Changes in the Economic Ecology of the World

By Zhang Yuncheng

Just as 2018 was a year of downturn for China-US economic relations, 2019 was a watershed in the world economy. In the year past, the global macro-economic environment experienced unprecedented challenges, as evidenced by the protectionist and unilateral measures taken by advanced economies and the failures in the international economic governance mechanisms. At the start of 2020, the outbreak of COVID-19 hit the Chinese economy, exerting mounting pressure on global growth and bringing considerable uncertainties.

Following the 3.8% growth in 2018, the fastest in the past 10 years, the world economy slowed down sharply in 2019 to its lowest level since 2000. In October 2019, the International Monetary Fund (IMF) revised down by a big margin its forecast for the global growth of 2019 to 3%, calling it a steep fall after the synchronized rebound across the world since 2017, a level that was not far from a global recession (2.5% is defined by the IMF as the threshold of recession). IMF Managing Director Kristalina Georgieva warned of a synchronized slowdown in 90% of the world and a decline to the lowest level since the dawn of this century.

Advanced economies experienced a notable slowdown. The moderation in the euro zone exceeded expectation. As early as in February 2019, the European Central Bank (ECB) projected a significant slowdown across the euro zone because of “the perfect storm” that had gathered due to weak global trade and chaotic Brexit. As forecast by the ECB, the real GDP growth in the euro zone in 2019 and 2020 was 1.1% and 1.2% respectively, a drop of 0.6 and 0.5 percentage point compared with the projection in December 2018 and both far below the 1.8% of 2018. The IMF put the blame on weak exports in the euro zone since 2018. Across the euro zone, the Italian economy came to a standstill in 2019; Germany grappled with a technical recession, with an expected growth of only 0.5%; the French was in a comparatively better shape, expecting a growth of 1.2%. Japan downgraded its growth forecast, the first time in three years. The OECD projected Japan’s growth to be 0.8% and 0.7% in 2019 and 2020 respectively, lower than the 1.1% registered in 2018.

As the world’s largest economy, the US was the bright spot among advanced economies in recent years. However, the uncertainties and risks are growing. According to the statistics published by the US Department of Commerce, the real annualized GDP growth of the four quarters of 2019 was 3.1%, 2%, 2.1% and 2.1% respectively, putting the whole year’s growth at 2.3%, while the Federal Reserve projected a growth of 2.2%, all significantly lower than the 2.9% of 2018 and far below the 3% target set by the Trump administration. 

On February 20, 2020, the White House published a 435-page presidential annual economic report, lavishing praises on the Trump administration and boasting of unexpected growth, robust labor market, rising wages, and record-low unemployment. However, the COVID-19 epidemic started to spread rapidly across Europe at the end of February and the beginning of March. Italy rushed to lock down the country, while the American financial market was seized by panic. In mid-to-late March, with soaring numbers of confirmed cases, the US became a new epicenter of the global pandemic after Europe. The impact of the epidemic on the American economy quickly spread from the financial market to the real economy.

The US stock market turned from bull to bear. At the end of 2019, the Dow Jones Industrial Average reached a new all-time high of 28,600 points, up 22.3% for the whole year, the best annual performance since 2017. The S&P 500 Index rose 29.2%  to a record of nearly US$6 trillion gains in market value, making 2019 a “landmark year” above 3,200 points. At the end of the year, the technology-heavy Nasdaq index broke through 9,000 points for the first time, rising 35.2% for the whole year, the best annual performance in six years. Over the past ten years, the S&P 500 Index has risen 189.72%, the Dow Jones Industrial Average 173.67% and Nasdaq 295.42%. However, the spread of COVID-19 in Europe and the US has precipitated the Wall Street into a “bear market” at the fastest speed in history. Beginning in late February, the three major US stock indexes began a nosedive. The Dow Jones Industrial Average surged to nearly 30,000 points on February 12 and then fell more than 20% in less than 25 days, faster than the 1929 Wall Street stock crash. It further slipped to around 22,000 points at the end of March, losing 27%. From March 9 to 18, the US stock market triggered the circuit breaker mechanism four times (only five times since 1987). The market panic index soared, the US debt interest rate plummeted, liquidity drained, and market confidence was dented.

Growth momentum has weakened. First of all, the manufacturing sector is in a slump. According to the data released by the US Department of Commerce on October 29, the added value of the manufacturing sector accounted for 11% of American GDP in the second quarter, falling to a 72-year low. As of November 2019, the manufacturing PMI had been below the boom line of 50 for four consecutive months, signaling the contraction in America’s manufacturing sector. Over the past three years, the Trump administration has called for revitalizing manufacturing, but its share in the US economy has been on a continuous decline. The ongoing spread of the epidemic and the disruption to the supply chains have taken a heavy toll on American manufacturing, especially automobile, machinery and precision instrument sectors. Ford, General Motors, Fiat Chrysler and Honda have all shut down their American factories. Boeing is on the verge of bankruptcy, with production stagnating and stock price plummeting. Second, the service sector, which accounts for 70% of the US economy, has been hit hard. In February, the PMI for the service sector was only 49.4, the first contraction since 2016. Tourism, movies, aviation, transportation and other sectors bear the brunt. Third, the bursting of the US stock market bubbles has strengthened the negative “wealth effect” and hit consumption and investment. On March 24, the US Department of Commerce announced that orders for core capital goods fell 0.8% in February, double the market expectation, indicating that corporate investment shrank further. In March, the University of Michigan Consumer Confidence Index dropped to 89.1 from 101 in February, the lowest since October 2016 and the largest monthly decline since October 2008. US consumer spending is expected to moderate in the first quarter and to contract even more sharply in the second quarter. In addition, the slumping global demand under the impact of the epidemic, the obstructed international flow of people and goods, and the rising dollar index have all suppressed the global demand for US goods. The US Economic Consultancy Bureau predicted that US exports would shrink by 3% in the first quarter of 2020 and face a gloomy prospect in the second and third quarters.

Unemployment soared. In the week from March 15 to 21, the number of Americans applying for unemployment benefits for the first time shot up to 3.28 million, almost five times the record (695,000) set in October 1982. The Bank of America estimated that at least 3.5 million people will lose their jobs in the second quarter, averaging more than 1 million a month, far exceeding the 750,000 a month in 2008. The St. Louis Federal Reserve predicted that the unemployment rate in the US might reach 30% in the second quarter, while Goldman Sachs forecasted 9% for the whole year.

The US has limited policy space for “counter-cyclical regulation”. The American economy grew by nearly 3% in 2018. The Federal Reserve raised interest rates four times, gradually raising the target range of the federal funds rate to 2.25% to 2.5%. In 2019, the Federal Reserve made a complete reversal, making three consecutive interest rate cuts, bringing it back to 1.5% to 1.75%. Since the beginning of March 2020, in response to the financial market panic caused by the epidemic, the Federal Reserve has taken forceful measures, cutting the federal fund interest rate, bank reserve ratio and overnight repurchase rate to around zero. While purchasing municipal bonds in large quantities, it announced plans to buy unlimited government bonds and mortgages. At present, the Federal Reserve has purchased and held almost all kinds of assets except corporate bonds, stocks and exchange-traded funds (ETFs). On March 25, the total assets of the Federal Reserve expanded to an unprecedented US$5.3 trillion. American think tanks pointed out that fiscal policy may be more effective than monetary policy in dealing with this shock. However, the American government does not have much space for fiscal policy. At the end of March 2020, the US Congress passed a US$2.2 trillion economic stimulus package, which may further increase the financial and debt burdens on the government. In 2019, the US federal government’s fiscal deficit ratio reached 4.7% of GDP, close to the level during the 1990-1991 recession. The Moody’s estimated that the US budget gap will reach US$2.1 trillion in 2020 and US$1.8 trillion in 2021, surpassing the record of US$1.5 trillion in 2009. At present, US federal debts total US$23.08 trillion, accounting for 112% of GDP, seriously restricting the government’s ability to launch expansionary fiscal policies such as infrastructure construction and secondary tax reform.

In addition, there are a series of structural problems plaguing the US economy.America’s population growth hit a century-low. The data released by the US Census Bureau on December 30, 2019 showed that as a result of the falling birth rate, the increasing number of deaths, and the slowdown of international immigration, the US population increase hit a record low in a century. According to the Census Bureau, the American population grew by nearly 0.5%, or 1.5 million, from 2018 to 2019, standing at 328 million. As reported by the Associated Press, the natural increase of the American population (births minus deaths) was less than 1 million for the first time in a few decades because of the aging of the baby boomers, the oldest of whom turned 70 years old in the past few years. Such a trend will only continue, making it hard to sustain economic growth and undermining the potential for growth. 

The wealth gap is widening in the US, with the rich getting richer while the poor becoming poorer. The United States is the only developed country where millions of people are in hunger. Statistics from the US Census Bureau in 2018 show that 39.7 million people are still poor in the country, at least 500,000 people are homeless every night, and 65 million people give up treatment because of high medical expenses. Among western countries, the US has the widest wealth gap, which has worsened in recent years. The richest 10% of American households hold nearly 75% of the total household net assets in the country. From 1989 to 2018, the bottom 50% households saw almost zero growth in their wealth.The economic growth in the US in the past decade, especially the “extreme prosperity” of the capital market, has not benefited the majority of the people. More than 85% of the richest 10% of Americans own stocks, but most Americans feel that their wages and the value of their homes don’t keep up with the investment of the rich.

America’s unilateral trade policies have made a deeper dent on its own businesses, which have lost confidence in America’s economic prospects. The Business Roundtable, which comprises CEOs of large US corporations, recently reported a seven-consecutive-quarter decline in the economic outlook indicator, a measure of corporate executives’ confidence. 68% of the respondents indicated that they wouldn’t increase capital investment, while 60% had no plan for enlarging recruitment in the coming half a year.

It is expected that this round of economic growth cycle in the United States will come to an abrupt end soon, due to the combined effects of the COVID-19 pandemic as well as periodic and structural factors. This round of economic expansion began in June 2009 and has lasted 127 months, the longest cycle of expansion in US history, exceeding  the 120-month period in the 1990s. However, the growth is mainly driven by ultra-loose monetary policy. The shadow of “high debt”, “high bubbles” and “low growth” has persisted. As such, the average real growth is only 1.6%, the lowest in the 12 growth cycles after World War II. In fact, since the second quarter of 2019, the American economy has slowed down, with the sometimes inverted yield curves of long-term and short-term treasury bonds, which portends recession. Affected by the epidemic, the US economy will stagnate in the first quarter and may fall sharply in the second and third quarters. The Bank of America, Goldman Sachs, Morgan Stanley and St. Louis Federal Reserve respectively forecast that the US economy will shrink by 12%, 24%, 30% and 50% in the second quarter, far worse than during the 2008 financial crisis. For the whole year of 2020, the US economy is likely to slide into negative growth, depending on how the US will contain the epidemic and how the world will collaborate. It is widely expected in the market that the epidemic in the US will be brought under control in the third quarter, and the suppressed consumption and investment demand will bounce back. Based on this, the S&P, Bank of America, Fitch, and Goldman Sachs respectively forecast that the US economy will grow by -0.5%, -0.8%, -1% and -3.8% for the whole year.

Major emerging economies have witnessed a synchronized slowdown. As a result of falling investment, slumping consumption and weak job growth, India finds itself in the most protracted recession since the republic was founded, with a growth of merely 5.4% in the first half of 2019. In the second quarter, the economy decelerated to 5%, the fifth consecutive quarter of slowdown and a six-year low. On October 4, the central bank of India downgraded its growth forecast from 6.9% to 6.1%. On October 10, the credit rating agency Moody’s revised its prediction for India’s growth from 6.2% to 5.8%. Moreover, the IMF predicted 0.4% and 1.1% for Mexico and Russia’s growth in 2019 respectively, 0.5 and 0.1 percentage point lower than in 2018. South Africa’s growth was 0.7%, the same as last year. Brazil did slightly better, picking up pace from 0.8% to 0.9%.

On the whole, five prominent changes have taken place in the world economic ecology.

The world economic growth is entering a period of deceleration. Constrained by a number of factors, including population aging, education inequity, growing inequality, anti-globalization sentiments, energy and the environment problems, as well as high debt levels, global productivity has come down substantially and stayed in the negative territory for the past few years. The world economy is transitioning from “making the pie bigger” to “dividing it fairly”. New areas and drivers of growth have yet to take hold. In October 2019, the World Trade Organization (WTO) downgraded this year’s trade growth forecast by a great margin, from 2.6% to 1.2%, the slowest since 2009. As predicted by the OECD, the real growth of the world economy in the coming five years will fall below 3% for the first time in nearly 20 years. According to the World Bank, the potential growth of the world economy in the next 10 years will be lower than that of the past 30 years. The world economy is getting onto the track of low growth, low interest rate, low inflation and high debt levels. 

The US and the Western world are putting up an economic Berlin Wall. Unilateralism is gaining momentum. In recent years, the disadvantaged groups in the US and Europe are growing in size. Social divisions are deepening, populism is spreading, and tolerance towards the outside world is diminishing, as evidenced by high barriers and tough conditions that have been set for international economic exchanges. Through additional tariffs, tighter foreign investment screening, technology blockades, and financial sanctions, these countries squeeze the living space for others’ and their own businesses. Trade policies are getting tough. The US is where this round of trade war began. America’s trade protectionism and unilateralism is so strong with such profound spillovers that the global economic order will evolve at a faster pace. Foreign investment review is tightening. The surge of outbound investment from emerging economies has been met with exclusionary polices adopted by the US and Europe, such as tighter foreign investment review regimes, broadening scope of “national security”, and explicit bans on foreign investment in areas that fall outside the sensitive category of infrastructure. The US went further to update its export control list to prohibit foreign businesses from specific government-subsidized programs.

America’s unilateralism, decoupling and threatening other countries to take its side are in essence “erecting walls”. So is Brexit, which was a “black swan” in the beginning but has grown into a “gray rhino” after a protraction of three years. It is premature to say the uncertainties associated with Brexit are over. With or without a deal, the day when Brexit is completed is the day when high walls are erected.

Emerging economies are diverging in a way that is unseen in many years. Growth potential is being curtailed. Emerging economies are mostly export oriented, depending much on external demand. As the international atmosphere sours for economic cooperation, emerging economies bear the brunt. In the face of an America that works to keep China down, some of them are forced to take sides, compounding their confusion about the development path to choose. Growths are divergent. In October 2019, the IMF predicted that the Mexican, Russian, Brazilian and South African economies would picked up pace slightly from the low patch of 0.4% to 1.1%. Emerging economies in Asia, including Vietnam and the Philippines, will continue to benefit from the supply chain restructuring and expect a growth of 6.5% and 6.2% respectively in 2020. The economic prospects of Venezuela, Argentina and other Latin American countries allow no optimism. In January, India’s growth in 2019-2020 may be downgraded substantially to below 6%. Competition among emerging economies is on the rise. In the broader context of global slowdown and falling market demand, the climate for cooperation among emerging economies is worsening. Concerned about the competition from China, India turned away from the RCEP. Brazil gave up the WTO developing country status that entitles it to special and differentiated treatment, a move that will hamper the coordinated efforts of BRICS to promote WTO reform.

There has been an unprecedented influx of liquidity on the capital market. Since 2019, over 30 countries and regions, including the US and the EU, have started to cut interest rates. Major countries are so addicted to loose monetary policies. In the face of an increasingly unfamiliar environment at home and abroad, they resort to unconventional measures, such as quantitative easing, negative interest rates, perpetual bonds, and commission fee abolition. As a result, the global financial market is distorted, assets are rapidly inflated due to negative interest rates, capital is not channeled to the real economy, and  investors are seeking new speculative opportunities. Global debts are therefore scaling up, with growing risks of asset price crash. According to the US statistical standards, the supply of broad money exceeded US$15.3 trillion, twice the size in 2008 when the financial crisis hit. According to the IMF, the number of low-income countries that are grappling with high debt risks or facing imminent debt risks grew from 13 in 2013 to 32 in 2019.

The shifting global economic governance mechanisms and policies are unlikely to provide buffers and safeguards for world economic growth. The US-led liberal international order is falling apart, while a new balanced and reasonable international order is yet to take shape. In international affairs, the previously predominant economic logic is giving way to ideological, political, and security considerations, undermining the rationale for international economic cooperation.

President Trump has severely disrupted the normal operation of several multilateral institutions by withdrawing US membership, delaying appointments, and blocking budget. At the end of 2019, the WTO appellant body came to a standstill and may become dysfunctional in 2020 due to insufficient funding. Between mid October 2018 and mid May 2019, WTO members introduced 38 trade-restricting measures, involving US$339.5 billion in trade. According to the Global Trade Alert, the first 10 months of 2019 witnessed the biggest decline in trade and investment facilitation measures in seven years. At the same time, the G20, which was at the core of post-crisis international economic governance, has seen its role diminished. With its capacity in macro-economic coordination limited, the international financial reform spearheaded by the G20 has come to a standstill. Currency competition is intensifying and unilateral acts of financial bullying are frequent.

In an international economic environment of complexities and uncertainties, China should seek to reshape international rules and respond to America’s unilateralism and protectionism through international cooperation. Bilaterally, China signed the phase one trade deal with the US on January 13, 2020, which is beneficial to the two economies and the stability of the world economy. China should also actively strengthen its relations with the EU, consolidating shared interests on climate change and WTO reform, steadily advancing negotiations on China-EU Investment Agreement, and addressing EU’s concerns about China’s industrial subsidies, market access and technology transfer. At the regional level, China should unite with ASEAN to conclude the RCEP as early as possible and push for substantial progress on China-Japan-ROK FTA talks. At the multilateral level, to tackle the impasse of the WTO appellant body, China should initiate discussions on a temporary mechanism with influential members such as the EU, Japan, Canada, India and Brazil, and explore the possibility of an alternative that excludes the US. China should promote international cooperation against tax evasion and on rules of digital tax. At the same time, China should be firmly opposed to the discriminatory trade agenda pushed by the US and the West. It should also seek the recognition by more countries of its market economy status in response to the “poison bill” introduced by the US against so-called non-market economies. 

The unexpected COVID-19 outbreak has increased the downward risks for the Chinese economy. The survival of small and medium-sized enterprises is at peril, making employment a challenging issue. On February 20, the IMF Managing Director made the prediction that the Chinese economy, affected by the epidemic, would show a V shape, falling abruptly before making a swift rebound after the virus is contained. Another scenario should not be ruled out, i.e. the economy would be in a U shape if the impact lasted longer. According to officials of the US Treasury Department, China’s growth under the impact of the epidemic would fall in the first quarter and then make a strong rebound. If the situation worsens, the impact would be more profound. And the impact depends on how the epidemic is contained. International organizations like the IMF and the World Bank agree that the fundamentals of the Chinese economy remain unchanged in the long run and that the government has sufficient policy space to respond.

That said, we should never lower the guard. If the spread of COVID-19 is not contained promptly, it will add to the uncertainties in the already fragile recovery of the world economy. Before the epidemic,the IMF has predicted that global growth will accelerate from 2.9% in 2019 to 3.3% in 2020 and 3.4% in 2021.The epidemic has already increased volatility on the global market and caused disruptions to industrial and supply chains. The IMF Managing Director has been conservative in her recent statements, saying that it is too early to make accurate predictions of global growth when the epidemic is still rampant. On February 19, the IMF warned that the COVID-19 epidemic may undercut the extremely fragile recovery of the world economy that had been expected in 2020. Analysts also issued alerts that the epidemic may have an impact on the economy no smaller than the 2008 international financial crisis did. Many in the industry still believed that as central banks around the world embarked on quantitative easing at the start of 2019, the China-US trade war has a lesser impact, and China is working to mitigate the risks to the world economy through its control efforts, emerging market may become engines of growth and stabilize the global economy.

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