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Global economic outlook: the sun appears to be coming out, but structural demand barriers are damping growth

Economic Quarterly Report

  • Global economic growth expected to outperform 2016 both this year and in 2018
  • Geopolitical developments still pose downside risks
  • Rising current account imbalances are hindering a powerful recovery

The global economy is still posting gradual growth

Global economic growth is expected to outpace growth in 2016 this year and in 2018 (figure 1). Compared to a year earlier, this increase will be driven mainly by higher growth in the United States (US), the eurozone and emerging markets in Asia and Latin America (table 1). Growth in China and the United Kingdom (UK) is however expected to be slightly slower than in 2016. Since our last Quarterly Report we have adjusted our growth forecast for the US and the UK to the downside, while we expect the eurozone and China to grow faster than previously estimated. We are seeing a global recovery in commodity prices, which is mainly benefiting commodity exporters such as Russia and Brazil.

As always, our forecasts are subject to uncertainties, most of which are geopolitical in nature. Although the protectionist stance of the US seems to have softened somewhat, delay does not necessarily mean renunciation. So far, we have not seen a trade war break out between the US and China. But the situation with respect to North Korea and the influence of China could have major consequences for US-China relations. This means that a trade war between these countries is certainly not yet off the agenda. Apart from the geopolitical concerns, the global economy appears to have stabilised, although this is largely a cyclical phenomenon. Much of the current growth is catch-up growth, which is why policymakers need to tackle global imbalances more in order to limit their braking effect on growth.

Figure 1: Global growth accelerates somewhat…
Figure 1: Global growth accelerates somewhat…Source: Rabobank, Macrobond, IMF, NiGEM
Table 1: … but not all countries benefit
Table 1: … but not all countries benefitSource: Rabobank, NiGEM

Geopolitics: is this the calm before the storm?

It looks as though the political drama on the global stage is working in favour of the economy, at least for now. For instance, relations between the US and China do not at first sight appear to have worsened since the first meeting between Trump and Chinese President Xi Jinping. A global trade war between the world’s two largest economies has so far not materialised. Fears of a nationalist and populist storm hitting the European elections with all the damaging consequences of this for the economy have also failed to materialise, as evidenced by the elections in France and the Netherlands. In Germany too, according to the current polls, the nationalists and populists are finding little support. Although this does not give any indication of the economic policy that will be pursued, the political uncertainties have significantly eased. For the time being, the EU is out of the danger zone.

The big question is whether this political calm is real. A year ago, we wrote about political instability in the Middle East, a slowing of growth in China and Brexit as the major geopolitical risks. After that, the US presidential elections and the risks posed by a protectionist president Trump for the global economy came to the fore. While the global economy appears to have stabilised and the worst tensions have diminished, risks are continually shifting. There could certainly be a threat to the global economy if the US ultimately decides to pursue a more protectionist course or if increasing risks in the Chinese economy lead to a slowdown. In addition, global economic imbalances are increasing, with all the risks that this entails. By global imbalances, we specifically mean the differences in national current account balances. These differences were an important factor in the run up to the financial crisis. It is therefore important to continue to analyse this situation. There are still countries with structural current account surpluses or deficits.

Balance of payments imbalances back in the spotlight

Recent statements by Donald Trump have led to a renewed focus on global imbalances. He accuses countries running a trade surplus with the US of intentionally manipulating their currencies in order to gain a competitive advantage. China and Germany are among the countries he blames in this respect. These imbalances have increased again in recent years (figure 2). Put simply, the current account balance is the difference between what a country earns abroad and what it spends abroad. In most cases, a country’s balance in the goods account is the determining factor for this.

Figure 2: Global demand still comes mainly from the United States
Figure 2: Global demand still comes mainly from the United StatesSource: IMF, Rabobank
Note: EZ*= eurozone excluding Germany. RoW**= rest of the world. The current account balance at global level does not always sum to zero due to statistical aberrations.

Trade imbalances are not a new theme. Since the 1990s, economists have been researching why some countries appear to have permanent deficits while others have surpluses. A current account surplus or deficit is not in principle either good or bad. A deficit may for instance be justified if investments abroad will be repaid at a later date. A surplus can be seen as a sign of a strong and competitive economy, however it can also be the result of manipulation of the national currency. Or, it might be a sign of underspending in a productive economy. These various interpretations are at the heart of the controversy of whether a surplus or deficit is justified.

The renewed focus on balance of payments imbalances is justified, as this could lead to disruption of the global economy. Before the crisis, credit-driven growth in the US led among other things to increased demand for Chinese products, which drove the US trade deficit with China higher. China used the dollars it earned to buy US assets, in particular US treasury bonds. This kept interest rates in the US low, encouraging further borrowing. One of the effects of this was an increase in house prices. Ultimately, the poor quality of the underlying US mortgages led to the onset of the financial crisis.

Surplus and deficit countries are slowly rebalancing …

Lending in the US and the US current account deficit have fallen sharply since the crisis (figure 3). This is justified: the credit-driven growth of consumption before the crisis was unsustainable. The other side of the coin however is that US demand for goods and services has fallen sharply. The US was (and is) the world’s consumer of last resort. Since the US no longer fulfils this role, global demand has waned significantly. Before the crisis, there was also higher (credit-driven) demand from the eurozone, especially from southern Europe. Here too, there has been substantial pay-down of debt and the level of lending is now much lower. This, together with lower demand from the US, is slowing global economic growth. The current account deficits in the US and the UK are automatically offset by surpluses in other countries. The specific surplus countries that stand out are China, Japan and Germany.

Figure 3: Less credit-driven consumption growth after the crisis
Figure 3: Less credit-driven consumption growth after the crisisSource: BIS, Rabobank
Note: Year-on-year growth of 4-quarter moving total household debt

After a large increase in the run-up to the crisis, China’s current account surplus as a percentage of GDP has declined substantially. China still has a trade surplus with the rest of the world, but only in goods. In services, it already has a deficit. China is engaged in a transition from an export and investment-driven economy to an economy based on consumption and services. As a result, the surplus will gradually decline further in the future as Chinese people import more goods from abroad. We have seen the contribution of goods to the surplus increase in recent years, though. This, in combination with a gradual depreciation of the yuan, is therefore the – actually unjustified[1] – bone of contention for Trump and has led to his allegations of unfair competition.

For several years now, the surplus in Japan has no longer been the result of a positive balance of trade, it is due to a large surplus on the primary income account[2]. This consists mainly of income from large foreign asset positions built up in the past and dividends from successful foreign divisions of Japanese companies (for example, car manufacturers).

[1] China is trying to slow the depreciation of the yuan by various means. Its foreign currency reserves have shrunk to USD 3 trillion through interventions in the currency market in an attempt to limit the downward pressure on the yuan.

[2] A sub-account of the balance of payments which consists mostly of income from (foreign) investments.

... apart from Germany

In absolute terms, Germany’s current account surplus is even higher than China's. This is almost entirely due to a surplus on the goods account. This comes from Germany’s strong competitive position, which is the result of competitive labour costs per unit product and high quality exports, for instance German cars. At the same time, Germany faces a structurally low level of domestic demand: the contribution of domestic consumption to growth is lower than in other advanced economies. Its strong competitive position and high level of income from abroad are thus not used to consume and invest at home. Germany therefore is permanently dependent on demand from the rest of the world (including the eurozone). This is why it would be better for Germany, Europe and the rest of the world if Germany did something about its unbalanced economy. For instance, it could use its budget surplus to reform and modernise the economy or provide an active fiscal stimulus to increase wages in the private sectors where the real development of wages has lagged behind the development of labour productivity.

A powerful recovery is being impeded

Most economists agree that large balance of payments imbalances are standing in the way of a powerful recovery in global growth. Countries running long-term current account surpluses create structural barriers to demand, and place a long-lasting brake on international trade and therefore economic growth. Surplus countries actually survive on demand from deficit countries, particularly the US. The imbalances have only increased in the last couple of years. But still, the controversial nature of the problem and the lack of clear solutions have led to other attempts to stimulate economic growth. In Europe, the focus has been mainly on the danger of debt and deficits, without realising that a surplus creates a deficit somewhere else outside Europe. Extreme monetary policy in the form of quantitative easing (QE) that has led to a (rather limited) lower exchange rate has not contributed to a rebalancing of the global economy (quite the contrary). China is making its contribution to bring more equilibrium at global level. But the Chinese government is trying to keep economic growth going by creating more debt, meaning that credit growth is approaching dangerous levels. A large current account surplus may be a positive sign of competitive strength. But it inevitably imposes a deficit somewhere else.

Björn Giesbergen
RaboResearch Global Economics & Markets Rabobank KEO
+31 88 726 7864
Daniel van Schoot
RaboResearch Netherlands Rabobank KEO
+31 88 726 7864

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