How People Prosper. . .

Global Economies Under Stress

New and unexpected tests during the coming decades are likely to increase global economic and financial stress, instability, and uncertainty.  Global growth will be driven more by the largest developing economies, especially India and China, whose economies will expand faster than advanced economies even if their pace slows from current levels.  Greater globalization is not certain, however, and is vulnerable to geopolitical tension.  Even with strong global growth, skepticism about the benefits of further integration and support for protectionism is likely to increase if the wealthiest economies continue to struggle to return to “normal” growth and income inequality rises across a range of countries.

  • Key sources of economic growth flagging.  Two of the world’s largest economies—China and the EU—are undergoing major transitions, with China the biggest wild card.  Demographic trends that led to growing workforces—and helped boost both output and demand—in the post-World War II period have reversed for most of the world’s major economies.  Many developing countries appear reluctant to pursue difficult economic reforms that would boost their growth rates over the longer term.
  • Global economic integration in play.  Momentum for further global trade liberalization is weakening after 70 years of progress, and a growing popular consensus against free trade could trigger spasms of protectionist sentiment and escalate into a broader retreat from integration.
  • The productivity challenge.  The productivity gains of the past 150 years have owed much to technology advances.  Use of new technologies in the economy is impossible to predict—and they may prove pivotal—but may fall short of the immense impact of electrification or the internal-combustion engine on economic output. New technologies will also introduce major social, political, and economic disruptions as they require different business processes and education to provide workers the skills needed to make use of them.

Major Trends

Sources of Economic Growth Flagging.  The global economy faces serious stresses as two of the world’s three largest economies—China and the EU—undergo significant transitions, with China the biggest wild card as it shifts from an investment-driven to consumer- and service-based economy.  This historic transformation, which is still not on a clear trajectory eight years after the global financial crisis, reflects the waning of an era dominated by China’s rural-to-urban migration and industrialization that drove the country’s building boom, raised living standards, and produced capital surpluses that help fund borrowing worldwide. China’s population will age rapidly because of decades of Beijing’s “one-child policy,” and its growth will be constrained by domestic overcapacity, high debt, and a vulnerable banking system.  The rest of the world, particularly developing countries, will have to adjust to a China that is no longer a center of ever-growing commodity demand but is instead a more-balanced trading partner.  Efforts by Beijing to forestall the inevitable difficulty and cost of this transition—as seen with Beijing’s latest round of officially-encouraged bank lending to state-owned enterprises (SOEs) in early 2016—will prolong the transition period, widen imbalances, and increase losses from the unproductive, debt-financed investments made.

Managing the transition and minimizing dislocation will be crucial.  A dramatic slowdown that causes ordinary citizens to doubt Beijing’s ability to improve living standards could undermine social stability and the Chinese Communist Party’s hold on power, leaving Beijing unable to rely solely on its authority—even with increasingly centralized power—and aggressive social control to maintain stability.

  • Beijing probably can cushion the transition by boosting spending and encouraging state-owned banks to finance projects to minimize the impact on the broader economy as investment declines—particularly on the part of large, inefficient SOEs.  Improving retirement and healthcare benefits could boost private consumption and help speed the process.
  • During its transition, China will be at risk of sharper, short-term economic shocks that emanate from external or domestic causes, such as a financial crisis affecting China’s largest trading partners or a domestic misstep that erodes public confidence.

A substantial disruption in China, the world’s second-largest economy, could cause a global slump and erode growth prospects for many of the country’s economic partners.

  • The end of China’s urbanization-industrialization boom and its decelerating economic growth have already undermined market assessments of the prospects for global demand for commodities, contributing to sagging prices and reducing revenue for states that depend on oil and mineral exports.  Further slowdown would tighten the squeeze on Russia, Saudi Arabia, Iran and other key countries.
  • A successful transition would be a boon to the rest of the world.  Strong Chinese consumer demand would offer the promise of new customers for a broad range of goods, from low value-added goods from other developing economies to luxury goods and cutting-edge personal technology gadgets.

European economies also are in transition—with many still trying to regain positive momentum since the Great Recession of 2008—as they struggle to manage high debt levels that provide less room for fiscal stimulus to appease aging populations and restive middle classes, and ease sharp divisions over economic policy.  Their evolution—or lack thereof—could affect momentum for economic liberalization and perceptions of Western global leadership.

  • Europe’s economic future is tied to strains over its political future, and uncertainty about the Britain’s political and financial relations with the EU will probably dampen investment and growth through the medium term.  In addition, the EU’s ability to use free trade agreements to promote growth has been constrained by the precedent set when the European Commission decided national parliaments needed to approve the recently signed Comprehensive Economic Trade Agreement (CETA) with Canada—in response to German pressure and perceived EU overstepping expressed in the Brexit vote.  Finally, the Schengen Agreement, which abolished passport and other border controls among the 26 EU states, is being undermined by controls set up by many member states trying to curb large-scale refugee cross-border movements.
  • Uneven growth rates in the EU and debt challenges in Greece, Spain, and Italy are dividing the Union, and the EU’s inability to craft monetary and fiscal policies that foster growth throughout its territory could be its undoing. The rise of nativist and antiglobalization voices in the EU undermines global support for free trade and economic liberalism.

The world will also closely watch to see if US growth rebounds to historically more-typical levels, to confirm or repudiate the viability of US economic policies.  Many countries appear more eager than a decade ago for US leadership on vexing economic and security challenges, but most are prepared to hedge their bets if they doubt Washington’s will or capacity to focus externally.

  • Expectations have faded of strong bipartisan support to propel the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership into being.

Developing countries lack the capacity to “fill the gap” in global growth amid the major economies’ weakness.  Most have taken steps to integrate into the global economy, but many are reluctant during a period of economic and political uncertainty to take harder—but necessary—steps to boost growth by reducing the role of state-owned enterprises, cutting back consumer subsidies that distort markets, implementing legal and governance reforms to encourage foreign investment, and liberalizing labor markets, including mitigating high levels of gender inequality.

  • India probably has the greatest potential to boost global growth because of its size and the success of its technology sector, but it would have to improve its energy, transportation and manufacturing infrastructure to sustain high rates of growth.  Infrastructure has improved in some locales but not in wide swaths of the country.  Unlike China, India will benefit from 10 million new working-age residents per year during the coming decades, yet harnessing such a massive labor pool increase in ways that increase productivity and boost output has proven difficult.  The global success of India’s technology sector, in contrast with its lackluster manufacturing success, underscores the imbalances between the country’s relatively strong higher education and its poor basic education, which would need to be improved to generate higher employment.
  • Optimism about Africa’s growth potential has largely tracked commodity price swings in recent years, but it has been muted by uncertainty over generational political transitions in several countries and its cities’ ability to absorb the continent’s massive population surge.  Demographers forecast that Africa will provide most of the growth in the world’s working-age (15-64) population over the next two decades, which could either be an economic boon or a cause of major instability if governments cannot create economies that can harness the productive potential of these mostly urban job-seekers.

Political leaders and publics throughout the developing world appear worried about the reliability of any model for stable development, although public confidence in their countries’ prospects is stronger than in the richer countries.  The best path for them to follow to that prosperity is unclear for many.  In this environment, countries seem to know they must engage with the global economy to reap benefits, but they fear disruptive forces and shocks will make it harder to gain stability and prosperity.

  • Financial crises, an increased sense of vulnerability among the middle class, growing inequality, and political polarization have tarnished the Western model in the eyes of some.
  • Beijing’s state-capitalist approach is also showing serious signs of strain as China’s growth slows, its financial and housing markets appear fragile, inefficient state enterprises sag under heavy debt, pollution worsens, and Communist Party ideology loses traction with the public.

The Challenge of Financial Adaptation

The financial sector has been one of the most adaptive over the years in creating new mechanisms to manage evolving markets, but even these networks are showing key limitations. In particular, the “non-system” patchwork of accepted practices, markets, and regulations around global currencies has empowered governments to use monetary and exchange rate policies as tools of global economic competition—even as the WTO prohibits efforts to affect competitiveness in trade. This tension is currently barely contained within the G-20 framework and could explode or give way to a new push for governance around currency relations.

Noteworthy successes in financial cooperation include establishment of the Basel Committee on Banking Supervision 40 years ago to help Central Bankers from more than 20 countries coordinate standards and communication. The Financial Action Task Force combat money laundering and the Global Forum on Transparency and Exchange of Information tackles tax evasion, although gains are continually challenged by new illicit tactics in an escalating “arms race.”

However, differences among major power and the declining ability of the United States to forge consensus may undermine attempts by regulatory institutions to secure agreements on—and ensure implementation of—emerging financial sector challenges, potentially setting the stage for a more fragmentary financial landscape.

Global Economic Integration at Risk.  The historic, steady increase in economic integration during the past several decades is meeting with greater resistance, with a growing number of political leaders and movements pushing back against free trade and more open labor markets.  After seven decades of major global and regional trade deals, most countries involved already have low barriers to trade in nonagricultural goods, and there is little remaining room for major gains in narrowly defined trade liberalization.  There is limited appetite for universal WTO global deals in agriculture and services trade, where domestic political resistance to liberalization is strongest in most countries.  As a result, contemporary trade negotiations have focused on ancillary issues, especially investment policy, and countries have looked to hybrid agreements—more-comprehensive regional “coalitions of the willing,” with the TPP and TTIP as prime examples.

  • Financial market volatility, the erosion of the middle class, and greater awareness of inequality feed the view that trade liberalization has gone too far.  Given that some of the loudest criticism of free trade comes from within the United States—a longstanding leader in pushing for more-open markets—other countries will be watching US leaders closely for signs of an economic retrenchment.  Trade skepticism in the United States threatens an agricultural deal, while sharp trans-Atlantic differences will be hard to reconcile on a range of regulatory issues on services.
  • The WTO sees the risk of “creeping protectionism” in some countries’ steps to restrict trade and opposition to new free trade agreements such as the TPP.  More-restrictive regulations or more-overt efforts to use currency policy to boost export-competitiveness could create a dangerous competitive cycle, with countries not wanting to be the last to counter such moves and leave their economies vulnerable.

The Productivity Challenge.  With global productivity gains and workforce growth flattening in the largest economies, finding new ways to boost productivity will become more important—and more difficult to maintain—during the coming decades.  The productivity challenge will be especially acute during a period when working-age population growth will slow in the United State and shrink in Europe, China, Japan and Russia, potentially eroding economic output.  The same age cohort will be grow significantly in developing regions of Africa and South Asia, but leaders there will be hard-pressed to rapidly scale up their economies.

  • Technology has been a crucial driver of productivity gains, and a source of anxiety for workers who perceive they are at risk of being displaced.  Continued technological advances will be vital to maintaining economic growth for countries facing flat or shrinking workforces, but future technology-driven productivity gains in advanced countries may be modest or take longer to realize.  Productivity in these economies has sagged or stagnated during the past several decades, even with major infusions of new information technology, possibly because the infusions have most affected activities done at no, or only indirect, cost to users or have helped eliminate for-cost business, such as social media, other on-line activities, gaming, and personal communications.  However, poorer countries, where modern ICT is less ubiquitous, are likely to enjoy substantial productivity gains as hitherto underserved residents gain communication access.
  • Productivity in all countries could also be increased through a broad range of more fundamental steps, such as improving education and training, infrastructure, research and development, and regulations and management practices, but these will require funding, expertise, and lead-time that may prove difficult for many developing—and even developed—countries to marshal.

Technology’s Impact on Jobs: Fears Despite a Positive History

Recent ominous forecasts about the potential for new robotic technology to eliminate large numbers of jobs have echoed writings of economists and the anxieties of at-risk workers since industrialization began in the 19th Century. One study projects that automation and artificial intelligence could replace 45 percent of the activities people are now paid to perform, including relatively high-paid workers like financial managers, physicians and senior executives. The rate of advances may lead to short-term dislocations in some sectors, but fears of widespread displacement have proven unfounded. Nonetheless, the fears may lead some government leaders and publics to call for slowing the use of new technology to protect jobs, potentially slowing gains.

Key Choices

Economic Integration.  Governments probably will be tempted to revert to protectionist measures as real, perceived, or anticipated challenges to their economies stir public fear and uncertainty.  Holding the line on economic integration almost certainly will become politically difficult, and taking new steps to open and reform markets will take even greater courage.  Hard choices will center on trying to forge policies that help retrain and sustain people displaced by market disruptions, particularly as tight budgets and rising debt limit fiscal options.

Technology.  How countries manage the commercialization of new technology will bear directly on their economic success and social stability.  Major technological breakthroughs will give companies significant leverage in seeking favorable business conditions in countries, and governments (and consumers) will have to decide how quickly they adopt new technology and how they cope with the repercussions.

Labor Force Participation.  For most countries, the greatest opportunity for boosting economic output will be increasing the share of residents participating in the workforce—particularly for societies that have low female employment and large numbers of rural citizens not engaged in the formal economy.  Longstanding cultural norms are likely to complicate moves to tap into an increasingly important talent pool by stirring social tension, but rising global economic competition will raise the cost of inaction.  Graying developed countries could also make gains by boosting participation rates of able-bodied older workers as fixed retirement ages and increasing life expectancies mean longer nonworking lives for typical workers, but curtailing pension benefits to workers will face political opposition, even if it helps ease fiscal pressures.