It’s barely February, but uncertainty has pervaded the global economy this year. Here’s what’s driving it, and what to expect next.
2015 has kicked off with an unusually high level of uncertainty (unavoidable) and a large dose of confusion (avoidable). The uncertainty is the product of three ongoing structural shifts:
- accelerating technological innovation, disrupting the competitive landscape for industries and countries;
- rebalancing world economy, which has multiplied the number of countries whose health is now important to global growth;
- rising geopolitical volatility, as the economic rebalancing upsets traditional power balances.
Moreover, oil prices have plummeted, the ECB has announced government bond purchases in last month’s watershed decision, and the Fed is set to start an unprecedented policy normalization experiment. If this were not enough, the economic debate is often confused and confusing, perhaps the result of the lingering post-traumatic stress disorder from the global financial crisis.
The discussion on the impact of oil prices on global growth is a case in point, so let’s start here.
What happened to oil prices?
The speed and magnitude of the collapse in oil prices has caught us all by surprise. It is a sobering reminder that this is a market where demand and supply information is subject to uncertainty and delays; and geopolitics and strategic decisions by a few key suppliers can have a major impact. Recent estimates indicate that the market faces a supply glut of about 1 million barrels/day. Demand or supply?
Quite simply, this is a positive supply shock, so it is good for global growth. It’s a transfer of income from oil exporters, which tend to save more, to oil importers, which tend to spend more. It acts as a tax cut on consumers, and reduces input costs for business. It reduces inflation, opening room for more accommodating monetary policy.
The IMF estimates that lower oil prices could boost global GDP growth by 0.3-0.7 percentage point in 2015 and 0.4-0.8 percentage point in 2016. A boost of about half a percentage point to a global economy running at just over 3 percent — not bad at all. (The IMF estimates were published in December, with oil priced at about $55 per barrel, and prices have fallen further since then.)
The biggest winners are in Asia: China — the world’s largest oil importer — as well as India and Japan. Lower oil prices will also help growth in the Eurozone, Central and Eastern Europe and Turkey, where they alleviate a substantial external gap. Though it has become fashionable to argue that where inflation is already low (notably the Eurozone and Japan), lower oil prices will curb growth through deflation, these concerns are largely misplaced.
The unpalatable truth is that low inflation — and Japan-style deflation — is a debt problem, not a growth problem. Japan will need strong nominal growth to ensure debt sustainability; and several Eurozone countries could definitely use a bit more inflation to reduce debt ratios. But they need growth a lot more, and lower oil prices will help.
Technology helped create this volatility. Expect to see more.
The collapse in oil prices is also the most visible evidence of the disrupting power of technology: it is advances in shale gas and oil extraction that have spurred a major increase in U.S. production, helping to bring us from the theory of “peak oil” to the reality of “cheap oil” within a short span of time. And the pace of innovation is accelerating across a wide range of sectors. We can expect to see more disruptions as digital technology pervades industries.
In some countries, policymakers have realized this and are stepping up efforts to move up the technology ladder, including through increased investment in R&D — China is a case in point. In others, innovation is emerging as a grassroots force that helps bypass limitations in infrastructure and institutions. Think of M-Pesa, the mobile banking and micro-financing system that originated in Kenya and Tanzania and has quickly by-passed the relative under-development of traditional banking. We will see more of this.
Technology will also have an increasing impact on the way we work, on the way work is organized in factories and economies. Rapid advances in robotics and Artificial Intelligence, increased recourse to crowdsourcing, broader adoption of advanced manufacturing techniques are beginning to reshape the way we work. This has already generated a significant degree of anxiety, centered on the likely impact on employment levels and the income distribution. Anxiety and uncertainty will continue.
And more countries are playing an active role in shaping the world’s agenda.
Emerging markets are no longer the can-do-no-wrong stars of the immediate post-crisis period; but neither are they as weakened as many think. China keeps humming along at the new normal rate of about 7 percent; India looks stronger than it has been in some time; Sub-Saharan Africa should hold up well to the decline in oil prices thanks to improvements in policies and institutions (see here and here).
Other important markets, like Indonesia, are using lower oil prices to cut fuel subsidies and put their fiscal policy on a better footing. On the other hand, Russia’s outlook has deteriorated significantly, and Brazil might be lost in stagnation until it reduces the cost of doing business and improves infrastructure. A mixed bag, but not an overall bad outlook. A quick glimpse at the latest IMF forecasts shows that, aside for China’s natural slowdown and Russia’s unnatural plunge, the growth outlook for other emerging markets is stable or improving.
2015 will be a key test for India — where lower oil prices will also help. Lower energy costs, lower inflation and lower interest rates will help to boost GDP growth in 2015. More important, however, is how much progress the new government will make on reforms. I see Prime Minister Modi’s approach as being focused on reforming the bureaucracy from within, and on creating the conditions that can make reforms stick. 2015 will tell.
In the U.S., conditions are favorable for the Fed to start raising interest rates: the U.S. economy is stronger, and ECB/Bank of Japan liquidity injections can cushion the global impact of Fed tightening. This means policy divergence will continue, causing yet more volatility in FX markets. An even weaker euro will help the Eurozone, where 2015 growth can surprise on the upside.
In a watershed decision, the ECB has launched “true” quantitative easing, including government bond purchases. As I argued in a recent piece, this is a move that highlights both the strengths and weaknesses of the Eurozone. Eurozone governments should use this window of opportunity to launch fiscal and structural reforms, but QE poses a moral hazard risk: high-debt governments could be tempted to just reap the benefits of lower rates and a weaker currency, without doing the hard work.
Combined with the recent Greek elections, the risk that high-debt Eurozone governments will keep delaying structural reforms is high. This would be a mistake. The way out is via structural reforms, less wasteful spending, more productive investment and innovation. Supportive monetary policy and a somewhat stronger global economy now provide a much better backdrop, but these steps do need to be taken.
2015 has kicked off under the sign of heightened uncertainty, brought about by the confluence of the several structural shifts. These forces are disruptive and mutually reinforcing. Throw into the mix the prospect of Fed rate hikes, the launch of ECB quantitative easing and the plunge in oil prices — and whatever your objectives for the new year might be, you will have to deliver them in a highly uncertain environment.
(Top image: Courtesy of Spencer Platt/Getty Images)
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Marco Annunziata is the Chief Economist and Executive Director of Global Market Insight at GE.