How far has the global economy come in its recovery from the financial crisis? Citi's ten-chart tour highlights that even now, six years after the financial crisis first erupted, the global recovery continues to face some very powerful headwinds. Among the most notable are drag associated with ongoing efforts to consolidate private-sector balance sheets, challenges with managing high levels of public debt and the eventual unwinding of central bank balance sheets, the still-incomplete pattern of adjustment in Europe, and deteriorating demographics across the advanced economies. We see these challenges as being mainly lodged in the advanced economies, where the global financial crisis raged most intensively. But the resulting softness of advanced-economy demand has become an increasing obstacle for growth in the emerging markets. The bottom line is that investors, central planners, and politicians alike are frustrated by the slow pace of global recovery.
Stated bluntly, our ten-chart tour provides substantially more reasons for concern about the global recovery than for comfort.
The recent growth performance of the world economy has been disappointing. Global trade volumes have moved sideways over the past 18 months, and purchasing managers indexes (PMIs) for global manufacturing point to stagnation in the sector. In addition, growth in the advanced economies is well below our estimated stall speed, suggesting vulnerability in the event of renewed shocks. Performance in the emerging market economies is somewhat more encouraging but hardly robust, and these economies face a daunting set of headwinds.
Balance sheet consolidation by households and firms has been a notable drag on growth in the advanced economies in the years since the financial crisis. Accordingly, private non-financial debt ratios have leveled out or declined, which is a promising development, but it is still too early to declare the deleveraging process complete. Indeed, in the aftermath of the bursting of Japan’s asset bubble in the 1990s, it took five years before the massive deleveraging of the country’s corporate sector gained momentum.
In the years following the onset of the crisis, policymakers moved aggressively to support demand through stimulative monetary and fiscal policies. These efforts prevented even more severe outcomes for the global economy, but have left governments with heavy debt burdens and central banks with bulging balance sheets. In the period after World War II, the U.S. achieved a smooth deleveraging of its sizable public debt, but we are skeptical that the forces which produced that outcome will operate in a similar fashion in the years ahead. We fear that high levels of public debt are likely to become the “new normal” for many advanced economies, with heightened vulnerability to shifts in market conditions and borrowing rates.
Lest we seem overcome by anxieties, our survey of the economic horizon also uncovers two notable positive developments.
First, we find indications of meaningful adjustment in external imbalances. For example, China’s ratio of exports to GDP has stepped down, and some of the euro-area peripheral countries are making progress toward improved international competitiveness. In contrast, Germany’s trade surplus is again widening.
Second, we see signs that the U.S. manufacturing sector may be poised for better performance in the years ahead. More generally, we read the recent data in the United States as pointing to a strengthening recovery. The discussion in the previous bullets underscores, however, that this recovery is unlikely to receive much support from the global economy.
Finally, looking well beyond the current recovery, we consider the prospects for growth in the United States, the euro area, and Japan through the next twenty years. Over this horizon, we see these economies as likely to struggle with the challenges of aging populations. But we expect that labor productivity will hold up relatively well. Japan’s experience suggests that an aging population tends to mean a lower quantity of labor input, but the quality of Japanese labor has remained favorable. We also see scope for substitution toward more capital-intensive technologies and industries and for innovations that will allow labor to be used more efficiently.
All told, our global tour highlights that even now, six years after the financial crisis first erupted, the world economy continues to struggle with a range of challenges and imbalances that are restraining recovery. Conceptually, these issues can be grouped into three separate categories:
First, some of the imbalances that triggered the global financial crisis and the subsequent disruptions in Europe still have not been fully worked off. High private-sector debt levels in a number of countries, as well as Germany’s persistent current account surpluses, fall into this category.
Second, other difficulties that policymakers now face are the consequence of necessary efforts to fight the financial crisis. This category includes, most notably, high public debt levels and challenges associated with managing central bank balance sheets.
Third, a number of countries are now facing a new set of structural problems related to population aging and deteriorating demographics. Japan has grappled with these issues for two decades, but other countries are starting to feel such effects as well.
We see these challenges as being lodged primarily in the advanced economies, likely reflecting that this is where the global financial crisis was most intense. But the resulting softness of demand in the advanced economies has, in turn, become an increasing impediment to growth in the emerging markets. Through the years of the financial crisis, many of the emerging market economies shifted the focus of their policies toward domestic demand and away from external demand. However, with business cycles in these economies now reaching maturity, the lack of solid demand from the advanced countries, along with the tepid performance of commodity markets and ongoing signs of softening in China, are increasingly restraining the prospects for the emerging markets.
Chart 2 - Is The global Economy Approaching Stall Speed? Yes
Chart 3 -Balance Sheet Consolidation in the Private Sector has been an important headwind contributing to the soft performance of the advanced economies in recent years.
Chart 5 - Central Banks With Bulging Balance Sheets... but we continue to worry about unintended consequences of these policies.
Chart 6 - Global Imbalances - Current Account Performance: Germany vs. the Peripherals
Since the financial crisis erupted, three major developments have been observed. First, the euro area as a whole has swung into more sizable external surplus. Second, France’s deficit has widened further. At the time of the introduction of the euro, France was a surplus country—and remained so through the middle of the last decade. But in recent years, France has recorded a growing deficit, as its competitiveness has slipped and its unit labor costs have marched steadily upward. We see this as an important cautionary tale for the country’s policymakers. Structural reforms to improve competitiveness seem unavoidable. Third, and equally striking, deficits in the peripheral countries have closed, as these countries have made progress in strengthening their external competitiveness.
Chart 7 - Global Imbalances - Current Account Performance: Germany vs. China
The improved external performance of the peripherals is encouraging. But what about the other side of the coin? Are we seeing meaningful adjustment in Germany? We believe that both of these observations may have worrisome implications for the global economy. For Germany, the country’s continued reliance on external demand is problematic. German policymakers should put efforts to stimulate domestic demand at the top of their policy agendas.
Chart 8 - U.S. Recovery Prospects: Thoughts on Small Firms
Since early 2010, small firm employment has rebounded but has not yet come close to reversing the job losses sustained during the financial crisis. This is an issue that we are watching as a key indicator of the cyclical performance of the U.S. economy. Another concerning development is the steady decline since the early 1980s in the rate at which small businesses are being established.
Chart 9 - U.S. Recovery Prospects: Thoughts on Manufacturing
Labor’s share of value added (i.e., aggregate payments to workers relative to manufacturing value added) has declined from about 65 percent as recently as a decade ago to just a bit above 50 percent at present. Workers in other U.S. industries have not seen a similar decline.
Chart 10 - Projections for Long-term Growth
Our view is economic activity in the decades ahead is likely to be shaped by ongoing challenges posed by aging demographics. Aging can weigh on growth through a number of channels. First, accelerated aging means rising elderly dependency ratios and likely a declining share of workers relative to the overall population. Second, aging also means that the average worker who remains in the labor force is older than was the case a decade or two before, and older workers have typically chosen to work fewer hours than their younger counterparts. Third, meeting the needs of aging populations is already exerting stresses on government budgets and raising concerns about medium-term debt sustainability.
Our ten-chart tour highlights that the global recovery continues to face some very powerful headwinds. Among the most notable are ongoing efforts to consolidate private-sector balance sheets, challenges with managing the eventual unwinding of central bank balance sheets and high levels of public debt, the still-incomplete pattern of adjustment in Europe, and deteriorating demographics in the advanced economies. The genesis of these challenges has varied, with some having plagued the global economy since the financial crisis, others being the unavoidable side-effects of the policies required to fight the financial crisis, and still others coming as largely new developments. Whatever their sources, these impediments to growth have been—and are likely to remain—a significant drag on global activity.