By Zhang Yuncheng 

The world economy has maintained notable growth on an upward trajectory in 2018, a momentum that has been seen since 2017. Countries have, therefore, growing confidence in their economic growth. At a time when global growth is yet to be established on a solid footing, uncertainties in the world economy, however, have increased as a result of escalating trade disputes between China and the US, the two largest economies, and the quickened pace in interest hikes by the US Federal Reserve. The year 2018 is the 10th year sincethe international financial crisis and the 20th year since the Asian financial crisis. The resilience of world economic recovery is being tested by long-standing problems such as lack of insufficient growth drive and structural problems and new challenges including trade protectionism, unilateralism and financial crisis. 

The World Economy on the Path of Continued, Volatile Growth

In 2018, the world economy maintains the momentum of recovery last year. In the first half of the year, international institutions and investment banks were optimistic about the economy, forecasting this year’s global growth at the same level as in 2017 or slightly higher, which would be the fastest growth since 2011 and the best performance in 10 years. Since June, however, downward risks in the world economy have increased significantly, with mounting concerns about global growth prospects due to escalating trade conflicts and tightening financial conditions worldwide. According to the latest World Economic Outlook released by the International Monetary Fund (IMF), global growth remains robust but may plateau because of multiple uncertainties. The forecast for global growth this year and next year was downgraded by 0.2 percentage points to 3.7%，the same level as last year. 

The cyclical drivers of world economic growth are still there. Many investment banks share the view that the world may be at the starting point of a new round of the Juglar Cycle driven by equipment renewal and capital investment.Since last year, equipment investment has picked up in economies such as the US, Japan and South Korea. After spending a long time repairing resident and enterprise balance sheets, US, Japan and Europe now see their leverage ratios at or even below the historical average. The new round of monetary loosening started simultaneously by central banks and fiscal loosening pursued by countries around the world over the last few years has provided an easy credit environment and expanding aggregate demand for the global economy and increasingly effective support for growth. Governor of the European Central Bank Mario Draghi said ECB’s monetary policy has played a key role in supporting private consumption and investment demand. Thanks to the pro-cyclical policy of tax cuts and fiscal expansion, the US economy is at its best in more than 10 years, characterized by dropping unemployment, a moderate rise in inflation and fast economic growth. 

Countries are pursuing economic reforms and stepping up structural adjustment to reshape their comparative advantages. The US passed at the end of last year the energy policy reform, financial deregulation as well as the tax reform legislation, whichhas an impact on both the American and world economy. France started its five-year large-scale investment plan to boost the labor market. India set out to reform its tax on goods and services and restructure bank assets. Private consumption and investment are growing strong in Latin America, where major countries are making medium and long-term economic development plans to increase infrastructure investment and improve the accessibility of higher education, so as to build a talent pool for economic restructuring and transition. After being re-elected as president, Putin started a new economic reform plan to revive Russia’s still fragile economy and give priority to people’s livelihood at home. His reform includes optimizing the industrial structure to raise manufacturing competitiveness and improving the investment environment to liberalize the economy. Other countries like Saudi Arabia, Thailand, Indonesia, Mongolia and Uzbekistan have also pursued economic and fiscal reforms. 

Despite the growth momentum, risks of instability and uncertainties in the world economy are building up. Region and country-wise, some Japanese media described early this year’s risks in the world economy as “ABC”.A refers to the “America First” doctrine. Trade disputes are unfolding in 2018, with the US on one side, and China, Europe and Japan on the other. These disputes, which have been unseen since the beginning of the new century, are unlikely to be resolved in the short run. And their negative impact on the world economy is playing out.B alludes to Brexit talks. In 2018, Brexit negotiations have entered into unchartered waters, with setbacks throughout the process. Both the UK and the EU take a tough stance. There is a growing possibility that a “no-deal” hard Brexit will happen in March next year, portending a new round of financial shocks worldwide. C stands for China’s economic slowdown. In the face of increasingly complex economic and political environment at home and abroad, especially the escalating trade frictions with the US, China is under mounting pressure to stabilize and reform its economy. 

Sectorally speaking, the “grey rhino” of the financial crisis may come any time soon. As global capital markets have been in a boom for eight consecutive years, there have been emerged concerns about a massive correction in the stock markets. This year, major US stock indexes, including Dow Jones, S&P 500 and NASDAQ, have hit new highs, and the IMF Global House Price Index has also come close to its pre-crisis height. A booming market inevitably falls. Bubbles on the markets are more inflated than in 2008. The question is when they will burst and what the fallout will be. As the US Federal Reserve moves faster to hike interest rates, the 10-year US Treasury Bond, which is known to be risk free, is seeing its yield jumping, exerting considerable pressure on asset prices. As a result, Dow Jones, S&P 500 and NASDAQ tumbled in one week between 4 and 11 October by 1755, 197 and 696 points respectively. Market corrections have set in amid early signs of the market turning bearish. What happened on the US market sent shockwaves across global markets too. The rising debt levels may, in time, become a timing bomb that triggers systemic risks.In 2009, American economists Carmen Reinhart and Kenneth Rogoff co-authored This Time is Different: Eight Centuries of Financial Folly, in which they made quantitative and empirical analyses of past global financial crises based on massive data of 66 countries and regions (whose actual output accounted for 90% of the global GDP) in 800 years. They concluded that crises of different types share one common feature: excessive indebtedness. Currently, the share of global debt in GDP is far higher than the pre-crisis level. According to the IMF, the non-financial sector of G20 countries owed a total debt of US$135 trillion in 2016, far higher than the US$80 trillion in 2007. In the post-crisis years, developed countries have maintained generally stable debt ratios. However, corporate debts have started to exert pressure on the market. The emerging markets have seen burgeoning debts. As the central banks of major countries move faster to lift interest rates, low-income emerging marketswith high percentages of external debts will bear the brunt of rising interest rates and currency depreciation. A case in point is the currency crisis that has gripped Argentina and Turkey in 2018. 

As global trade conflicts intensify, the recovery momentum may be curbed. A salient feature of this round of recovery is the rebound in global trade and manufacturing. The Trump administration is bent on “America First” and identifies the “five pillars” of its trade policy, namely supporting national security, strengthening the American economy, reaching better trade deals, enforcing domestic trade laws, and reforming the multilateral trade system. Brexit is happening at a time when major European countries are experiencing political, economic and social imbalances. Protectionism, populism and separatism, which started to surge two years ago,have not yet come to an end. Moreover, developing countries are advancing competitive reforms and stepping up market and resources protection. According to the Global Risk Report released early this year by the World Economic Forum, mercantilism and protectionism that has emerged in many countries will trigger more widespread global risks. As things stand now, risks of trade conflicts are playing out. The latest World Trade Outlook Indicator published by the WTO indicates a continued slowdown in global trade growth in the third quarter this year. The IMF thinks that previous forecasts for global growth have been over-optimistic given the persisting disturbances in global trade policy. If a full-blown trade war between China and the US breaks out, the Chinese and American GDP growth will be clipped by 0.9 and 1.6 percentage points respectively in 2019. The world economic growth in 2020 will drop by 0.8 percentage points and the long-term growth will fall by 0.4 percentage points. 

Risks resulting from interconnected political, security and social factors have always been a real challenge for global growth and are testing the resilience of the on-going world economic recovery. Oxfam International, a non-governmental development and assistance organization, holds the view that inequality is worsening as the wealth in the hands of the top 1% of the global population is more than the total held by the rest. The year 2018 is a year of elections in the emerging economies. Latin America has its most intensive political agenda in 10 years, which includes general elections in Costa Rica, Cuba, Paraguay, Columbia, Mexico and Brazil. Plagued by old and new conflicts, the Middle East and North Africa is at its most violent and chaotic moment in history, facing multiple and more severe challenges including economic reform, post-war reconstruction and geo-conflicts. Moreover, there has been frequent extreme weather. The unusually high temperature and heat waves in many parts of the world have taken a toll on food production. 

Negative Spillovers of the Developed Countries’ Policies

In recent years, developed countries have shifted from quantitative easing to tightening monetary policies, intensified trade and investment protection, and are about to make major policy adjustment. Given the increasing difficulty in global economic policy coordination, the two sides of the Atlantic have become a major source of instability for the world economy. 

The Trump administration is pursuing both trade unilateralism and investment protectionism. By threatening to close the American market, it intervenes in the division of labor that has existed in the global economy for many years. The so-called “America First” undermines the foundation of collective growth and casts a shadow on the world economy.Since 2017, the Trump administration has exited TPP, the Paris Agreement and UNESCO, reduced funding support to the World Bank and other multilateral economic institutions, threatened not to follow the rulings of the WTO dispute settlement mechanism, and sought to strike “fair” deals through bilateral negotiations. Joseph Stiglitz, a Nobel Economic laureate, bluntly criticized Trump for sabotaging the hard-won global economic governance structure and turning the United States into a “rogue” state. 

Negative spillovers are coming out of developed countries’ monetary policy adjustment. “Black swans” in the American and European financial policies should be closely watched and guarded against. Limited monetary policy space is not enough to tackle the next crisis. In previous crises, the US Federal Reserve cut the benchmark interest rate by 5.5 percentage points. Currently, the market expects the interest rate to be ultimately maintained at around 3%. In the event of a new crisis, even the Fed cuts the interest rate to zero, it will still be short by 2.5 percentage points. The central banks of Europe, UK and Japan are keeping their interest rates at even lower levels. At the same time, developed countries have taken synchronized moves to tighten monetary policies, adding to the uncertainties on the international capital markets. The US exited quantitative easing at the end of 2014 and started to lift the interest rate in December 2015. There have been seven interest hikes so far. In October 2017, the Fed started to shrink its balance sheet. In view of the economic acceleration in the euro zone, the European Central Bank is winding down its 2.5 trillion euro bond purchase, which has been reduced to 15 billion euros per month and will stop at the end of December. As developed countries converge on monetary policies, which are diverging from those of the developing countries, global liquidity is tightening fast, putting upward pressure on interest rates. The 1994 Mexican currency crisis and the 1997 Asian financial crisis were, to some extent, attributable to the interest rate increases in America, Europe and other developed countries. At the moment, the risks in developing countries, caused by currency depreciation, capital outflows and increasing financial volatility must not be overlooked. In mid-2018, currencies tumbled in emerging markets, such as Argentina, Brazil, Venezuela, Turkey, Russia, Indonesia, Iran, Sudan and Nigeria, showing that local financial volatility has taken place and that emerging markets may be once again hit by crises. IMF warns that capital outflows from emerging markets may push the global economy into recession.

Trade and investment protectionism is surging in developed countries. Everyone’s nerves are on edge as the China-US trade dispute defies a solution that works for both sides in the near term. The trade tensions are the result of structural issues between the two countries that have built up over the past years, or rather, the “dualistic economic problems” in the US, and the outbreak of US grievances toward China. The current China-US trade frictions are different from the past. On the surface, it is an issue caused by China’s trade surplus with the US, which is traced to structural differences between the two economies. Fundamentally, it boils down to the competition between the American model of free economy and the Chinese system of socialist market economy. The US is keen to get at the negotiation table what it loses in trade. With the shifting balance of power between the two countries in economic terms, China-US trade frictions will be here to stay for many years to come and become increasingly serious. 

Why do anti-globalization backlashes, trade protectionism and populism all happen in developed countries? This is an issue that merits close attention. Since the turn of the century, America’s innovative economic sector and traditional manufacturing sector have taken divergent paths, bringing about structural economic and social problems. In contrast with the world-leading innovative economic sector, the traditional American economic sector, comprised of traditional manufacturing and low-end services, is less competitive and fails to provide quality jobs. According to the US Bureau of Labor Statistics, 4.8 million manufacturing jobs were lost between 2000 and September 2017, a drop of nearly 30%. In such a “dualistic economy”, the surplus labor released from traditional economic sectors could not be absorbed by the innovative economic sectors. Before leaving office, President Obama describedthis as a kind of “economic disjoint”. In fact, the election of Trump and the subsequent policy changes are the political reflection of the American “dualistic economy”. Likewise, the ongoing trade tensions and disputes between China and the US are the results of America’s “dualistic economy” and the outbreak of its grievances toward China.

China in the Face of Daunting Economic and Financial Challenges

This year, the Chinese economy is operating stably and making fast transition. The World Bank believes that macro-prudential monetary policy, tightened financial regulation, economic restructuring and continued deleveraging will lead to a slight moderation in China’s economic growth. Morgan Stanley describes the Chinese economy at a stage of “slower growth of higher quality”. The IMF forecasts a 6.6% growth of the Chinese economy this year and says that some of its sectors are in a technologically leading position. 

In 2018, China is confronted with daunting economic challenges. Prominent risks still weigh on its efforts to pursue stable growth. Domestically, the economic transition, which is already in unchartered waters, is beset by homegrown risks, such as falling housing prices, constrained local public finances, shortage of social security funds, difficult corporate deleveraging and restructuring, and growth derailed by the hasty tightening of monetary policy. Externally, risks that pose a direct threat to China remain prominent. Developed countries are resorting to more restrictive and aggressive trade policies. China and the US are locked in escalating trade disputes. At the same time, China is grappling with financial dangers. This year has witnessed an increasing number of internal and external financial risks for China. As China makes real efforts at financial opening-up and internationalization, it will surely be subject to the impact from outside its borders. To maintain financial security, China is faced with new challenges like never before. The financial sector is yet to support the real economy with higher quality and efficiency. As risks abound, China’s financial system won’t sustain itself without addressing the structural issues therein. According to the IMF special financial report on China, China’s financial assets have increased from 263% as its share in GDP in 2011 to 467% in 2016. Among them, assets held by banks account for 310% of GDP, ranking No.1 in the world. This highlights the imperative to maintain financial stability. In terms of imported risks, China won’t stay unaffected by new financial risks that threaten to undermine the financial stability of all countries. These risks may be caused by uncertainties in the world economic growth, the tighter-than-expected global liquidity, the beggar-thy-neighbor economic and financial policies pursued by developed countries, rising international energy and commodities prices, geopolitical tensions, intensifying competition between major powers, as well as economic and financial sanctions.

During China’s 40 years of reform and opening-up, the world has undergone major changes on the economic landscape. There have been both great opportunities and challenges. China has been integrated into the world and taken a lead on some issues. Over the past 10 years, the world has weathered the 2008 international financial crisis, the 2010-2012 European sovereign debt crisis, and the tumbling international commodity prices between 2014 and 2016, and also witnessed the Chinese economy deeply integrated into the world economy. At the moment, the unclear world economic outlook is in itself a complicated challenge. As an old Chinese saying goes, “Those who can identify and seize challenges are wise, and those who have the courage to break ground will win.” “Minsky Moment” is an important concept in economic and financial research. It refers to a scenario where after an extended period of stable growth that leads to increased debts and rising leverage levels and encourages investors to take on greater risks, the economy may collapse at a tipping point in the balance of payments. In this vain, when will the “Minsky Moment” in the world economy occur and in what way? Likewise, in the discussions about the Thucydides’ trap and the middle-income trap, a far more daunting challenge is to know exactly when such moments will come. 

At the 19th National Congress of the Communist Party of China on October 18-24, 2017, the Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era was established as a guideline for China. And the Xi Jinping Thought on Socialist Economy with Chinese Characteristics for a New Era was unveiled at the CPC Central Economic Work Conference (CEWC) on December 18-20. Under the strong leadership of the CPC Central Committee with Xi Jinping as the core, China, united in one purpose, has the ability to overcome all challenges to maintain sustained, stable economic development and transform the economy from quantity to quality. The CEWC set financial risk prevention and control as a priority for preventing and defusing major risks in the coming 3 years. This is a move of practical significance under changing circumstances. At the past CEWCs and when speaking on the world economy in the past five years, President Xi has stressed the importance of seeing the world’s changes from the perspective of international financial crisis. This requires us to have a full and accurate understanding of the new dynamics and features of the world economy, adapt to the new changes, and find the right position to serve opening-up efforts in the new era. Only in this way can China sustain its economic development and establish a modern economic system. 




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Zhang Yuncheng is Director of Institute of World Economy, China Institutes of Contemporary International Relations.