RaboResearch - Economic Research

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Global Economic Outlook: Waves of uncertainty

Economic Quarterly Report

  • We expect the global economy to contract by 4.4% in 2020 and recover by 4% in 2021
  • Stock markets have recovered, but the real economy still faces a huge amount of uncertainty
  • Large-scale use of job retention schemes mask the shock of the crisis on the labor market
  • Hard-hit sectors could continue to suffer the “scarring” effects of corona even after a vaccine is introduced
  • China is actively pursuing a decoupling strategy, which could lead to less trade and increased geopolitical tensions
  • We believe the US-China trade deal will fall apart before the year is out
  • A possible Biden victory in the US elections might not help China much
 Source: RaboResearch


GDP print for Q2

Economic growth figures for the second quarter of 2020 have been published by the statistical offices of virtually all major economies. The magnitude of the contraction across countries is largely dependent on the stringency of the lockdown (Figure 1). The Q2 realizations have led to only minor downward revisions of our forecasts. Currently, we expect the global economy to contract by 4.4% in 2020 (previously: 4.1%) and expect a recovery of 4% in 2021 (previously 4.3%).

Table 1: Economic outlook for major economies
Table 1: Economic outlook for major economiesSource: RaboResearch, Macrobond, IMF
Figure 1: Lockdown stringency determines economic contraction
Figure 1: Lockdown stringency determines economic contractionSource: RaboResearch based on Oxford University, Macrobond, OECD, national sources
Note: for China we use realizations for Q1 and for emerging markets we use y-o-y mutations.

COVID-19: vaccination and the second wave

Our forecast assumes that a vaccine will become available next year. We expect a full normalization of economic activity starting 2021Q3. Currently, there are nine vaccines in Phase 3 of clinical trials. In this phase, the vaccine is tested on thousands of people to confirm safety and effectiveness.

Race to the moon

The provision of the COVID-19 vaccine is becoming more and more politicized. Russia has raced through developing a vaccine and named it after the satellite it put in earth’s orbit during the Cold War (Sputnik 5). The US is allegedly preparing to release a vaccine on November 1st, two days before the US elections. Recently, however, pharmaceutical companies have given pushback against political pressure to rush through a vaccine, in a jointly issued statement. In any case, instead of taking the multilateral route, many countries have made bilateral deals to ensure themselves hundreds of millions of doses of non-approved vaccines, leaving the less wealthy countries stuck solving their own vaccine problems.

This bilateral approach could feed into existing geopolitical tensions and increase protectionism. One possible scenario is that the world ends up with a Chinese, a European, and an American vaccine, all of which are distributed via bilateral deals to other countries. Vaccines could then become political levers that countries with vaccines can pull to pressure countries without. Emerging markets generally bear the brunt of such power play.

Second wave?

Figure 2: Winter is coming
Figure 2: Winter is comingSource: RaboResearch based on European Centre for Disease Prevention & Control, Macrobond

At the moment, we have not penciled in new full-scale lockdowns to combat a renewed pickup in COVID-19 cases. Regardless, the global pandemic is back on the rise and a second wave could come before a global vaccination is possible. A second wave is becoming more probable in the Northern Hemisphere, as COVID-19 has similarities to influenza viruses which normally spread more easily during winter, due to more indoor activities and drier air. If a second wave leads to new full- scale lockdown measures, we will have to revise our forecasts downward.

Recovery uncertainty

Figure 3: Financial markets and economic forecasts out of sync?
Figure 3: Financial markets and economic forecasts out of sync?Source: RaboResearch, Macrobond, S&P, BEA

The positive news of a potential vaccine and the fact that we the economic trough (i.e. Q2) is most likely behind us provides some room for cautious optimism. A superficial glance at the US stock market seems to reflect this optimism. The S&P500 has already recovered to levels above the pre-corona peak (see Figure 3).

But we should be cautious about using the stock market as an indicator of where the real economy is heading. The stock market does not have the same sector distribution as the whole economy, and it reacts quicker to changes in expectations and monetary policy. Very loose monetary policy has propped up asset prices. Meanwhile, the real economy is not performing well in many countries and the fundamental drivers shaping the exit from the corona crisis (the labor market, investment, and productivity) are still shrouded in uncertainty.

Labor market uncertainty

Unemployment rates in many OECD countries (except in the US) have not risen in line with the deep contraction in global production. One has to keep in mind, however, that governments have been doing the heavy lifting to keep employment in check with job retention (JR) schemes. Examples of these schemes are the Kurzarbeit in Germany and the Noodmaatregel Overbrugging Werkgelegenheid (NOW) in the Netherlands.These government programs compensate firms for employing redundant workers in order to prevent massive layoffs. During the height of the corona crisis in May, 50 million jobs across OECD were supported by JR schemes. While these schemes might have prevented unemployment from spiking in the short term, JR schemes will have to be gradually phased out. But phasing out direct support by the government also exposes firms to more economic headwinds and they could be forced to lay-off workers after all or even face bankruptcy.

Figure 4: Hidden corona crisis in the labor market
Figure 4: Hidden corona crisis in the labor marketSource: RaboResearch based on BLS, Macrobond, national sources
Figure 5: This does not look too promising…
Figure 5: This does not look too promising…Source: RaboResearch, Eurostat, Macrobond

While JR schemes may have mitigated the labor market shock to some extent, part of it has only been postponed and will become visible at a later stage. One sign that this is more or less inevitable is the rapidly deteriorating demand for labor, as indicted by the sizable drop in the job openings rate (Figure 5).

Investment and productivity uncertainty

Investment and productivity are also prone to major shifts and uncertainty. First, there is the risk that if job retention schemes are not properly phased out, jobs that are unviable in the medium to longer term will be supported by taxpayers, disrupting the effective division of labor within the economy. This might keep so-called zombie firms afloat, but ultimately only at the expense of productivity, something we have elaborated on before.

More generally, investment and productivity could be linked to shifts in the sector composition of an economy. It is likely that some industries, such as online retailers and providers of IT hardware, will continue to thrive, whereas industries that are vulnerable in a six-foot economy (i.e. air transport, hospitality/tourism, and the entertainment sector) will continue to struggle to adapt to the new reality and see their relative importance decline. Even if a vaccination program is rolled out on a major scale at short notice, vulnerable industries might be scarred by the corona crisis for years to come due to an investment gap during the crisis and/or subdued investment appetite and demand going forward. Especially Southern European countries are vulnerable in this respect (Figure 6).

Figure 6: Southern Europe will likely face largest shifts in sector composition
Figure 6: Southern Europe will likely face largest shifts in sector compositionSource: RaboResearch based on EUKLEMS.
* Air transport, hospitality, and the entertainment sector.
Figure 7: Global trade took a big blow due to COVID-19
Figure 7: Global trade took a big blow due to COVID-19Source: RaboResearch based on CPB, Macrobond, IMF

Finally, shifts in trade and between trading blocs will have large ramifications on investment and productivity. Global trade and globally-integrated supply chains could be partially reversed, not just by the corona crisis itself (see Figure 7), but also by national policies. More specifically, we have found that US firms started shifting their supply chains away from China in 2019, a trend that will likely be put in overdrive due to the corona crisis.

Geopolitical uncertainty

Global trade and supply chains will face more challenges against the backdrop of rising geopolitical tension.

Brexit uncertainty

In Europe, geopolitical tensions are growing over Brexit, as negotiations between the United Kingdom and the European Union are once again going down to the wire. While Brexit is already a fact of life, there is still no agreement on the future trade relationship. The risk of a no-trade-deal Brexit is real, as the current status quo will already end on December 31. Given the limited amount of time available, and the divergent strategies of the United Kingdom and the European Union, the scope of the aspired agreement remains limited to a simple free trade agreement (FTA) with hardly any additional arrangements, such as common external tariffs (i.e. Customs Union). This means that EU-UK trade frictions will increase considerably whether a deal is struck or not. The increased “economic distance” between the UK and the EU will have negative ramifications for the UK economy and, to a lesser extent, the EU economies that have a close economic relationship with the UK. Although the short-term economic damage is being overshadowed by the pandemic, it will still lead to an incomplete recovery. After a 10.5% contraction in 2020, we expect the UK economy to grow by 4.4% in 2021.

China in the geopolitical spotlight

China has been at the center of several geopolitical conflicts. It has received criticism over its new Hong Kong security law and has been at loggerheads with several of its neighbors, which even led to a clash with India. In July, US Secretary of State Mike Pompeo gave a speech which signaled that US policy may be shifting away from China.

In response to the increasing geopolitical stress, several countries launched policy measures against China. For instance, India and the US banned Chinese apps (e.g. WeChat). The US, UK and Australia banned Huawei from participating in their 5G networks. The US introduced sanctions on 24 Chinese firms responsible for construction in the South China Sea. Australia, Japan, and India have started a Supply Chain Resilience Initiative to decrease their supply chains’ reliance on China. Trump has openly discussed the idea of decoupling form China.

These developments could foreshadow a further decoupling of China from the rest of the world. But instead of adhering to the wishes of the D-10 (top 10 democratic countries) China could be driven to form a block with, for example, Iran, North Korea, and Pakistan. Iran has major oil reserves, Pakistan plays an important role in China’s so-called One Belt, One Road initiative, and North Korea has ample mineral resources, which it already exports chiefly to China.

China’s policy aims for decoupling

Indications of China’s active decoupling strategy can be found in a recent speech by President Xi Jinping, where he mentions China’s new strategy of “dual circulation”. This encompasses an increased focus on the Chinese domestic market and less reliance on exports. In general, China’s new economic strategy seems to be one of self-reliance. It includes (1) focusing on its domestic market (dual circulation), (2) using the renminbi as its preferred currency to conduct international trade, (3) relying on the Chinese stock market to raise capital, (4) using China’s own financial infrastructure (such as CIPS instead of SWIFT) and even (v) using its own version of GPS (BeiDou). This focus on self-reliance is a long-term strategy and might be included in the upcoming Five-Year Plan in 2021.

Consequences of decoupling

China’s decoupling strategy would certainly change the face of the global political landscape, which would have serious consequences on the global business environment and trade. For China specifically, decoupling is not risk free. First, increasing domestic reliance also means that China’s current account surplus will likely decrease. This could hinder China’s ability to stimulate its economy by means of monetary finance, where the central bank essentially finances additional government expenditure with newly-minted money.

Secondly, as decoupling takes shape the US might start increasing pressure on China before it becomes fully self-reliant and weaken the Chinese economy in the process. The US could crank up the pressure against China to restrict access to US dollar liquidity, for example, by denying Chinese banks access to US dollar payment systems (although we consider this the nuclear option), restricting Chinese firms from listing on US stock exchanges, and threating to sanction countries whose banks lend US dollars to Chinese firms.

When will the Phase One deal be buried?

Against the backdrop of increasing geopolitical tensions, it is becoming increasingly likely that China will not be able to hold up its end of the Phase One Deal with the US, most notably China’s promise to buy an addition USD 200 billion in goods and services from the US by 2021. We have developed a so-called Phase One Monitor (POM) to keep track of this progress. China only has five months left to boost imports of US goods and services (covered by the deal) by USD 100bn in order to reach the 2020 target (Figure 8). Even so, we still think the Phase One deal will be dead before this year is over.

Figure 8: When will Trump bury the Phase One deal?
Figure 8: When will Trump bury the Phase One deal?Source: RaboResearch based on Oxford University, Macrobond, OECD, national sources
Note: for China we use realizations for Q1 and for emerging markets we use y-o-y mutations.

US elections: A Biden victory might not help China much

US presidential elections are scheduled for November, and Democratic candidate Joe Biden currently has a lead on Trump in the national polls, but that could certainly change. Biden is widely seen as more moderate than Trump and less protectionist, which some might perceive as offering possible relief to China.

Figure 9: Not only Republicans have an unfavorable opinion of China
Figure 9: Not only Republicans have an unfavorable opinion of ChinaSource: Pew Research

However, a Biden win might not be what China is hoping for. First, it would leave Trump with no downside (as he doesn’t have to worry about getting re-elected again) to make China’s life as tough as possible before he leaves office. Trump might do this because it will cement his image as being the “only president that stood up to China,” a legacy he might want to pursue. One of his children could use this accomplishment as a selling point in future presidential elections.

Second, Biden is more likely to improve ties with Europe rather than with China, and he will likely not reduce pressure on China because of anti-China sentiment among the US public. In fact, a recent Pew Research study shows that both Republicans and Democrats increasingly take a negative view of China (Figure 9).

Hugo Erken
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2223 1650
Raphie Hayat
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 1038 7752
Wouter van Eijkelenburg
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 1034 4147

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