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The Real Economy

Global outlook: Slowdown followed by recovery as India leads the way

Jul 06, 2023

Key takeaways

India and the United States remain areas of growth.

But the EU appears to have slipped into recession, and China’s rebound is not as strong as expected.

Price stability remains the overriding global economic issue for now.

Economics The Real Economy

The global economy is in a precarious state these days, with the resilience exhibited earlier this year expected to fade.  

While India and the United States remain areas of growth, the European Union appears to have slipped into recession. And China is not experiencing the strong post-pandemic recovery many expected.

The World Bank forecasts that global economic growth will slow to 2.1% this year before a tepid recovery to 2.4% next year.

Leading indicators of growth in the G20 and G7 economies*

Worse still, cheap-money borrowing by third-world economies has the potential to become untenable, with the diminished demand for emerging market resources and higher interest rate payments setting the stage for a replay of the debt crises of previous eras.

As of March, the Organisation for Economic Co-operation and Development’s (OECD) outlook was slightly more optimistic than six months before, supported by improved business and consumer confidence, declining food and energy prices, and the reopening of the Chinese economy.

The OECD forecasts annual gross domestic product (GDP) growth in the United States at 1.5% this year and 0.9% next year, assuming monetary policy continues to moderate demand pressures. 

In the euro area, growth is projected to be 0.8% this year but pick up to 1.5% next year.

In the euro area, growth is projected to be 0.8% this year but pick up to 1.5% next year as the drag on incomes from high energy prices recedes. We expect growth in China to rebound to 5.3% this year and ease to 4.9% next year.

The OECD’s leading indicators for developed economies remain underwater for now, signaling the effects of more than a year of financial tightening by central banks in their campaign against inflation.

The trajectory of those leading indicators suggests the possibility of eventually achieving price stability and restoring normal monetary conditions, consumption and investment.

A downturn among developed economies

Germany, France, Italy and the United Kingdom have dropped into recession or near-recession levels as inflation takes its toll on household consumption and the higher cost of capital eats into investment.

The war in Ukraine will have its greatest impact on Europe. But we are a global economy, and slowdowns in Europe (and the shutdowns in China) are bound to have lingering spillover effects.

The economies of North America, Japan and South Korea are expected to slow into next year, according to the consensus of economists surveyed by Bloomberg. Personal consumption in New Zealand has already dropped, with economists projecting contraction in the next four quarters. Economists anticipate Australia will avoid a recession, with growth decelerating to low levels.  

As of April, the International Monetary Fund (IMF) expected growth among developed economies to fall from 2.7% last year to 1.3% or 1.4% this year and next.

Economists surveyed by Bloomberg are less optimistic regarding growth in the Group of Eight (G8), a smaller sample of the major economies. Real GDP growth of less than 1% is anticipated for this year, rising to only 1.8% in 2025.

Even if growth among the major developed economies were to escape the worst of a slowdown or recession, recovering from the inflation shock and financial tightening is unlikely to reverse the low-growth trend of recent decades.

Without a shift in structure, most likely coming from the government investment in infrastructure and from industrial policies to decrease dependence on China’s factory floor, we cannot expect much in the way of an economic miracle. The more developed economies in the West have yet to escape their dependence on the mineral resources of the global south.

Projections for a slowdown in North America, Western Europe and Australia/New Zealand*

Inflation and unemployment  

Price stability remains the overriding issue for now. In most cases, elevated prices will require additional financial tightening by the G8 central banks and slower growth ahead.

After inflation averaged 7.8% last year, economists expect G8 inflation rates to drop to 4.6% this year, but with a wide spread of price increases ranging from Japan’s 2.7% and Canada’s 3.7% to the U.K.’s 6.9%. Economists see the reason for G8 inflation to drop to 2.6% next year and then to 2.2% in 2025, which is within the inflation target of most central banks.

Unemployment, the other implied concern or actual mandate for monetary policymakers, is expected to average 4.3% in the G8 labor force this year, rising to 4.8% next year as the economic slowdown takes hold.

There are lingering effects of demographic changes and adjustments in the labor market that are likely to keep downward pressure on the labor supply while pressuring wages higher.

But those higher wages appear to draw some of the population back to work, resulting in higher labor force participation rates. The risk, of course, is that the effort to control prices could stall economic growth and the positive trends in the labor market. 

Labor force participation rates in selected countries

While real GDP growth in the U.K. teeters on the edge of recession, Germany’s output has declined in three of the past four quarters.

Both economies suffer from high inflation, with food costs in the U.K. increasing by 19% in April and nearly 15% in Germany in May.

The cost of food in the UK increased by 19% in April, and by nearly 15% in Germany in May.

U.K. housing costs, including rent and energy, surged by 26% in March and 12% in May. Germany’s housing costs increased by 6.4% in March.

With such high inflation, the markets expect the Bank of England to hike its policy rate from 4.5% to 5.5% by the end of the year. The market expects the euro-area overnight indexed swap rate to increase by 50 basis points by the autumn, which implies the policy rate moving from 3.75% to 4.25%.

The increases in credit cost should reduce demand and investment among developed economies.

The drop in domestic demand will have ripple effects on demand for commodities and manufactured goods in emerging economies. At the same time, the increase in interest rates will increase the cost of maintaining debt accumulated in emerging markets.

Germany real GDP growth

India on the rise

The IMF is projecting the world economy to grow on average by 3% for the next five years. Projections for advanced economies are for growth of only 1.6% per year, while growth in emerging economies forecasts to reach 4% per year.

The emerging economies category covers a lot of ground, though, with China and India as the center of gravity. Not only are they the most populated, but the GDP generated also makes them the second- and fifth-largest economies in the world.

Despite the growth, China and India remain third-world countries, at least in terms of their income per capita, fractions of income among residents of developed economies of the OECD.

IMF actual and projected GDP growth in the world and advanced and emerging economies

India’s outlook

We expected India’s economy to have slowed in the first quarter of this year. But it remains the fastest-growing economy in the world and is expected to gather steam with a 6.25% average growth through 2025.

While its institutional barriers have delayed India’s becoming a production center, the attractiveness of its young, educated, English-speaking workforce makes it the world’s outsourcing capital.

India’s wages remain extremely low compared to Western economies. But they are increasing in rural areas, according to limited hard data, and we can assume some spillover into urban workplaces. Any increase in per capita income would be a step toward losing its third-world status.

We cannot ignore India’s role as the world’s largest democracy. Nevertheless, reluctance to forego lockstep alignment with the West is a function of self-interest and its need for energy and food.

India’s growing economy and demand for energy make for strange bedfellows by Western standards. But it also creates an excellent opportunity for the growth of the renewable energy industry.

Its position between Russia and China and its experience with colonialism might explain its history of nonalignment.

As explained by Nirupama Rao, India’s foreign secretary from 2009 to 2011 and former ambassador to both Russia and China, India does not seek the role of the world’s conscience. 

Instead, there is a need for the development of the global south. As opposed to China’s Belt and Road Initiative, India sees its role as a founding member of the International Solar Alliance and its grant assistance, lines of credit, technical consulting, and aid and educational programs as benefiting global south countries.

Rao extolls India’s role as the third-largest pharmaceuticals manufacturer in the world, the average age (28) of its population and its growing economy. Still, its neutrality regarding Russia’s invasion of Ukraine and its reliance on Russian oil is cause for concern in the West.

Rao contends that India’s relationship with Russia has deep roots, with Russia supplying 60% of its defense equipment. While maintaining those ties without condemning Russia’s aggression might seem distasteful to the West, Rao noted that India kept doing business with the United States during its numerous periods of aggression.

As it stands, Rao wrote that the United States is India’s largest export destination and trading partner. The United States is also India’s technological partner, with the creation in May 2022 of the U.S.-India initiative on Critical and Emerging Technology.

Strategically, India is both an essential buffer to China’s aggression and a barrier to a Russia-China alliance. Rao reports the security partnership of the Quad—which includes Australia, Japan, the United States and India—and India’s playing both sides with its part in the Beijing-led Shanghai Cooperation Organization, as well as its membership in the BRICS association of vibrant emerging economies.

Finally, Rao warns that India’s economy is not free of regulatory bottlenecks. There is also a risk of India slowing should global growth be further affected by rising interest rates. 

Where is the economy going? Read more perspectives on economic headwinds facing the middle market from RSM US.

China’s muscle

In contrast to India’s altruism in the global south, skeptics see China’s reestablishment of the Silk Road trade routes as a Trojan horse and its investment in impoverished nations as a potential debt trap, according to a recent analysis by the Council on Foreign Relations.

China’s vast development and investment initiatives launched in 2013 to link East Asia and Europe through physical infrastructure.

Since then, the project has expanded to Africa, Oceania and Latin America, significantly broadening China’s economic and political influence.

According to the Council on Foreign Relations, 147 countries—accounting for two-thirds of the world’s population and 40% of global GDP—have signed on to projects or indicated an interest in doing so.

China’s biggest investment is the estimated $62 billion China-Pakistan Economic Corridor, a collection of projects connecting China to Pakistan’s Gwadar Port on the Arabian Sea.

China’s President Xi has promoted a vision of a more assertive China, even as the country’s outstanding loans have grown to the equivalent of over a quarter of its GDP, according to the Council.

The Belt and Road Initiative serves as pushback against the so-called American pivot to Asia, as well as a way for China to develop new trade linkages.

The accumulation of outstanding foreign loans adds to a domestic debt problem. With the pandemic and the Russian invasion of Ukraine roiling global markets, many low-income countries are struggling to repay loans associated with the initiative, with the potential for a wave of debt crises.

China’s spectacular economic rise stalled last year as its zero-COVID-19 policy closed large swaths of its economy.

Rather than accept the efficacy of the MNRA vaccines developed by the West or the SARS-CoV-2 vaccine developed at the Baylor College of Medicine that has proven to be safe, efficacious, and affordable for the bottom billion of the world, China chose to go it alone.

An analysis by Daniel Rosen in Foreign Affairs contended that China’s recent economic record is a pattern of bold attempts at reform followed by retreats.

For instance, China’s foray into foreign direct investment went from owning the Waldorf Astoria and Carnival Cruise Lines to a 25% decline in foreign exchange reserves and then back to stagnant outbound investment.

Each of China’s numerous attempts at liberalization has resulted in a mini-crisis. China’s debt-to-GDP ratio has risen from 225% when Xi first took office in 2013 to at least 275% as of 2021.

Rosen adds that the productivity growth that rose so spectacularly to 9.6% before the Xi years fell to 6% before the pandemic. Wage growth and household incomes have also slowed.

Skeptics on China’s ability to maintain its role as a high-growth marvel point to interest payments on debt that are double annual GDP growth, causing bank failures and defaults on state-owned enterprises.

Second, the population is shrinking, implying a smaller labor force and fewer people to buy an oversupplied housing market. And finally, the West has come around to shrinking its engagement with China, which would act to reduce its market share.

The third point is eerily similar to the American experience with Russia. Where the West once welcomed Russian liberalization as a sign of the triumph of democratic values, the fascination with China’s emergence into a medium-income economy has deteriorated into concerns over the safety of Hong Kong and now Taiwan. 

Lessons for the U.S.

After years of developing its economy into a global power, China’s increased aggression is laying the groundwork for its isolation.

China has moved beyond simply being the factory floor for the global economy. While the U.S. has concentrated on developing its scientific skills, China has developed its now unrivaled productive skills and labor force.

According to an analysis by Dan Wang in Foreign Affairs, Chinese firms have moved beyond assembling foreign-made components, with their process skills leading to a growing technological ability that now rivals the United States in some areas.

The shift from trading partner to technological competitor began with the Trump tariffs. With the Biden administration now putting restrictions on the transfer of technology to China and with an industrial policy to develop a U.S. domestic chip industry, China is working hard to cultivate its own chip industry.

Wang adds that if the United States is to compete with China on technology, it will need to focus beyond scientific knowledge to develop its capacity to bring innovations to scale.

The failure of the U.S. productive sector to adequately supply face masks and other health care equipment during the pandemic should have been the clarion call.

China’s dominance in renewable energy is unmistakable, with the decline in solar costs driven by its manufacturing innovations. China is also leading the way in battery production and technological advances.

Recent moves toward distancing the American economy from China would probably not have occurred if China had maintained its nonaggressive posture. American companies would continue searching for the most efficient and least costly production centers, with American consumers welcoming cheap goods.

The turning point was the threat to Taiwan more than the end of Hong Kong’s independence. Just as Russia’s invasion of Ukraine is cause for concern for its neighbors, a threat to Taiwan would spark concern for the democracies in Japan and South Korea.

Policy prescriptions

While democracy and state control of enterprise are incompatible, government intervention is needed in the case of market or policy failure (the Great Depression or the financial crisis) or national security (World War II).

These policies might include the following:

  1. International tax reforms among the developed economies that incentivize domestic production facilities instead of offshoring
  2. Agreements among developed economies for subsidizing the friend-shoring of essential goods like health care equipment or pharmaceuticals, either along the lines of military spending or treating these industries as public utilities with guaranteed rates of return
  3. Educational development of the labor force displaced by advancing technology

Stumbling blocks in the global economy

  • Inflation: There is the possibility of continued labor market tightness and growing wage pressures, requiring tighter monetary policies. Continued energy and food shortages or sticky prices are also possible.
  • China’s uncertain recovery: There could be a further slowdown in China’s property sector, a domestic debt overload or the inability of emerging economies to repay Chinese loans.
  • Geopolitical uncertainty: An escalation of the war in Ukraine would further destabilize energy and food markets and further fragment the global economy. Friend-shoring is unlikely to happen overnight.
  • Emerging markets: Unchecked inflation, particularly in Europe, could disrupt the financial markets, with increased risk affecting the ability of emerging economies to fulfill debt requirements.

RSM contributors

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