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Monday 19 Feb 2018 | 22:50 | SYDNEY
Monday 19 Feb 2018 | 22:50 | SYDNEY

Global economy: Still firing, 'boringly normal' growth expected



25 January 2016 08:51

To judge from the financial media reports or market commentary, global growth prospects are bad and deteriorating fast. But the IMF's just-updated growth figures — actual and forecast — are more sanguine, if less sensational. For each of the past four years, the IMF's purchasing power parity figures show global percentage growth starting with a '3', as do the forecasts for this year and next.

Curiously, the Fund's accompanying commentary echoes some of the market's gloom. Perhaps this is because the commentary focuses on the forecasts, not the actual historical performance. Successive updates have revised earlier forecasts downwards, reflecting the Fund's persistent bias towards optimism in GDP forecasting. Rose-tinted forecasts might seem, at the time they are made, helpful for business confidence. But when reality arrives, yet another confidence-sapping downward revision is required. Yet, despite all of these forecast downgrades, global growth can best be characterised as 'steady'. Within this global aggregate, advanced countries are still lacklustre, with recent years a bit stronger but still too slow to take up the slack created by the 2008 financial crisis. The emerging and developing economies, having done the heavy lifting for growth both during and after the crisis (accounting for almost 80% of global growth in 2010-2015), are slipping a little, but they are still growing at well over twice the pace of the advanced economies.

GDP Growth % Q4 on Q4Source: IMF

That said, the current global share-market slump, the plunging oil price and the pessimism surrounding the Chinese economy might suggest that prospects are much worse. Let's look at each in turn.

Share markets are sometimes given credit for being forward indicators of economic cycles but, as Paul Samuelson famously observed, 'stock-markets have called nine of the last five recessions'. Financial market innovation may have made stock-markets even more prone to volatility: financial institutions and portfolio investors use similar risk models so they respond to new information in the same way and behave like lemmings, while high-frequency algorithmic trading has detached the process of equity-price discovery away from any notion of fundamental values. The fundamental metrics are more positive: global corporate profits have been historically high, while price/earnings ratios are around historic norms.

While petroleum price falls have, in the past, been positive for world growth, Paul Krugman argues that this time might be different. A fall in oil price usually lowers inflation, creating room for easier monetary policy, but monetary policy in most advanced economies is already as low as it can sensibly go. Usually the rich oil producers, which lose when the price falls, don't cut their expenditure much, but this time they are fiscally constrained and will trim spending. Then there is the shale-oil investment story. Shale-oil production has added 5% to global supply in the past five years. Conventional oil producers invest serious money in exploration and drilling, and then the oil flows at low marginal cost. Shale oil producers get results more quickly, but have to keep drilling to maintain production, making running costs higher. They will react more quickly than conventional producers to lower prices. Thus we now see a halving in what has been one of the strongest components of US investment.

All that said, lower oil prices have to be good news for energy importers like China, India, Japan and Europe. While they will hurt Brazil, Venezuela and Russia (all with sharp GDP falls forecast by the IMF), on balance it's hard to see this as cataclysmic news for global growth.

Will petroleum price go lower and trigger some greater disruption? The daily price is dominated by the exigencies of the quotidian demand/supply balance, so it could go lower over the short term. The Saudis have made it clear that they are not going to give up any market share to accommodate the arrival of Iran's now-unembargoed oil. Some US shale companies will go on producing at a loss, just to delay bankruptcy in the hope of change.

Over time, however, the underlying economics will assert itself. The key analytical insight is still a supply-cost curve like the one shown in the second graph here. Updated, this would show that improved technology has reduced the supply-price of shale-oil, but sharply falling investment suggests that production can't be maintained in the medium term at current prices. Sooner or later, the price has to approximate the costs of the most expensive producer, so the equilibrium price won't be determined by Saudi low-cost oil, but by more expensive shale or offshore production. Thus, whatever the pain being administered by the current low price, chances are this will ease and petroleum will cease to be an excuse for market panic.

If you accept the arguments in my posts on China last week, then you would also accept the IMF's forecast that China will continue to meet the official growth target of 'around 7%'. The IMF's precise figure is 6.8% for this year, slowing to 6% by next year. You can be sceptical about the GDP figures, but the rising ratio of job vacancies suggests that the GDP figures, even if fiddled at the margin, reflect an underlying reality that China is still growing at two or three times the pace of the advanced economies, adding as much to global GDP (in dollar terms) as it did when it was growing at double-digit rates but from a lower base.

In due course, the IMF may have to make its customary downward adjustment to its forecast figures, but this would still leave the global economy jogging along, too slow for comfort, but fast enough to refute the current pervasive pessimism. So here is the bad news for all those who have to write exciting stories about global growth: it all looks boringly normal.

Image courtesy of Flickr user Hammonton Photography

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