Ten years after the “Lehman shock,” the world economy’s steady post-crisis recovery might have peaked, according to the OECD. The warning from the Paris-based organization follows escalating trade tensions, tightening financial conditions, and political risks that have heightened fears over a new global downturn.
Downgrading its previous forecasts released in May, the OECD’s latest projections released September 20 point to a slowing global economy, with rising divergences compared to the earlier broad-based expansion.
The 36-nation economic organization sees world growth rising by 3.7 percent this year and next, down 0.1 and 0.2 percentage points, respectively, from its May forecasts. This follows weakening confidence, slowing trade and investment growth, and sluggish wages growth, despite unemployment falling below its pre-crisis rates.
Among the OECD’s projections, the United States, the world’s biggest economy, is seen slowing from 2.9 percent gross domestic product (GDP) growth this year to 2.7 percent in 2019. The Eurozone is also seen cooling, slipping from 2 percent growth in 2018 to just 1.9 percent next year.
In the Asia-Pacific, the OECD points to a mixed outlook for the world’s fastest growing region. China, the world’s second-largest economy, is seen sliding from 6.7 percent GDP growth this year to 6.4 percent in 2019, amid slowing credit growth and infrastructure investment.
In third-ranked Japan, growth could drop from 1.7 percent GDP growth last year to just 1.2 percent this year and next, although there are signs of a “modest upturn” in wages growth.
South Korea is also showing a mixed outlook, cooling from a 3.1 percent expansion in 2017 to 2.7 percent this year and then rising 2.8 percent in 2019, helped by sizable fiscal expansion.
Australia, however is projected to pick up speed, rising from 2.2 percent GDP growth last year to 2.9 percent this year and 3 percent in 2019, helped by strong investment growth and job creation.
Another improved performer is Indonesia, increasing from 5.1 percent GDP growth in 2017 to 5.2 percent this year and 5.3 percent in 2019, aided by improved infrastructure investment and consumer spending.
Overall though, India is expected to be the best-performing G20 economy, with recent reforms seeing its GDP growth rate increasing from 6.7 percent last year to 7.6 percent in 2018, dipping slightly to 7.4 percent in 2019 on the back of higher oil prices and tighter financial conditions.
While such forecasts remain relatively healthy, the OECD warns that further trade restrictions could have adverse effects on jobs and living standards, particularly for lower-income households.
Global trade growth has already eased from 5 percent in 2017 to around 3 percent in the first half of 2018, and recent restrictive measures enacted by the United States and China could see this slowing further.
“Trade tensions are starting to bite, and are already having adverse effects on confidence and investment plans,” said OECD chief economist Laurence Boone.
“Trade growth has stalled, restrictions are having marked sectoral effects, and the level of uncertainty on trade stances remains high. It is urgent for countries to end the slide toward further protectionism, reinforce the global rules‑based international trade system, and boost international dialogue, which will provide business with the confidence to invest,” Boone said.
“With tighter financial conditions creating stress on a number of emerging economies, especially Turkey and Argentina, a strong and stable policy framework will be key to avoid further turbulence.”
The OECD urged policymakers to “enhance resilience, boost productivity and improve inclusiveness.”
“Policy should address the root causes of financial market pressures, including excessive asset prices and indebtedness in various forms, both public and private; improve resilience to shocks in both emerging and advanced economies; steer fiscal policy toward measures that support long-term growth; and focus reforms on skills and labor market inclusion to improve opportunities for all.”
The OECD points to a protracted recovery from the 2007-08 global financial crisis, with the upturn achieved “only with an exceptional degree of policy support.”
“On a per capita basis, growth has now improved in the majority of advanced and emerging-market economies, but living standards continue to fall short of what might have been expected prior to the crisis if growth had continued at its long-term average rate over the past decade,” it said.
Yet a prolonged period of “very accommodative” monetary policy to spur recovery in the Eurozone, Japan, and North America has resulted in new financial vulnerabilities, including elevated asset valuations and higher levels of public and private debt. While reforms have strengthened the banking system, “risks have shifted toward less tightly regulated non-bank institutions,” the OECD said.
Emerging market economies with large external deficits or high foreign-currency denominated debt are seen as particularly exposed, with a faster-than expected normalization of monetary policy in advanced economies potentially triggering capital outflows from emerging markets.
In Asia, India, Indonesia, and the Philippines have been described as “weak links” due to their current account deficits, although the heavy debt levels of China, South Korea, Taiwan, Hong Kong, and Singapore are also viewed as making them vulnerable.
With such warnings, should Asia fear a repeat of the “Lehman shock”?
Capital Economics suggests the risk of a recurrence in the near future “appears to be low,” thanks to reduced “risky lending,” better capitalized banks, and less inflated asset prices compared to a decade earlier.
Nevertheless, the London-based consultancy points to new risks, including rising debt levels, weak productivity growth, and the reduced ability of policymakers to respond to the next downturn.
Global non-financial debt (public and private) has risen from around 200 percent of world GDP a decade ago to 235 percent, with China alone accounting for two-thirds of the debt growth in the past five years.
Lower productivity growth has also slashed global growth to an estimated 3 to 3.5 percent, down from 4 to 4.5 percent a decade earlier.
“The result will be slower wage and profits growth, which, other things being equal, will make it harder to service debt burdens,” Neil Shearing, group chief economist, said in a September 13 report.
Weaker productivity growth also has cut the “equilibrium” or “neutral” real interest rate, which in the United States is estimated to have fallen from around 2 percent a decade ago to 0.75 percent currently.
As a result, the next downturn likely will start at a lower level of real interest rates, “thus leaving less room for conventional policy easing.”
With interest rates still low in advanced economies and central banks’ balance sheets bloated from quantitative easing (QE), policymakers will have far less room to loosen policy or engage in further QE should another crisis hit.
“Combined with high public debt, this would leave policymakers in advanced economies dangerously underequipped in the event of a global shock or significant economic downturn. Given our view that the U.S. economy will begin to slow next year, policymakers could be tested sooner than most anticipate,” Shearing said.
With Asian financial markets already feeling the effects of higher U.S. interest rates, a worsening of the U.S.-China trade war threatens to drag down an already weakening global economy and Asia along with it. For the world’s most economically dynamic region, the alarm bells are ringing ever louder.