What crucial trends are driving the industry?
Economic and political analysts are talking these days about a “new normal” driven by uncertainty and fat-tailed event probabilities that make projections considerably challenging. However, it is difficult to determine which factors contribute more to this unclear environment. Geopolitical risks, social and demographic changes, immigration trends or decoupling monetary policies are only some of them.
All in all, the global economy prospects are not bright for 2016. The slowdown in emerging economies is bringing some clouds and the doubts surrounding statistical reporting in countries like China add to the uncertain prospect. The situation of the emerging economies is weighing on global trade and economic growth. Recent efforts such as the acceptance of the China’s renminbi as a currency in the IMF basket are only new attempts of delaying the inevitable, a declining rate of economic growth. The main reason is that structural weaknesses and currency control in China prevent markets from truly accepting the renminbi as a reserve currency. In my opinion, it will not be possible for China to rebalance its excess capacity and, in turn, unemployment will significantly grow. The social consequences are unpredictable.
Changes in monetary policy are also imposing important restrictions on a number of countries to maintain currency stability and recover the path of their potential economic growth rate. Even if an interest rate hike in the US is discounted by the market, the liquidity movements around the world are likely to be important and to persist for some time, and emerging markets are likely to suffer significantly more than other geographical areas. In any event, the uncertainty also spreads to Europe, which will virtually decouple from the US, with an expansive monetary policy in the Eurozone whose effects are still unclear.
All in all, average global economic growth is expected to be around 2.5% in 2016, well below its long-run potential.
Particularly challenging for the global economy would be the geopolitical risks which would rank in second place as the main fat-tailed risks after emerging markets for 2016. Among the economic risks, fiscal crises and unemployment will also be particularly relevant in Europe and the US.
What segments of the economic sector will experience the most growth and why?
Trade and services will mainly drive economic growth in the near future but their illness is a reflection of both short-term and structural trends. In the short-term, monetary and currency instability will add to the problems of emerging economies with some of them such as Brazil being particularly worrisome. Trade will suffer to a large extent and only if the problems to release the projected big international trade agreements are solved, the situation can relatively improved. On top of this there are some structural changes whose effects on trade and in the production structure of a number of countries have not been yet properly assessed. One of them is the strategic change in energy markets, with some oil producers (in the Gulf mainly) being more resilient to the downward pressure on oil prices while others (i.e. Venezuela, Mexico) suffering to a larger extent. Another strategic ingredient is the change in the way services are provided with new technologies reducing the role of labour-intensive industries. This was a trend that was already in place before the crisis and that can explain to some extent why labour creation in territories such as the US or the EU is being achieved at the expense of a poorer job quality. This may also explain by potential economic growth already began to decline in advanced economies before the crisis while it increased in emerging market economies. This could be ultimately attributed to changes in total factor productivity growth, which declined in advanced economies, as innovations in information technology have not been yet internalized.
Investment flows are back to US markets, where corporate bonds are gaining momentum again after several years of relative slack. Companies related to growing energy sectors such as fracking have gained momentum while information technology requires a much more selective investment strategy as the apparent success of this industry is often affected by a cherry-picking fallacy.
What are the key challenges?
There seems to be two options for the global economy in the long-run: i) assuming that high economic growth rates are not sustainable with the current labour-technology mix; or ii) finding new ways of economic growth. Even if the second option is followed and current and forthcoming innovations are properly internalized, other challenges introduce short-to-medium term uncertainty with social and geopolitical risks being the main restrictions.
It is not possible to be back to the pre-crisis growth of total factor productivity in emerging market economies, as these economies will necessarily make a move towards labour and technological conditions, which are not compatible with such growth rates. In the short-run, geopolitical risks around the world are present and the risks for commodity exporters such as Brazil and Russia are also in play. Geopolitical risks do not only involve military conflicts or terrorism as they also include environmental risks, pandemic health contagion and the vulnerabilities in cyberspace and information protection. Cooperation will be key to prevent and reduce these risks.
Additionally, in a large number of both advanced and emerging economies the only way forward to a more competitive and efficient productive structure will be market reforms, more aggressive investments in R&D, well-designed tax structures, and ambitious and stable trade agreements.
Demographic changes will also be key, in particular in advanced economies with ageing populations where taxes and public and private pension design should be incentive-compatible.
Finally, in my opinion, one of the undervalued risks is that related to social instability. Inequality has increased both because of the crisis and due to the changing labour-technology structures and in some countries where those structures have been particularly unbalanced (i.e. emerging markets) the poor economic growth prospects may trigger social discontent and a sudden and relatively traumatic change in those structures.