The outlook for the global economy next year is clear, but it isn’t pretty: recession in Europe, anemic growth at best in the US, a sharp slowdown in China and in most emerging-market economies. Asian economies are exposed to China. Latin America is exposed to lower commodity prices (as both China and the advanced economies slow). Central and Eastern Europe are exposed to the eurozone, and turmoil in the Middle East is causing serious economic risks — both there and elsewhere — as geopolitical risk remains high and thus high oil prices will constrain global growth.
At this point, a eurozone recession is certain. While its depth and length cannot be predicted, a continued credit crunch, sovereign-debt problems, lack of competitiveness and fiscal austerity imply a serious downturn.
The US — growing at a snail’s pace since last year — faces considerable downside risks from the eurozone crisis. It must also contend with significant fiscal drag, ongoing deleveraging in the household sector (amid weak job creation, stagnant incomes and persistent downward pressure on real estate and financial wealth), rising inequality and political gridlock.
Elsewhere among the major advanced economies, the UK is double dipping, as front-loaded fiscal consolidation and eurozone exposure undermine growth. In Japan, the post-earthquake recovery will fizzle out as weak governments fail to implement structural reforms.
Meanwhile, flaws in China’s growth model are becoming obvious. Falling property prices are starting a chain reaction that will have a negative effect on developers, investment and government revenue. The construction boom is starting to stall, just as net exports have become a drag on growth, owing to weakening US and especially eurozone demand.
Having sought to cool the property market by reining in runaway prices, Chinese leaders will be hard put to restart growth.
They are not alone. On the policy side, the US, Europe and Japan, too, have been postponing the serious economic, fiscal and financial reforms that are needed to restore sustainable and balanced growth.
Private and public-sector deleveraging in the advanced economies has barely begun, with the balance sheets of households, banks, financial institutions and local and central governments still strained. Only the high-grade corporate sector has improved.
However, with so many persistent tail risks and global uncertainties weighing on final demand, and with excess capacity remaining high, owing to past over-investment in real estate in many countries and China’s surge in manufacturing investment in recent years, the capital spending and hiring of these companies have remained muted.
Rising inequality — owing partly to job-slashing corporate restructuring — is reducing aggregate demand further, because households, poorer individuals and labor-income earners have a higher marginal propensity to spend than corporations, richer households and capital-income earners.
Moreover, as inequality fuels popular protests around the world, social and political instability could pose an additional risk to economic performance.
At the same time, key current-account imbalances — between the US and China (and other emerging-market economies) and within the eurozone between the core and the periphery — remain large. Orderly adjustment requires lower domestic demand in over-spending countries with large current-account deficits and lower trade surpluses in over-saving countries via nominal and real currency appreciation.