The year ahead: an economic overview

It seems fitting that my first blog post of 2019 should offer an overview of the economic outlook for the new year—particularly given some of the dramatic headlines we’ve seen in this area in recent weeks.

Among the most vivid have been those about the Eurozone. “Italy falls into recession”[1]; “German economy posts weakest growth in five years”[2]; “Eurozone slowdown feeds fears about faltering global growth”[3] – these were just some of the gloomy assessments in the media, on top of European Central Bank president Mario Draghi’s observation that risks for the euro-area economy are now on the downside.

That recent data have been weak is unarguable; what first appeared to be a temporary bout of weakness in the third quarter of last year now looks like something broader and deeper. Still, I think a bit of perspective is in order. Even with downgraded projections for 2019, the eurozone’s growth trajectory is still looking reasonably solid. We should remember that even assuming modest growth of around 1.5% for 2019, average annual growth over the 2014-19 period would be just under 2%, compared with -0.4% post financial crisis and during the sovereign debt crisis (2009-13).

What about closer to home? There is no shortage of dramatic headlines in the UK either, although these are currently about political rather than economic developments. One of the most interesting things about UK economic forecasts at the moment is the remarkable degree of consensus among forecasters, given the huge extent of the political uncertainty. Consensus Economics, which publishes the results of its surveys of numerous financial and economic forecasters, gives a consensus GDP growth forecast for the UK of 1.5% in 2019. (For comparison, The Office for Budget Responsibility’s current forecast is 1.6%, and the OECD’s expectation is 1.4%.) The standard deviation of the 31 different Consensus Economics forecasts is just 0.2 – although their publication notes that the outlook for the UK “does not encapsulate the intensifying levels of uncertainty caused by Brexit”. In other words, forecasters all appear to be using the same (or similar)—fairly benign—assumptions about the Brexit process this year.

The UK situation is a good example—but by no means the only example—of the fact that the main risks to economic expansion in 2019 are political rather than economic. But this poses a couple of distinctive challenges. For one thing, political risk is generally harder to predict and certainly harder to mitigate than classic economic risks like inflationary pressures or over-leveraging. Compounding this is the fact that political uncertainty can imply a range of potential outcomes that is relatively extreme; potential outcomes based on economic uncertainty tend to be more calibrated. Indeed, this can be seen in the forecast probabilities published by Consensus Economics. Their current Consensus Forecasts report notes that the probability of the UK’s GDP growth falling into the central range of 1.2%-1.8% in 2019 is 44% - but the probability of growth below 1.1% is almost as high, at 35%. Indeed, a 15% probability is attached the possibility of growth below 0.4%! In contrast, in countries where the risks are more purely economic, the probability attached to the central scenario is higher (Germany, for example, where the probability assigned to growth of 1.1%-1.6% is 58%.

And what about the rest of the world? In a presentation for the Institute of Directors last week I made the potentially controversial decision to focus on the US and China as I looked to the “global economy” beyond Europe. By way of context, however, I presented this slide:

Slide 4

It serves as a reminder that together, the US, China, Japan and Germany account for fully 50% of the global economy (the US and China alone comprise 40% of world GDP!) When we look at contributions to growth, the picture is even more stark, and the US and China in particular make overwhelming contributions to global economic growth. Here too, alas, the risks are on the downside. Political risk abounds in the US as well as in Europe; in China, meanwhile, economic vulnerabilities like the recent rapid rise in debt raises some questions about the government’s continued ability to manage a controlled economic slowdown. A particular challenge comes from the fact that China’s ongoing effort to transition from an export- and investment-led model of growth to more consumption-led growth is now happening amid more difficult external conditions.

Still, as with the Eurozone, perspective is in order. In the 40 years to 2017 China’s average annual growth rate has been 9.6%. After such an extraordinary run of sustained high rates of economic expansion, it would be unreasonable to expect continued growth rates of 8-10% per year. The Economist recently made a similar point, noting that recent headlines about the supposedly dire prospects for Chinese growth are misleading:

First, the sheer size of its economy means that China’s growth last year generated a record amount of new production. Nominal GDP increased by 8trn yuan ($1.2trn), well above the 5.1trn yuan added in 2007, when it notched up 14.2%, its fastest growth in recent decades. The point is simple: China is now growing from a much larger base. But this was overlooked in the flurry of headlines about its slowdown.[4]

In short, it would be more accurate to say that China won’t provide additional stimulus in 2019, rather than saying, as many have done, that it will act as a drag on global growth.

[1] Sky News, 'Italy falls into recession as quarterly GDP drops', (February 2019), available at: https://news.sky.com/story/italy-falls-into-recession-as-quarterly-gdp-drops-11623135
[2] CNBC, 'German economy posts weakest growth in five years', (February 2019), available at: https://www.cnbc.com/2019/01/15/germany-2018-gdp-data.html
[3] Wall Street Journal, 'Eurozone Slowdown Feeds Fears About Faltering Global Growth', (February 2019), available at: https://www.wsj.com/articles/eurozone-slowdown-feeds-fears-about-faltering-global-growth-11548930934
[4] The Economist, 'Headlines about China’s weak growth are somewhat misleading', (February 2019), available at: https://www.economist.com/finance-and-economics/2019/01/24/headlines-about-chinas-weak-growth-are-somewhat-misleading