Authored by Pingfan Hong, originally posted at Project Syndicate,
The world economy has experienced another year of subdued growth, having failed to meet even the most modest projections for 2013. Most developed economies continued trudging along toward recovery, struggling to identify and implement the right policies. Meanwhile, many emerging economies encountered new internal and external headwinds, impeding their ability to sustain previous years’ economic performance.
Nonetheless, some positive developments in the latter part of the year are expected to gain momentum through the coming year. Indeed, according to the United Nations, the world economy is likely to grow by 3% in 2014 – notably stronger than the 2.1% annual rate estimated for 2013.
Among developed countries, the eurozone has finally extricated itself from a protracted double-dip recession; the pace of growth in the United States has continued to accelerate; and Japan’s expansionary policies seem to be working better than anticipated. For the first time since 2011, all major developed economies are expected to align themselves on the same upward trajectory, possibly triggering a virtuous cycle that lifts the entire global economy.
While the US Federal Reserve is poised to begin tapering its bond-buying program – so-called quantitative easing (QE) – developed-country monetary policy will remain largely accommodative in the next two years, creating a salutary environment for continued strengthening of the financial sector and the real economy. Moreover, European and US fiscal-austerity programs are expected to be scaled back, if not terminated, in the coming year, alleviating the concomitant drag on growth.
In the developing world, large economies like Brazil, China, India, and Russia have managed to halt the slowdown that they have been experiencing in the last two years. In some cases, growth has even begun to quicken, albeit moderately. Meanwhile, African countries’ growth prospects remain relatively robust, buttressed by increasingly effective economic governance and higher infrastructure investment to accommodate rapid urbanization.
But these economies are also facing tough macroeconomic-policy tradeoffs, owing to volatile capital flows, commodity prices, and exchange rates, which are accompanied in some countries by inflationary pressure and widening budget deficits. Fortunately, many developing countries are undertaking critical reforms – covering areas like social security, income distribution, the financial sector, taxation, energy, transportation, education, and health care – which should improve their longer-term potential growth rates.
Another positive development is the $1 trillion trade deal reached, after 12 years of impasse, at the World Trade Organization’s recent ministerial conference in Bali. Although the agreement failed to meet the ambitious goals set out in Doha in 2001, and is not expected to boost world trade in the short run, it has renewed faith in the multilateral trading system – and thus confidence in the global economy’s future.
But the global economy is still subject to significant downside risks. Among the most important stems from the uncertainty associated with the unwinding of QE by major central banks. The Fed’s recent announcement that it would begin to taper QE in January did not generate any financial turbulence, largely because markets had already undergone sizeable adjustments last summer, when the Fed first indicated its plans to move in this direction. But there is no guarantee that the eventual unwinding of QE will go smoothly – especially given that the policy has caused major central banks’ balance sheets to swell in recent years.
A disorderly unwinding of QE could cause long-term interest rates to rise too high too fast, triggering a sell-off in global equity markets, a sharp reversal of capital flows toward developed countries, and a spike in emerging economies’ external-financing risk premiums, as occurred in mid-2013. This could lead to a hard landing for emerging economies with large external deficits and deteriorating budget balances. In fact, falling capital inflows led to sharp currency depreciations in Brazil, India, Indonesia, Turkey, and South Africa earlier this year – and, in some of these countries, depreciation pressures are again intensifying.
China, which is less susceptible to external shocks than its fellow emerging economies, is also experiencing rising risk, stemming from its shadow-banking sector, mounting local-government debt, a growing housing bubble, and widespread overcapacity. The good news is that the Chinese authorities have acknowledged these risks, and seem to be taking steps to minimize them.
Furthermore, while the eurozone has made some progress in the last year, it remains subject to substantial fragilities, with credit conditions extremely inhospitable in some member countries and aggregate demand exceptionally weak. At the same time, unemployment rates have skyrocketed, reaching as high as 27% in Greece and Spain.
For their part, Japan and the US are facing policy-related uncertainties. The effects of the long-awaited “third arrow” of Abenomics – namely, structural reforms aimed at supporting Japan’s long-term growth – are yet to be seen. And, although the US has managed to reach a bipartisan agreement on the budget, political wrangling over the debt ceiling and other fiscal issues may continue to plague policymaking.
In short, while the global economic outlook for 2014 has improved, policymakers worldwide must remain vigilant about downside risks and strengthen international cooperation. Developments in 2013 provide strong incentive for policymakers to do so.