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Wrong on the recession

The clouds darkened last month. Forecasts of the world’s economics prospects became distinctly gloomier.

Naturally there is a range of opinion but the mid-point moved toward the glum end of the scale. The World Bank captured the shifting mood by sub-titling its twice-yearly Global Economic Prospects report ‘Darkening Skies’ while downgrading its growth forecasts. Olof Scholz, the German finance minister, told a German newspaper that “the years of plenty are over” (co-opting the title of a well-known German film to make his point). It also emerged that at its December meeting the European Central Bank considered further downgrading the region’s economic outlook.

There were several reasons why the mood is shifting. First, the US is starting to suffer the impact of quantitative tightening while the fiscal stimulus is losing its impetus. As a result there is widespread talk of the Federal Reserve pausing in its rate hikes or perhaps even cutting rates. 

Second, China has downgraded its GDP forecast to the lowest level since 1990 – and many analysts argue that the official figures understate the scale of the weakening. 

These two factors alone would be enough to spell trouble for the euro-zone. In fact, the slowdown in China might spell more trouble for Europeans than the US one. The euro-zone’s export-oriented economy, particularly that of Germany, is heavily dependent on Chinese demand.

The mainstream forecast is for a slowdown rather than a recession in the near future. But it is widely accepted that adverse political developments could tip the balance further in the wrong direction – Brexit, populism, trade war and the US government shutdown are all seen as culprits.

“The key challenges facing the western economies are structural rather cyclical”

Unfortunately, there is an important element missing from this discussion. The key challenges facing the western economies are structural rather cyclical. For example, labour productivity growth in the euro-zone has fallen back to its long-term parlous state after signs of a possible uptick last year. Remember that economists generally view productivity as the single most important indicator of economic strength.

The consequences of this structural weakness are becoming clearer. Ashoka Mody, a former assistant director of the International Monetary Fund’s European department, has made a plausible case that even Germany is losing its role as an economic dynamo. It is way behind South Korea in terms of innovation, while nearly half of Germany’s population has not seen incomes rise in a generation.

The seriousness of the structural challenges dwarfs the scale of any cyclical downtick. 

Daniel Ben-Ami, Deputy Editor
daniel.ben-ami@ipe.com

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