms whereby their economies can function more efficiently. While such reforms will increase the growth potential of the countries concerned over time, their effect on the economy in the short term will be negative. This is why budgetary policy needs to be eased in the coming years, as this will give the weaker Member States more time to get their finances in order. The surplus countries, which in this context concern the countries with a current account surplus in the balance of payments, would have to implement a powerful expansion of their budgetary policies. This would not necessarily mean that the criteria of the Stability and Growth Pact (SGP) would have to be stretched without limit. It would however be a good thing if the SGP could offer more flexibility for investment in infrastructure that increases productivity. This budgetary easing would not only focus on boosting economic activity and creating jobs, but also on strengthening the growth potential of the European economy. This means investment in infrastructure, sustainable energy, education and research.
The result could be that Europe-wide economic growth would pick up substantially, leading to a clear reduction in unemployment across the board. The quality of growth would also improve, since business investment in new equipment leads to an acceleration of the rate of growth in labour productivity.
This positive policy would also be a way of normalising monetary policy over time. The policy of quantitative easing could be dismantled. Policy interest rates would remain low for a while, leading to a return to a positive yield curve. The policy initiative described here would require much courage, determination and a European consensus. There is a good chance that it will not succeed.
In this case, the EU will continue to struggle. The upcoming elections in many EU countries may well be a turning point in this respect. Anti-European electoral success could lead to a loss of confidence in the existing policy consensus. This would make it highly likely that an increasing number of countries will ignore the budgetary agreements, leading to a significant deterioration in government finances, especially in southern Europe and France (the ‘periphery’). If market conditions so dictate, the peripheral countries could decide to immediately place new government debt with their central banks, whereby they would completely ignore the explicit prohibition of monetary financing as included in the European treaties. It could even be the case that Germany, which strongly believes in the prohibition of monetary financing, would decide to leave the euro. In the worst scenario, this could lead to the dissolution of the eurozone or perhaps even the EU.
Conclusion: We will not suffer for ever
This Outlook 2017 has focused mainly on economic developments. It should be obvious that our forecasts are surrounded by numerous economic and political uncertainties. These range from the conflict in the Middle East, a slowing of growth in China, increasing worldwide protectionism, Brexit and the associated threat of a break-up of the European Union (EU). Issues in the background include the European refugee problem, which appears to be somewhat less pressing than in 2015, but has certainly not been solved, and rising tensions in South-East Asia. We cannot deal with all these risks here, but it is important to remember that they could affect confidence at one time or another.
For now, we expect 2017 to be a year of very moderate economic growth of around 3%. The contours of the future direction will however gradually become visible during the course of the year. President Trump’s policy will become clearer, and there will also be a clearer view of whether the positive effects of a strong boost to spending will dominate the US economy or the negative effects of a more protectionist stance will gain the upper hand. If the US Congress succeeds in tempering the sharp edges of his protectionist plans, the positive effects of Trump’s policy on the economy could well dominate in the short term, although in the longer term we are concerned that the negative effects of his protectionist policy will be more significant.
A scenario in which the European economy continues to struggle along for years or even decades is not highly likely. The rise in anti-Europe sentiment demands effective answers. If nothing is done, there is a risk that the EU could be gradually undermined.
There are two choices. Either European cooperation comes to a halt and we fall back into economic nationalism or protectionism, which will lead to a recession in Europe, or we generate higher growth through a more effective cooperation, more economic reform and a more expansive budgetary policy. It will ultimately be policy choices that decide where Europe is going in the coming years. The situation is not one of an inevitable natural phenomenon. We could also be on the verge of a powerful growth recovery. The ball is now in the court of the politicians.
The Outlook 2017 is a publication of RaboResearch of Rabobank and a co-production with Financial Markets Research. The date of completion is the 28th of November 2016.
The views presented in this publication are based on data from sources we consider to be reliable. Among others, these include Macrobond. These data have been carefully incorporated into our analyses. The economic growth forecasts and scenarios are generated from the NiGEM global econometric structure models.
The use of this publication in whole or in part is permitted only if accompanied by an acknowledgement of the source. RaboResearch accepts, however, no liability whatsoever should the data or prognoses presented in this publication contain any errors.
Abbreviations for sources: CBS: Statistics Netherlands, OECD: Organisation for Economic Co-operation and Development, CPB: Economic Policy Analysis Netherlands, IMF: International Monetary Fund, ECB: European Central Bank, Fed: Federal Reserve.
© 2016 - Coöperatieve Rabobank U.A., Nederland