The slowing of the Chinese economy, along with growing evidence of European growth under pressure, cast a big cloud of uncertainty over the global economy coming into 2019. Data released last week provided further support for the notion of short-term stabilisation in China, but there isn't yet a convincing longer-term case for higher growth, or for a less uncertain road for a global economy characterized by divergent performance among its most important economies.
For decades, China has skillfully used the global economy as a tailwind to leverage beneficial and powerful demand-and-supply transformations at home: From accessing foreign markets to expand production, income and employment, to importing and internalizsng technological advances that enhance productivity and enable China to compete throughout the global value-added chain. These efforts have turbocharged the impact of the country’s impressive economic-policy management, which has pulled hundreds of millions of citizens out of poverty, driven high growth and turned the Asian powerhouse into the world’s second-largest economy.
More recently, however, this tailwind has turned into a headwind characterized by three distinct, yet reinforcing elements:
Chinese export markets have become less dynamic, particularly in Europe. The US has imposed tariffs on Chinese imports and threatened more in response to grievances, also shared by other countries, about China’s use of non-tariff barriers and intellectual property theft. Certain aspects of the initial implementation of China’s ambitious Belt and Road Initiative have led to growing concerns about the lack of transparency of terms and conditions, the worsening indebtedness of some of the most vulnerable developing economies and even national security issues.
As headwinds from abroad are reflected in worsening domestic economic indicators, the Chinese authorities have opted for an aggressive set of stimulus policies, including expansionary monetary and fiscal policy measures, as well as directives to state-owned enterprises. Essentially, there has been a return to a set of measures that were successfully used in the past to avoid a prolonged economic slowdown, including in the aftermath of the 2008 global financial crisis.
Still, the initial evidence of the effectiveness of this round of stimulus has been less encouraging, at least until recently. It has taken longer for the economy to respond. Meanwhile, worries about collateral damage have increased. Then there is the list of potential inconsistencies with the longer-term structural reforms needed to continue to power the Chinese economy through the middle-income transition, one of the trickiest phases of the development process. This shift has tripped up many developing countries in past decades, including Argentina and Brazil, solidifying the notion of a “middle-income trap.”
The more recent data suggest, however, that the stimulus measures have started to bite. Less-disturbing purchasing managers' index numbers were accompanied last week by indications of a significantly higher amount of credit making its way into the economy. Together with a rebound in the monthly export number for March after a terrible February, and growing expectations of a China-US trade deal in the next few weeks, there is good reason to expect a pickup in growth.
That’s also good news for the global economy and for markets. Projections released last week show that the International Monetary Fund expects more than two-thirds of the world to slow in 2019. The unfavourable impact on financial asset prices has been powerfully countered by the remarkable dovish U-turn by the Federal Reserve in the first quarter of this year, but the continued dependence of markets on central banks fuels concern about sustainability and the risks to financial stability down the road.
Overall, it’s too early to turn this short-term relief into strong longer-term optimism, both for China and for the global economy.
As the Chinese authorities have recognized, the country needs to quickly return the policy focus to the continued implementation of the more fundamental reform measures needed to power an increasingly complex economy. Not only are the short-term stimulus measures likely to prove increasingly ineffective over time, but they conflict with the authorities’ stated goals to de-lever the most indebted pockets of the economy, reduce reliance on inefficient state-owned enterprises and, more generally, continue to shift to more price-directed allocation of resources. The short-term actions can also undermine the authorities’ desire to deepen domestic financial markets, limit their potentially destabilizing roller-coaster price action and underpin them with sound and sustainable fundamentals.
It’s also too early to declare the all-clear for the global economy. In addition to concerns about the sustainability of a Chinese economic activity bounce, there are important questions about the health of Europe that haven't been answered by decisive policy actions. They include:
The five largest economies (France, Germany, Italy, Spain and the UK) remaining under pressure. Regional policy coordination, formulation and implementation continuing to be undermined by tensions (including those around Brexit, and between Germany and France, France and Italy, Italy and the European authorities, and the European authorities and Hungary). The region’s growth fast approaching stall speed. Some of the more vulnerable economies being particularly at risk, including Italy, where a continuation of recessionary conditions risks reigniting worries about long-term debt sustainability.
For the next few weeks and months, China’s economic stabilization is likely to constitute good news for its citizens and for the global economy. The longer-term prospects for both, however, remain uncertain.
In China, much will depend on the authorities’ ability to handle a tricky policy mix: maintaining stimulus while gradually pivoting back to lasting reform policies. The potential short-term contractionary effects of those policies would be more than offset by the beneficial transformations needed to avoid the middle-income trap and to maintain impressive long-term growth and development record.
The health of the global economy and markets needs even more. It requires the mobilization of steadfast European political will, at both the national and regional level, to implement the pro-growth policies that would avoid economic stall speed, reduce the risk of debt instability, alleviate regional fragmentation pressures and allow for less complicated domestic political setups. It’s a significantly taller order than what’s facing China, even though Europe is a lot further along the development process.