A speech given by Anjalika Bardalai, Chief Economist and Head of Research, TheCityUK for ACT working capital conference.
Click here to download the presentation slides.
Good morning everyone, and thanks very much for the invitation to be here today. For those of you who may not be familiar with TheCityUK, it’s the industry body that represents UK-based financial and related professional services. That grouping covers the full range of financial services, as well as legal, accounting and consulting services. Today I’m pleased to have the opportunity to set some macro context for the rest of the day’s discussions.
Of course it’s hard to think about covering global economic trends and prospects in just half an hour, so what I’d like to do is offer a snapshot of the outlook for 2020, and also look at a couple of key countries and key themes in a bit more detail.
I know remarks like these are often accompanied by lots of slides, but I’m only going to show you a few charts, just to illustrate some of my main points. I’d mostly like to talk to you, and basically set the scene for the working capital sessions later on.
So, let me dive in by presenting an overview of the macro outlook for 2020.
Here you’ll see the outlook for growth for several major economies. But first you can see this line, showing the forecast for global economic growth. I’ve used the IMF’s data for the baseline forecasts, and you can see that the expectation is a nice rebound in growth next year and beyond, following a pretty significant slowdown this year.
I’ve also charted here the growth outlook for the US, where the expectation is for a continued slowdown but still fairly robust growth of 2.1% next year.
Here you see that growth in China is really a major driver of global growth. Although there’s been a lot of talk in the past year about vulnerabilities in the Chinese economy, and the impact of the US-China trade war, you can see that the slowdown in growth is expected to be fairly moderate.
But I’ll come back to talk about this in a little bit.
The weakness that we’ve seen in the Eurozone is expected to persist.
And one interesting thing that we’ve done at TheCityUK is to calculate the growth forecast for the EU27. This is based on IMF data but we had to do our own calculations since of course the EU27 won’t exist as an official grouping until the UK actually exits the EU.
Finally, I’ve presented several forecasts for the UK. I did this because I was interested to see how much divergence there was in forecasts given the highly uncertain political framework, and the uncertainty around the timing and process around Brexit, which is expected to have an impact on growth and other macro variables.
I think it’s beyond the scope of this talk to go into detail about Brexit and the macroeconomy – for one thing, we could be here for several hours if we go down that road, and for another, there’s no shortage of analysis from think tanks and official institutions that covers scenario-based impact assessments.
So here is the baseline forecast from the IMF; and here is an alternative forecast from the Office for Budget Responsibility; and finally, the Bank of England’s forecast. The Bank of England’s projections are a little more optimistic than the other two, but what’s interesting is the high degree of consensus among these forecasts – all three institutions expect UK growth to pick up slightly in 2020 and in 2021 compared to 2019.
Even more interesting is that the assumptions they are using to arrive at these similar forecasts are slightly different. The OBR forecast is from March, because the upcoming election means that they didn’t publish an updated forecast in November as is usually the case. And so their numbers were actually based on the assumption that Brexit would take place on March 31st. The Bank of England is assuming Brexit happens on January 31st ; and that the UK and the EU agree an FTA; and the IMF assumes “an orderly exit from the European Union followed by a gradual transition to the new regime”.
So, whether you think these forecast numbers are credible depends mostly on what you think will happen in the political sphere rather than the economic sphere, and the extent to which you think political developments will have knock-on effects on the real economy. And although I’ve only referenced Brexit so far, the elephant in the room in this regard is obviously the election in just 8 days’ time, and the economic policy pursued by whichever party is in power after the 12th of December. So without wishing to sound evasive, I do think it’s probably just a week too early to take a detailed look at the forecasts for the UK because at this point, almost anything I could say would be very speculative and, more importantly, would incorporate a great deal of political forecasting.
But let’s look just a little more closely at UK economic trends.
You can see here that growth has been slowing over the past couple of years, and in particular in the last few quarters. The latest data release was just a few weeks ago and there was a lot of speculation about whether the third-quarter data would show that the UK was in recession. But third-quarter growth was actually a little stronger than second-quarter growth on a quarter-on-quarter basis. Here I’m showing year-on-year growth rates, and the key point is that average growth has fallen pretty significantly from 2.4% over 2014-16 to 1.6% over the past three years.
So the main point I would make about the UK is actually that in addition to weathering a huge amount of uncertainty, the economy is also grappling with a number of structural challenges. I don’t have enough time to properly examine the structural issues facing the UK, but many of them are probably familiar to you already—things like the low savings rate and weak productivity growth. And I would argue that together, the structural issues plus the political and policy uncertainty explain the slowdown that you see here, and will provide quite a challenging backdrop for the economic policy pursued by the next government.
Turning now to what I’ve called the Big 2: the US and China.
Growth in the US is expected to slow next year, but at around 2%, it’s still putting in a very respectable performance. In China, meanwhile, a sustained deceleration in growth is underway as the restructuring of the economy away from investment and exports and towards domestic consumption continues. The IMF forecasts growth of 5.8% in 2020, down from 6.1% in 2019 and 6.6% in 2018. But in addition to the structural factors, the effects of the US-China trade war are also having an impact on growth. China’s exports decreased by around 1% year on year in the third quarter of this year, and imports fell by more than 6%.
I’ll come back to the trade war in a few minutes, but I want to pause for a moment here and do some more context setting to explain why we need this focus on the US and China.
We all know that the US is the world’s largest economy and China is the world’s fastest-growing major economy—but I think we sometimes don’t consider the sheer scale of these countries’ importance to the global economy. China and the US alone account for 41% of the global economy in terms of nominal GDP. In terms of contribution to growth—in other words, when the IMF forecasts global growth of 3.4% next year, as you saw on my first slide, how much of that 3.4% comes from which countries—China accounts for around a third of global growth, and the US for another fifth. So it’s slightly provocative, but actually not that much of an exaggeration, to describe the world economy ‘the US and China show’, as I’ve done here.
Another way of looking at this is through the lens of global trade. For context, we should also remember just what a prominent role trade plays in the global economy – global trade is fully 60% of global GDP.
This diagram was produced by the Bank of England as you can see, it shows the network of global goods trade, with the thickness of the lines reflecting the amount of goods trade between regions, and the pink lines showing direct trade links with China.
What you see is, once again, how central China is to global trade. The US is again the other country that’s really prominent here, but you can see from this visual representation that US trade flows are primarily with its North American neighbours, the Eurozone, and China. Whereas China’s trade links are much more global and wide-ranging.
You might be wondering how relevant all this is to the UK, and so I’m going to address that point in just a moment.
You might also look at this diagram and say, this is an unfair representation because it only shows goods trade. What about services trade, you might ask? And of course, services trade is something I spend a lot of time considering, given TheCityUK’s focus on financial and related professional services.
It’s definitely true that services trade happens primarily among advanced economies like the UK. But even for the UK, total trade is dominated by goods: in 2018, the value of goods trade was almost twice as high as the value of services trade. (The values were around £800bn and £500bn respectively). When you look at the global economy, goods trade represents fully 80% of global trade, and services trade, just 20%.
Another way to look at it is here.
On the left you see the huge difference between goods and services trade in value terms, and on the right you see that although services trade growth has generally been higher than growth in goods trade, goods trade is definitely still driving overall trade given that it’s growing pretty steadily, and from a much higher base.
Now, there is one important caveat here, which is that generally speaking, services trade is under-measured, and quite a lot of it is not captured in the data at all. Unfortunately I don’t have enough time this morning to go into this topic in detail, and also it would be a bit of a tangent. But I’m sure many if not most of us in the room represent services businesses so if this is of interest, I’d be happy to share the work I’ve done in this area.
But, moving on for now. Why is any of this trade stuff relevant?
The growth forecasts I showed you earlier were fairly sanguine, but I want to come now to some of the challenges associated with this outlook. And in my view, there are three main challenges.
The first is political and policy uncertainty. I discussed this quite a bit already in the context of the UK, and of course everyone in this room is fully aware of the dynamic here. But uncertainty is rife across the globe, from the protests in Hong Kong, to next year’s presidential election in the US, to Argentina’s new government which will take office on Tuesday and will have to negotiate again with private bondholders about debt restructuring.
You can see here
a very clear indication of relatively high levels of global policy uncertainty.
The second challenge is trade headwinds—which in some cases is a particular manifestation of political uncertainty.
Most prominent of course is the US-China trade war, but the US has also recently imposed tariffs on goods from other countries including Brazil and Argentina, and just this week it’s been France that’s been in the headlines, with the threat of US tariffs on some foodstuffs and luxury goods. Once again, thinking about the timing and nature of the resolution of these trade tensions would require political forecasting, which I think is beyond the scope of these remarks. But as we’ve seen, trade tensions have already had a direct impact on the economies of the US and, even more so, China. Beyond the direct effects of higher tariffs, business confidence is negatively impacted by ongoing trade tensions, potentially leading to knock-on effects from lower investment. All in all, the IMF estimates that the overall impact of the US-China trade war on economic growth is almost 1% of global GDP in 2020.
And finally, a word about what I’ve called policy constraints—and here I’m referring specifically to monetary policy. Monetary policy is once again being used to support the economy in a number of advanced economies—in some cases it could almost be described as pre-emptive stimulus, or monetary easing in the face of the potential negative impact of tougher global conditions. But the issue is that there isn’t much scope for central banks to act given that policy interest rates in advanced economies never rose to anything close to their historic levels before being cut again.
And finally, I want to talk about what I think is the biggest vulnerability we should be focusing on, which is debt.
Here you can see that credit to the private sector has risen sharply over the past few years, and now stands at 130% of global GDP—which is higher than it was before the 2008-09 financial crisis. This is crucial in so many different ways.
For example, in the UK, the level of household debt is a critical indicator of the economy’s vulnerability because consumer spending is the main driver of the economy, accounting for 65% of GDP. That’s a structural factor—meaning it is a long-term feature of the economy, and in this respect the UK is very similar to most other advanced economies. But this is a particularly resonant point at this moment in time, given the uncertainty I spoke about earlier. That uncertainty has led to a significant decline in business investment, which means that households are carrying more of the burden than usual in terms of sustaining economic growth. Thus far, household spending has been relatively resilient—but indebted households are more likely to retrench than non-indebted households, and if the household sector started to retrench, you’d see a negative impact on the economy overall.
Another example is one that the Bank of England flagged in its latest Financial Stability Report. They explained:
Global debt vulnerabilities can affect UK financial stability: directly through UK banks’ exposures to vulnerable economies; indirectly by financial contagion through UK banks’ exposures to other affected banks; and through macroeconomic spillovers to the UK economy, testing banks’ resilience to UK economic downturns.
A final example links together this debt issue and the trade issue. Rising debt levels have been a particular concern in China, where non-financial sector-debt as a percentage of GDP has risen from around 100% to more than 200% in the past ten years. If Chinese economic growth were to slow more sharply because of these elevated debt levels—either because authorities took more stringent measures to reduce credit growth, or because debt vulnerabilities triggered knock-on effects in the real economy—the centrality of China in global trade means that the impact on the global economy would be considerable. The Bank of England also notes that UK financial stability would be affected because UK banks have significant exposures to China and Hong Kong.
I could continue and give lots more examples, but I’m sure that’s enough to give you a sense of the importance of this issue. It’s important not only because of the risk that debt presents to the UK—both directly and indirectly. But also because it illustrates so well the inter-regional linkages, the relationship between different parts of the economy, and the links between the financial sector and the real economy.
Incidentally, it’s these sorts of interlinkages that make it so hard to meaningfully reduce economics to bullet points in my opinion. As an aside, I know the discipline has come in for quite a lot of criticism in recent years, and while I think a lot of this criticism has merit, I would also say that any field replete with nuance and detail faces particular challenges in a ‘highlights and sound bites only’ sort of world. That’s a bit of an aside of course…
But for that reason, I won’t leave you with the standard 3 key take-aways that normally round off remarks like these. I don’t have a concluding slide, and instead, I’ll be a little more discursive and end with some food for thought as we move towards the sessions focused more specifically on working capital.
In short, I think the outlook for 2020 is more positive than 2019 has been, at least in terms of the pure economics. But uncertainty still abounds, and any number of political or policy shocks present significant downside risks to the baseline forecasts.
In the UK, this is manifesting itself in subdued investment and cautious—though so far resilient—consumers. One thing I’ve tried to emphasise by presenting developments and prospects globally as well as for the UK is how trends and factors that might be quite far off the radar here may well end up influencing growth and financial stability. In recent years I think it’s been especially easy to focus on domestic issues because those issues have loomed so large, and have seemed, at times, so all-consuming. But we should remember that for open and globally integrated economies, risks can be global as well as home-grown.
I still remember some of the presentations I gave in 2009 and 2010 and 2011, in the wake of the financial crisis, when the scale of the downturn was so severe that almost all the discussion was inevitably about resilience and damage limitation. As we move today from this macro discussion to more micro discussions, I’m reminded that back then, we were talking about the importance when faced with challenging macro circumstances of going back to basics, including cash management—especially if there are concerns about future tightening of credit conditions—and cost management. And of course those fundamentals still hold true now.
But now, since the potential challenges are thankfully nothing like what we faced a decade ago, we can also look at possible opportunities, like taking maximum advantage of digital technologies—for example, to enhance cost reductions or seek new revenue opportunities. I’m sure you’ll be covering both the challenges and the opportunities in the rest of the day’s sessions, but in the meantime, I hope my remarks have been helpful in setting the scene and providing some macro context. In case you have any questions I’ll be here for the rest of the morning so feel free to come and talk to me during the coffee break. And otherwise, I wish you a very successful conference and—slightly early—a prosperous 2020.