What next for the world economy?

Global growth could come to an abrupt end due to rising trade conflicts and a dangerous cocktail of economic factors, according to the International Monetary Fund. It is calling for immediate action to ‘fix the roof’ before it caves in.

The latest World Economic Outlook (WEO) from the IMF is pretty good news for global businesses. The world is experiencing a ‘strong upswing’, investment and trade is accelerating, and the IMF predicts growth this year and next will be 3.9%.

Shouldn’t we all be celebrating?

Not really. Shortly after the WEO was published, IMF Managing Director Christine Lagarde issued a stark warning in Hong Kong on April 11 that unless action is taken against protectionism, fiscal and financial risk, and short termism, there could be serious consequences for the world economy in the medium term.

How big is the threat?

This largely depends on how the current trade conflict between the US and China pans out and whether the rise in protectionism continues unabated. It also depends on whether policymakers change tack to create a fairer and more collaborative trade system, according to the IMF. This latter point could prove to be difficult based on evidence up to now.

The good news

Let’s start with the good stuff, and there’s plenty of it when it comes to growth of the world economy. The IMF has updated its growth projections substantially in recent months. There is continuing strong performance in the euro area, Japan, China, and the United States, all of which grew above expectations last year.

While advanced economies are projected to have 2.5% growth in 2018 and 2.2% in 2019, emerging markets and developing economies are predicted to achieve faster growth rates of 4.9% this year and 5.1% next. The IMF claims the global upswing is being powered by accelerations in investment and trade.

IMF table.jpg

Flirting with a trade war

Are economies really in danger of throwing this all away? Maurice Obstfeld, the IMF’s economic counsellor and research development director, says “major economies are flirting with a trade war” and “the prospect of trade restrictions and counter-restrictions threatens to undermine confidence and derail global growth prematurely”.

Why would economies even consider a trade war at a time of economic expansion? Maurice Obstfeld relates this to the erosion of public optimism about the benefits of economic integration by “long-standing trends of job and wage polarization, coupled with persistent sub-par growth in median wages”. He points out “many households have seen little or no benefit from growth”, although he believes these trends are more to do with technological change than trade.

What needs to be done?

A potential trade war is just one of the threats to global growth. IMF managing director Christine Lagarde says the momentum expected for 2018 and 2019 will eventually slow because of fading fiscal stimulus, including in the US and China, and because of rising interest rates and tighter financial conditions as major central banks normalize monetary policy. “Add to this the issue of aging populations and weak productivity, and you have a challenging medium-term outlook, especially in the advanced world.”

She calls on governments to:

  • steer clear of protectionism
  • guard against fiscal and financial risk
  • foster long-term growth that benefits everyone

Ending unfair trade practices

Criticising protectionism, she says unfair trade practices have little impact on a country’s overall trade deficit with the rest of the world and the best way to address macroeconomic imbalances is not to impose tariffs but to use policies that affect the economy as a whole, such as fiscal tools and structural reforms. This means better protecting intellectual property and reducing the distortions that favour state enterprises.

She claims “each country has a responsibility to improve the trade system by looking at its own practices and by committing to a level playing field where everyone follows the rules”, and she warns “that system of rules and shared responsibility is now in danger of being torn apart”. This would be an inexcusable, collective policy failure.”

Tackling debt

On fiscal and financial risk, the IMF is urging policymakers to tackle global debt which has reached an all-time high of $164 trillion, 40% higher than 2007. China alone is said to account for 40% of the increase.

The IMF managing director calls on policymakers to reduce government deficits, strengthen fiscal frameworks, and place public debt on a gradual downward path, as well as increasing buffers in the corporate and banking sector, especially in China and India.

She also stresses the need for the international regulatory framework to keep pace with the rapidly evolving fintech landscape. Above all, she calls for a strong global financial safety net to help countries to better cope with capital flow volatility in times of distress.

If the world economy does nose-dive in the medium-term, the IMF predicts this would worsen economic inequality, debt concerns, and political polarization. It would also mean slower improvements in living standards and a widening income gap between those countries and the advanced world.

Going digital

To tackle this, the IMF calls on governments to unlock the potential of the service sector, especially in developing economies with more public investment in education, training, and job-search assistance. It also calls for more competition in the service sector.

Finally, the IMF calls on increased digitalisation of government to deliver services more efficiently and effectively. This is in light of research by McKinsey which reveals that almost 20 percent of public revenues worldwide, or about $5 trillion, go missing each year, because of tax noncompliance and misdirected government payments.

New economic landscape

If the recent outpourings from the IMF are to be believed, we are at a critical point in the growth of the world economy, with dark clouds looming in the medium-term.

The question is, are governments listening? And if they are, how far are they prepared to go to follow the route mapped out by the IMF?

The fund wants policymakers to act while the going is good, but some would argue it’s only good for the minority. Whether there is the will to make sweeping changes for the good of everyone remains to be see.

Christine Lagarde is not just calling for the roof to be fixed, she is urging governments to work towards a new economic landscape, “where open trade is fairer and more collaborative; where financial systems are safer and more supportive of economic growth; and where the digital revolution benefits not just the fortunate few but all people”.

It’s an ambitious wish list, but there are tough decisions to be made if we are to get anywhere near making it a reality.

This article was written for Praxity, the world’s largest alliance of independent accounting and consulting firms.