Thanks to my colleague Claire Jones for keeping Free Lunch running while I was away, with her thought-provoking pieces on how much we should really fear for the banks and on how the EU risks losing its leadership on the transition to a zero-carbon economy.Being away means I also missed the IMF and World Bank spring meetings, so I can’t report first-hand on the current sentiment among the global policymaking elite. (Consult my colleagues Gillian Tett and Chris Giles for that.) But as longtime Free Lunch readers know, I find it useful to survey the analytical arguments that international institutions focus their flagship reports on, as these often lay out the intellectual premises for both international and domestic policy debate. So here are the main points that struck me while browsing this month’s crop of publications.First, where is the world economy headed? The overall forecasts are not great but no more gloomy than earlier (though as Chris Giles has explained, we should take these forecasts with a big bucket of salt). But take a closer look at the “tail risks” in the IMF’s analysis, the really bad outcomes the fund’s economists think are possible even if not the most likely. The World Economic Outlook puts a one-in-seven chance of a “severe downside scenario” involving a credit crunch that would lead to global growth of no more than 1 per cent per year. That is one big negative risk for the global economy! And it gets worse. From the fund’s Global Financial Stability Report we learn the following: “Our growth-at-risk metric, a measure of risks to global economic growth from financial instability, indicates about a 1-in-20 chance that world output could contract by 1.3 percent over the next year. There’s an equal probability that gross domestic product could shrink by 2.8 percent in a severe tightening of financial conditions in which corporate and sovereign spreads widen, stock prices fall, and currencies weaken in most emerging economies.”A few weeks before the meetings, the World Bank warned that the global economy’s sustainable growth rate was set to fall to only 2.2 per cent by the end of the decade, one-third lower than at the start of the century.Even if such bad outcomes do not materialise, the international financial institutions are clearly in “risk off” mode. Exuberance, whether rational or not, is nowhere to be seen.Second, what about persistent inflation and rising debt — two of the worries most frequently mentioned by economic policymakers and observers? The fund’s policy message is conventional enough: keep interest rates high and tighten government budgets to bring inflation down and bring debt under control. What I find curious is that this conventional message comes alongside important observations that could at least be recognised as pulling in the opposite direction. The IMF thinks “neutral” interest rates will remain low, which implies that current monetary policy is already very tight. Its World Economic Outlook finds “no sign of a wage-price spiral” and documents that inflation expectations are no higher than before the pandemic. On debt, meanwhile, its research makes a big point of how it is easier to reduce it during a boom — and shows how inflation has already helped bring about some telling improvements in public debt burdens. In the chart below, the country that has shrunk debt-to-GDP by more than 20 percentage points in just one year is Greece!
Given all this, you might think we could worry a little less about inflation and a little more about not holding back growth. But no, the IMF’s chief economist Pierre-Olivier Gourinchas describes the fact that the banking turmoil will slow economic activity as a “silver lining”. On debt, by the way, the outlook is not all bad. The fascinating chart reproduced below shows that the increase in global debt is above all driven by the US and China. When excluding those two economies, advanced and emerging economies’ debt-to-GDP ratios are forecast to fall or remain stable, respectively; the debt burden of low-income countries is forecast to drop too.
Even those averages could, of course, include some serious problem cases. And in “low-income developing economies, higher borrowing costs are also weighing on public finances, with 39 countries already in or near debt distress”. It’s to the IMF’s credit that it repeatedly mentions that debt restructuring needs to be considered in the policy menu.The third big issue in the global economic policy debate is “decoupling” (between China and the US) or “fragmentation” (more generally). The fund has done us the favour of mapping some of the territory and estimating the economic cost of a less integrated global economy.While we mostly talk about trade when we discuss fragmentation, the IMF usefully asks us to look at other economic links, in particular foreign direct investment, where cross-border activity really has fallen (unlike in trade).
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To do so, the World Economic Outlook features a very clever measure of “political distance”, defined by voting records in the UN General Assembly. Applying this measure to FDI flows over time, the report establishes that an increasing share of cross-border direct investment takes place between politically similar countries. The same is true of geographical distance. And in “strategic” sectors, such as semiconductors, the number of foreign investments into China has halved in less than a decade.
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What would the cost be of such “friendshoring”? The IMF estimates efficiency costs of 2 per cent of global GDP, but divided very unequally across countries. The biggest economic hit from decoupling or fragmentation would be felt by emerging and developing economies. In more volatile financial flows, too, the fund examines the risk of fragmentation. The GFSR finds that greater political distance reduces not just FDI but also portfolio finance and banking flows. What to make of all this? Perhaps simply that the signs from the global economy are confusing. But as one of my graduate school professors — a former US presidential economic adviser — taught me in my first macroeconomics class, “in economics, to be deeply confused is to be profoundly informed”.Other readablesRussia’s war against Ukraine has transformed the small town of Rzeszów near the Poland-Ukraine border into a huge military entrepot and diplomatic way station.Kenan Malik cuts through the fog around elite-bashing. The renminbi’s share of global trade finance is climbing. But as an FT editorial and Bloomberg’s John Authers both explain, the US dollar need not worry about its status.Numbers newsThe OECD has published a report on raw materials critical for the green transition, documenting the concentrated supply that has made western countries look for policies to reduce import dependence.Nearly $80bn of Chinese infrastructure loans in countries that partnered with its Belt and Road Initiative went bad in the past three years. That is four times more than the previous three-year period. Tens of billions more have been issued in rescue loans by Beijing to prevent borrowers from defaulting. More
