Global economy is riding the wave, but risks can cause a wipeout

One year ago, the global economy welcomed a much-needed, broad-based acceleration in growth. The economic cycle picked up pace in the second half of 2017, led by stronger investment and trade growth.

Momentum has carried forward into 2018, but as the latest update to the Brookings-Financial Times TIGER Index reveals, growth is starting to level off and a multitude of risks loom large.

The TIGER (Tracking Indices for the Global Economic Recovery) Index is a set of indexes that aim to take a pulse on the state of the global economy through a set of real economic indicators like: 

• output,
• trade and employment,
• a set of financial indicators like stock market indices and credit and
• a set of confidence indicators for consumers and businesses across the major advanced and emerging market economies of the world.

The data is presented through an interactive data feature at Brookings.

{mosads}While the world economy continues to ride the cycle, heightened trade tensions, geopolitical risks, domestic political fractures and debt-related risks threaten the sustainability of the growth momentum. In other words, there are grounds for optimism on the state of the world economy, matched by pessimism about how durable it is. 

Advanced economies had an especially strong year in 2017, though the pace of growth has moderated slightly this year. The U.S. economy is in good shape, led by good investment growth and a more confident U.S. consumer as wage and inflationary pressures slightly pick up, albeit less than one would expect at this stage of the cycle.

The overall U.S. trade deficit has risen this year despite strong external demand and a weak dollar lifting exports. The eurozone registered its fastest growth in a decade. Both manufacturing and services sectors remain solid in the zone, but have cooled off slightly this year.

Strong net exports gave a good growth contribution to the U.K. economy, which still lags other European countries in terms of growth. The Japanese economy is in the midst of a long expansion and continues to perform well, but domestic demand and wage growth are easing and trade frictions are rising.

Policy environments have remained accommodative or expansionary, but the era of growth fueled by stimulus with no side effects such as high inflation may be no more.

Despite the U.S. economy performing at or above its potential, the injection of significant fiscal stimulus is keeping the Fed on guard to likely lean against potential inflationary pressures from the stimulus.

In the eurozone, the European Central Bank (ECB) is expected to continue buying new bonds in its quantitative easing (QE) program until later this year.

Overall, mounting public debt in advanced economies has reached its highest level as a share of GDP since World War II, presenting its own risk factors, especially with the expectation of policy rate hikes by the Fed, the end of QE by the ECB later this year and possibly tightening by the Bank of Japan. High debt ratios also suggest reduced policy space for responding to shocks. 

Ultimately, deep-rooted reforms to improve productivity remain central to achieving and sustaining high growth. Aging populations make these reforms even more necessary. Estimates from the recent International Monetary Fund’s World Economic Outlook suggest that potential growth rates remain well below pre-crisis averages, held back by aging populations and lackluster productivity. 

Among emerging market economies, solid growth last year has many on track to grow faster in 2018. Stronger global demand from the broad-based and synchronized global upturn has lifted export growth for a broad set of emerging markets.

Emerging Asian economies have also benefited from stronger domestic demand. Rising external debt levels in some emerging market economies, heightened trade tensions and vulnerability to capital flow reversals, especially if the Fed, ECB and Bank of Japan tighten their monetary policy stances this year, are key risks.

India remains the world’s fastest growing major economy and is reasonably well insulated from global shocks, but its domestic financial system remains a weak link. In China, growth remains robust and well-balanced across sectors.

The key challenge for China is the execution of the proposed financial and economic reforms, now led by a team of experienced and reform-minded individuals put in place by President Xi. Brazil and Russia have recovered from their recent recessions but remain vulnerable to risks at home or abroad.

The world economy is benefitting from good growth momentum. The economic cycle will not last forever, and rising vulnerabilities from a multitude of risks threaten to shorten the cycle and derail growth.

Policymakers cannot continue to rely momentum alone. Additional measures are needed and, ultimately, deep-rooted reforms that can underpin sustained growth well into the future. 

Karim Foda is an associate fellow in the Global Economy & Development program at The Brookings Institution.

Note: This piece was based on analysis by Foda and Eswar Prasad, also of The Brookings Institution.