Global Recession Is Coming. But Not In 2020.

Preface

Our title may have caught you off guard given the evolving threat that is coronavirus. Let us explain. This article was originally written in the very beginning of 2020 when coronavirus was perceived as a local outbreak that would rapidly resolve, rather than a serious threat to the global community and economy. Despite all the risks that had accumulated by the end of 2019, there was no reason to expect these risks would materialize in the short-term as a threat to the global economy or that governments and central banks would fail to rise to these challenges.

Then, coronavirus.

The growing uncertainty led to a collapse in financial and commodity markets. The first official estimates of the state of China’s economy seem shocking. Various alternative data point to forthcoming contraction of economic activity in Europe and the United States. Prominent research and analytical institutions released several alarming forecasts in recent days.

The coronavirus pandemic will now undoubtedly have a sustained negative impact on economic growth globally. Nevertheless we look optimistically on 2020 as a whole. While we are not in the business of making predictions on the US economy or any other, we have data in our repository that currently contradicts what many of the pundits in the media are saying about a global recession. You be the judge! And, if the data signals are wrong? Even in the worst scenario, according to the OECD, world GDP will lose about 1.5 percentage points in 2020. That still translates to 1 percent global growth.

Introduction

Doom and gloom are pending for the global economy in 2020, according to investment banks, multilateral agencies, and maybe even the common person watching his/her real wage decline. True enough, disintegration in Europe, structural imbalances in many emerging markets, trade wars, protests and armed conflicts, debt overload and financial bubbles, among other factors, are not only daunting but together could undermine global economic stability. Layer in fresh uncertainty within market fundamentals, including “green” pressure on the real sector, growing inequality, labor automation, and the ultimate wildcard that is the coronavirus outbreak, and who wouldn’t be pessimistic about 2020?

All of the factors mentioned above are relevant, and yet recession expectations are fueled mainly by experience. And there again, history is a gloomy guide. We know that no economy has continued to grow indefinitely, recession free; thereby, the prolonged growth stories of the world’s two largest economies seemingly spell impending recession. The US economy is experiencing the longest expansion in its history, with GDP growing for more than 10 years. The Chinese economy has been growing for a record 43 years without downturns.

Moreover, the real economic conditions in these economies are not ideal. High debt levels, for example, represent a major risk factor for both countries. Beijing also faces an oversupplied housing market, aging population, and shrinking labor force, while Washington is staring down growing debt and overestimated financial assets as well as budget imbalances squeezing the manufacturing sector and the middle class.

In this article, we delve into five reasons why the global economic recession will not happen in 2020 despite the doom and gloom. Our analysis will be dedicated mostly to economic indicators pertinent to China and the United States because recession in either of these two countries would very likely turn into a global crisis. So too then would economic strength help sustain the global economy.

1. The US Economy Remains Strong

In 2019 we saw a lot of signs suggesting that recession was just around the corner. The most cited is an inverted yield curve for US Treasury bonds. Inverted yield curves have preceded every recession for the past 50 years, but it may take up to 34 months (22 on average) before the economic downturn comes.

Since the difference between the 10-year Treasury rate and the 2-year Treasury rate fell below zero at the end of August last year, we can then expect recession to start by June 2021. In the meantime, the US economy is growing and continuing to add jobs.

The behavior of key short-term economic indicators also demonstrates no sign of recession. The drop in industrial production observed in 2015-2016 and at the end of 2019 is simply indicative of the interplay between the US real sector and global oil market movements. True, US industrial production is currently depressed by falling crude oil prices, but the rest of the US economy is benefiting from these low energy costs.

2. Beijing Has Enough Economic Power to Support Growth

China’s unprecedented economic growth over the past three decades has made it the world’s largest economy. Not only did its production of goods and services increase, but the quality of life of the Chinese population improved substantially as well, propelled by a tenfold increase in real wages between 1990 and 2019.

That said, the Chinese economy is transforming. Rapid increases in real wages and a shrinking labor force have undermined China’s export-oriented economic model, a model based on cheap labor. Nowadays China is stepping into capital and technology intensive markets, placing it in direct competition with the US, EU, South Korea, and Japan, among other countries with well-developed high tech sectors. Simultaneously, as China is poised to become a  net capital exporter, its economy is becoming more driven by household consumption rather than domestic investment and exports.

As China enters a new stage of development, lower rates of economic growth are expected. And, in China’s growth story, structural imbalances accumulated during the period of rapid industrialization serve to slow growth even more. That is why a soft landing without recession is challenging.

The good news is that the Chinese government has resources in place to prevent a recession, at least in the short term. Beijing has implemented a wide range of economic stimulus, from tax cuts to easing monetary policy and expanding public investment. Overall the volume of stimulus amounted to $1 trillion in 2018-20191 and yet China has maintained financial stability: foreign exchange reserves are 1.6 times greater than the country’s external debt. The Chinese economy has even withstood the pressure of US trade sanctions and given no signals that the Chinese government will falter because of internal imbalances, including the relatively high debt burden of the private sector, decreasing returns on capital investment, and an oversupplied housing market.

3. Leading Indicators Do Not Point to Recession In the Short-Term

Another way to look into the future, at least for the next 6-12 months, is with the help of business cycle composite indicators.

Business cycle indicators are the composite indices that are built from a set of high frequency economic indicators. In theory it is possible to create three types of business cycle indicators – leading, coincident, and lagging. The indicators predict changes in business cycles, demonstrate the current state of economy, and confirm whether a shift in the economy has actually occurred, respectively. We focus here on leading indicators published by the OECD because the data covers the broadest set of countries of any of the mainstream producers of these indicators.

According to the latest update on leading indicators from the OECD, we can expect stable economic growth during the next six to nine months in most advanced and emerging economies, including China, the Euro Area, and the United States. Although the pace of economic expansion is expected to be below long-term trend growth rates, there are no signs of recession in the short-term.3

4. Low Energy Costs Support Economic Growth

An economy simply cannot grow when the price of any irreplaceable vital resource is too high. And among intermediate resources, energy is the most important. Whatever and whenever something is produced, whether goods or services, production always requires energy.

It is empirically confirmed that the growth of total energy costs (measured as a share of GDP) above a certain upper threshold is accompanied by an economic recession.4 When energy prices are too high, economic agents have to cut all other expenditures to hold energy consumption unchanged, which ultimately depresses economic activity.

The specific upper energy cost threshold depends on the composition of the energy basket. Nevertheless, assuming standard methodology, the ratio of energy expenditures to GDP is stable across developed and developing countries and over long-term periods.4

As a benchmark for global energy expenditures, we used the US economy mainly due to the availability of historical data on energy consumption and prices. Our estimates of the US energy cost to GDP ratio and its comparison with GDP growth rates show that economic growth did not fall below zero when the United States’ expenditures on primary energy were lower than 7% of its reported GDP.  In 2019,  the value of primary energy consumed in the US amounted to about $700 billion, or just 3% of its GDP—much lower than the upper limit of 7%.

We assess that fundamentally the pressures today that are keeping energy costs low globally—including growing US oil and gas production—will not change in the short- and even medium-term future (unless the world does an about-face to switch to renewables) and cheap energy will continue to fuel economic growth.

5. US-China Trade War Will Not Undercut Global Growth in 2020

During the first 18 months of the US-China trade war (2018-2019), import tariffs jumped from 4-7 percent to 21 percent, on average. Bilateral trade flows fell to 30 percent year-over-year in separate months. By the end of 2019, the US and China had imposed 20 percent import tariffs on more than 60 percent of bilateral merchandise trade turnover.

Disruptions in trade between the world’s two largest economies as well as a number of lower scale mutual trade restrictions between the US and its other trade counterparts finally led to a noticeable decline in economic activity globally in late 2019. According to our estimates, the US-China trade war reduced world GDP growth in 2019 by an average of 0.5 percentage points.

It is clear that further escalation would bring even more harm to the world economy, casting doubts on the benefits to either country, if any. Fortunately, as the US and China signed a phase one trade deal in January 2020, the US-China trade war is far less likely to undercut global growth in 2020. Moreover, the ultimate slashing of import tariffs under the deal creates the basis for some recovery in bilateral trade and economic growth.

In Conclusion: Short-Term Headwinds Will Not Lead the World Economy into Recession

In 2019, a number of adverse factors slowed global economic growth. Among the major ones were global trade disruptions, waning fiscal stimulus in the United States, economic disintegration in Europe, and social protests around the world. And, it would now seem that early 2020 has been still more cruel, denying us the glimmers of progress we’d hoped for and replacing them with alarming predictions as to the fate of global economic growth.

While acknowledging the importance of all these factors, we would like to emphasize their short-term nature. We’ve left behind many of the negative economic factors in 2019, muting their negative influence in 2020 with the easing of monetary and fiscal policies. The central banks and governments of the world’s largest economies still have enough room to expand economic stimulus even further in the event new short-term threats emerge.

We can’t predict the future. But, the economic data that is available today shows that short-term headwinds are not enough to lead the global economy into recession in 2020.

References

  1. OECD Economic Surveys: China. OECD, April Link. Delve deeper into US unemployment figures with one of our past features: Something Has Gone Wrong with US Unemployment Estimates.
  2. Business Cycle Indicators Handbook. The Conference Board, 2000. Link
  3. Composite Leading Indicators (CLI), OECD, January 2020. Link
  4. Bashmakov I. 2006. Oil Prices: Limits to Growth and the Depth of Falling. Voprosy Ekonomiki. Link

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