Despite increasingly gloomy commentary we still see solid economic growth in most of the world’s regions and expect this to continue into 2020.
There are however spots of weakness. The manufacturing and tradeable goods sectors remain under stress globally and countries that have activity concentrated in these areas are close to recession. The most prominent example is Germany, followed by South Korea. However, the two biggest economies – the United States and China – are consumer-driven, contrary to the outdated claims of some commentators about China’s model, and trend growth in these countries remains around sustainable rates: two per cent for the US and six per cent for China.
While our baseline forecast for global economic growth remains relatively positive, the risks around that baseline have steadily moved to the downside over the course of 2019. The clear top risk is a sharp deterioration of activity stemming from ongoing uncertainties around the US-China relationship, not just the narrowly defined ‘trade war’. So far, these uncertainties are causing firms to pull back or postpone investment decisions and households to dial back discretionary spending. This investment pullback has been the principle drag on growth over the past year or so. The real worry is that this weakness spreads to households and the labor market, dragging down consumption spending, which is the main driver of growth in most countries.
We do not think that the main sticking point around US-China relations is trade. In some sense, lowering the overall US trade deficit is straightforward: the US has to save more. The larger issue is the difficulty in fitting the state-led Chinese economic model into the post-World War II global order. US and other foreign firms regularly complain about the lack of a level playing field in China, arbitrary regulations, and forced technology transfer through joint ventures – not cost competition that needs addressing by tariffs.
The transfer of technology is a particularly thorny issue. Events over the past few years have shown that China is vulnerable to disruptions in semiconductor chip value chains, as the most advanced components are sourced from the US, German and Japan. Chinese acquisitions of capital goods and technology companies in the West have also raised concerns on national security grounds. Furthermore, Chinese growth in the next decade will be increasingly fueled by productivity gains derived from technology acquisitions.
What does a deal look like? Some issues in the US-China spat can be resolved in the near term, including larger Chinese purchases of US goods, and agreements (including verification processes) around IP protection and ease of doing business on the mainland. Other issues, such as the frictions caused by the Chinese state-led model and technology purchases, will likely require an ongoing, high-level framework to communicate and work things out.
With global growth again slowing, and the risks clearly on the downside, the issue of macro policy accommodation is back. The main change to our view over the past year has not been the macro numbers. It has been the shift in the views around central bank policy rates. Whereas we previously saw central banks on a steady path toward normalisation, we now see rates heading lower. This monetary easing should be accompanied by fiscal stimulus, particularly as central banks approach the zero bound and, in some cases, may go deeper into QE territory. The policy mix matters: central banks cannot be the only game in town.
From our economic team’s perspective, the case for fiscal stimulus is more compelling now given extraordinarily low government interest rates. The economic argument for such stimulus is that any public sector project with a rate of return higher than the funding rate should be undertaken. Infrastructure, which has direct effects on capital expenditure and employment, is an obvious example. In Germany, where the entire government yield curve is below the zero line and growth is slowing due to weak investment, the case for fiscal stimulus is strongest. But this argument applies to any country.
Turning to Australia, the extraordinarily long expansion is part good luck, but mostly good policy. Australia has hitched its economic wagon to China, whose demand for commodities and, more recently, educational and tourism services, continues to provide a healthy support to growth. While activity growth has softened due to property market weakness domestically and weaker investment sentiment globally, the outlook remains relatively strong. Two RBA rate cuts and a weaker exchange rate should underpin growth going forward. Of note, these two channels in Australia are stronger than in most other countries. Finally, Australia is plugged into the non-contentious parts of the Chinese economy, meaning that the risks around technology transfer and doing business in China noted above apply less to Australia than for other countries.