What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
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In its latest examination of the global economy, the World Bank has drawn attention to what it calls the “largest, fastest, and most broad-based wave of debt accumulation among emerging and developing economies in the last 50 years.”1 Total debt rose from 115 percent of GDP in 2010 to 170 percent in 2018. This happened at the same time that economic growth decelerated. Moreover, the World Bank notes that emerging market debt has risen rapidly and that a growing share of such debt, especially private sector debt, is held by nonresident investors. Thus, there is a growing exposure to foreign currency risk. It also notes that the lion’s share of the increasing debt-to-GDP ratio is due to private sector rather than public debt. The World Bank acknowledged that debt accumulation can often be beneficial to an economy. Public debt can be used to boost productivity through infrastructure investment, and private sector debt can fuel business investment that generates faster economic growth. Yet the World Bank also notes that past episodes, including the last three, of rapid debt expansion ended badly. It said: “While currently low interest rates mitigate some of the risks, high debt carries significant risks. It can leave countries vulnerable to external shocks; it can limit the ability of governments to counter downturns with fiscal stimulus; and it can dampen longer-term growth by crowding out productivity-enhancing private investment.”
For now, there are two risks that should potentially concern investors and economists. First, if there is a further slowdown in the global economy, perhaps driven by trade tensions, it could exacerbate the difficulty of servicing emerging market debts. That, in turn, would represent a risk to financial institutions. Second, if the trade conflicts between major countries worsen, it could hurt the ability of emerging markets to boost exports. That, in turn, would hurt their ability to service foreign currency debt. Again, that could be problematic for banks and other financial institutions.
In the midst of general weakness in the global manufacturing sector, the resilience of services has helped the major developed economies to avert recession. This has been especially true in the United States and Western Europe. Thus, the strength or weakness of services remains of critical importance. Services is defined as most nonmanufacturing, nonconstruction, and nonagricultural activities including retail and wholesale trade, telecoms, transportation and distribution, finance, professional and business services, utilities, tourism and hospitality, education, and health care. IHS Markit has released the latest purchasing managers’ indices (PMIs) for the broad services sector in multiple countries. These PMIs are meant to signal the direction of activity in services. They are based on sub-indices such as output, new orders, employment, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth.
The services PMI for the United States rebounded nicely from November to December but remained well below the level from a year earlier.2 Specifically, the services PMI rose from 51.6 in November to 52.8 in December, a level indicating modest growth in activity. The PMI had been 56.0 as recently as 10 months earlier. Thus, service activity has clearly decelerated, but continues to grow. IHS Markit noted that the improvement in December was largely due to improved consumer demand for services while demand on the part of business remained weak. In addition, it said that while output of services improved in December, sentiment on the part of service company executives remained weak.
In the Eurozone, the services PMI rose from 51.9 in November to 52.8 in December.3 The latter figure was a four-month high. Evidently, the growth of services has more than offset the dismal performance of manufacturing, thus allowing the Eurozone economy to continue growing, albeit very slowly. The strongest growth of services in December took place in Spain and Ireland. In Germany, which has the worst-performing manufacturing sector in the Eurozone, the services PMI rose from 51.7 in November to 52.9 in December, a four-month high. Although new orders for services in the Eurozone accelerated, export orders for services continued to decline. Among service industries, the strongest growth was in tourism and hospitality as well as telecoms services.
In the United Kingdom, the services PMI rose from 49.3 in November to 50.0 in December.4 The figure indicates that services activity neither grew nor contracted in December. There was strong growth of new orders and business sentiment. IHS Markit said that businesses are hopeful that a new era of political stability promises a better business environment.
Finally, China’s services PMI fell from 53.2 in November to 52.6 in December.5 Nonetheless, it remained at a level indicating modest growth. The sub-index for new domestic orders accelerated while that for new export orders declined. Business sentiment remained “subdued” while prices charged by service providers fell.
Job growth in the United States decelerated in December but remained stronger than was needed to absorb new entrants into the labor force. Many investors reacted positively, seeing the jobs reports as indicative of a relatively strong economy, but not so strong as to fuel an increase in inflation. Equity prices in the United States initially rose to record levels on news of the jobs report. Investors likely saw the report as confirming the Federal Reserve’s decision to keep interest rates steady. Also, for the first time since the last recession, women represented a majority of payroll jobs. The government has two employment reports—one based on a survey of establishments, the other on a survey of households. Let’s consider both.
The establishment survey revealed that 145,000 new jobs were created in December, down from 256,000 in November.6 It was the slowest job growth since May. Even then, the Federal Reserve has said that the economy need only generate about 100,000 jobs per month in order to absorb new entrants into the labor force. Employment fell in manufacturing, mining, and transportation and warehousing. There was strong growth in health care, leisure and hospitality, and retailing, the last being somewhat of a surprise. Indeed, it was the biggest job growth in retailing in nearly two years. Also surprising was the tepid pace of growth in professional and business services, which previously had made a major contribution to overall job growth. Also, the establishment survey revealed that wage growth decelerated in December. This is a surprise given the tightness of the labor market. Average hourly earnings were up only 2.9 percent from a year earlier, the slowest wage growth since mid-2018. This slowdown might be due to the surge in low-paying retail employment in December. Still, it is notable that despite being one of the tightest job markets in two generations, wages have not accelerated further.
The separate survey of households revealed that job growth was in line with labor force growth, thus leaving the participation rate unchanged.7 Also unchanged was the unemployment rate at 3.5 percent, the lowest level in 50 years.
Debapratim De, an economist with Deloitte in London, provides some comments on Deloitte’s latest survey of British CFOs.
The latest survey of British CFOs conducted by Deloitte demonstrates the positive impact of the recent election on business sentiment. The survey underscores the impact of policy uncertainty on business confidence, with a sharp derating of political risk in the United Kingdom after the general election. CFOs reported the biggest-ever increase in optimism in the 11-year history of the survey, taking it to its highest-ever level. The scale of the improvement eclipses previous surges in the wake of interest rate cuts during the financial crisis in 2009 and following the European Central Bank president’s pledge to ”do whatever it takes” to save the euro area in early 2012. The fog of uncertainty that has beset the United Kingdom since the EU referendum in 2016 seems to be lifting. CFO perceptions of external uncertainty have fallen from one of the highest-ever readings to near-average levels. Brexit has topped CFOs’ worry list since the EU referendum but has dropped to third place in the fourth quarter.
Clarity on the nature and timing of the United Kingdom’s formal exit from the EU, if not future trading arrangements, seems to have bolstered CFO spirits. The election of a political party with a commanding parliamentary majority and an end to the immediate possibility of a radical Labour government have further reduced political uncertainty. Brexit is no longer the top concern for CFOs, who expect UK corporates to increase capex for the first time in four years.
Recent Bank of England research, drawing on CFO Survey data, testifies to the toxic effect of uncertainty on investment. With reduced uncertainty has come a strong rebound in CFO expectations for business investment. Whether this translates into greater corporate activity this year will depend on a continuing positive trend in sentiment and uncertainty. But all things considered, CFOs go into 2020 with sentiment at levels that would have been unimaginable at any time in the last three years.
The economy of South Korea has been troubled lately, hit by a combination of the US-China trade dispute, a slowdown in China and the United States, conflict with Japan, and changes in the global market for memory chips of which Korea is a major producer. Despite historically low interest rates and increased government spending, the economy has not improved. Consequently, the government announced it will boost spending by more than US$50 billion,8 with the lion’s share of spending earmarked for public infrastructure and housing. It is hoped that the fiscal stimulus will lead to a rebound in economic growth.
This is interesting because South Korea now becomes a laboratory for an idea that has been widely discussed by economists and policymakers. That is, in many countries monetary policy has been unusually easy, yet economic growth has faltered. Many analysts have called for the use of fiscal policy as a tool for reviving growth at a time when monetary policy appears to have reached the limits of its usefulness. This idea has been proposed in Europe, especially in Germany. It has also been suggested by Mark Carney, former governor of the Bank of England, as well as a Ben Bernanke and Janet Yellen, both former chairs of the US Federal Reserve. Their view is that, with interest rates historically low, central banks lack room for influencing economic activity. Thus, fiscal policy becomes more important and potentially efficacious. Now, South Korea will test this idea.
What follows are my views about what transpired in the global economy in 2019 and what can be expected in the new decade:
As for public policy, in the coming decade, it is likely to be dominated by debates about four things: how to manage the changing technological environment, how to adjust to significantly changed demographics, how to protect the physical environment from the threats created by past technological innovations, and whether to move toward or away from further integration of the global economy.
Although the United States and China have agreed to a modest trade deal that avoids new tariffs and reduces some existing tariffs, the reality is that average tariffs imposed by each country on the other remain very high relative to recent history.10 As recently as early 2018, the average US tariff on Chinese imports was 3.1 percent. Currently, it is 21.0 percent. With the new agreement, the average tariff will drop to 19.3 percent. Under the agreement, China will also slightly reduce tariffs. China’s average tariff on US imports was 8.1 percent at the start of 2018 and is now 21.1 percent. With the new agreement, that number will drop to 20.9 percent. Thus, the agreement leaves tariffs historically high and not much reduced from late 2019. The United States will continue to impose punitive tariffs on two-thirds of all imports from China, including 93.0 percent of intermediate inputs, 69.0 percent of consumer goods, and 40.0 percent of capital goods. Moreover, there is continuing uncertainty about US trading relations with the European Union, with the United States threatening a variety of new trade restrictions on European countries and goods. Thus, it is likely that the negative effects of trade disputes and uncertainty are likely to endure.
What exactly are the negative effects of the trade dispute? A study conducted by the Atlanta Federal Reserve in conjunction with Stanford University and the University of Chicago offers estimates of the economic impact.11 The authors of the study conducted a survey of large US corporations. They found that, in the first half of 2019, about 12.0 percent of companies said they reduced or postponed capital expenditures. This included 24 percent of companies that produce goods and only 4.0 percent of companies that produce services. In addition, 22.0 percent of manufacturing companies said they cut or postponed capital expenditures. The authors estimate that this implied a US$36 billion reduction in capital expenditures in the first half of 2019, or a decline of 3.8 percent below what would otherwise have been the case. This is consistent with GDP data showing that business investment declined in the second and third quarters of 2019.
With the new US-China trade agreement, and with the completion of the United States–Mexico–Canada Agreement (USMCA), will businesses feel more comfortable engaging in capital spending in 2020? That is a critical question. Many investors are betting that investment will rise, as evidenced by the surge in equity prices in recent weeks. But is that optimism warranted? It is too early to say. The answer will depend in large part on how the United States approaches trade issues in the coming year. On the one hand, it might decide to avoid creating greater uncertainty which could undermine the administration’s hopes for reelection. On the other hand, it might choose to shift gears and increase its focus (and perhaps its ire) on the European Union, which in fact trade negotiator Robert Lighthizer has signaled he intends to do.12 Meanwhile, the relatively high tariffs are likely to have a greater impact in 2020 than in 2019 as they directly influence the pricing of imported goods.
After several months of improvement, the global manufacturing sector appears to have decelerated in December. The purchasing manager’s index (PMI) of global manufacturing published by IHS Markit, fell slightly from 50.3 in November to 50.1 in December, remaining only marginally above the level separating growth from contraction.13 The PMI is a forward-looking indicator meant to signal the direction of activity in the manufacturing industry. It is based on sub-indices such as output, new orders, export orders, employment, pricing, inventories, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth. The latest global PMI fell because of a sharp deceleration in output. Growth of new orders remained steady while export orders continued to decline, although at a slower pace. There was an especially sharp decline in the PMI for companies producing capital goods. This bodes poorly for global business investment. By geographic region, there was moderate growth of activity in the United States, slow growth in China, and a continued decline in Europe. Below are the details:
After rising for a few months, the PMI for US manufacturing fell in December. It went from 52.6 in November to 52.4 in December, a level indicating moderate growth in activity.14 The PMI remains well below the level from a year earlier. Output growth decelerated while new orders and export orders continued to grow at a modest pace. However, Markit commented that “business sentiment about the outlook remains especially subdued compared to a year ago, reflecting ongoing worries about geopolitics and trade wars, especially the impact of tariffs.” It also noted that “the impact of tariffs was clearly evident via higher prices, while the relatively subdued level of business confidence manifested itself in a pull-back in hiring.” Thus, the survey suggests that, despite a new trade deal between the United States and China, the negative effects of trade restrictions continue to take a toll on the US manufacturing industry. On the other hand, the US manufacturing industry continues to grow more strongly than in most other parts of the world. Only in Greece and India was the December PMI higher than in the United States.
The Institute of Supply Management (ISM) released its own PMI for US manufacturing and the results were quite different from that of Markit. The latest survey from the ISM reported that the PMI fell from 48.1 in November to 47.2 in December.15 This is a level indicating a significant decline in activity. It is the fifth consecutive month in which the PMI was below 50 and it is the lowest reading since June 2009, which was at the tail end of the last recession. Most major sub-indices worsened between November and December, but none more than the output index which fell from 49.1 in November to 43.2 in December. The PMI from the ISM suggests a US manufacturing sector in recession, while the PMI from Markit suggests a manufacturing sector that continues to grow but is facing significant headwinds. Why the difference? The ISM index is based on an arithmetic average of the sub-indices while the Markit index is based on a weighted average of the sub-indices, with more forward-looking indicators given greater weight. However, that alone does not explain the entire difference. In addition, the two surveys ask somewhat different questions and poll a different sample of companies. In any event, the fact that there are differences means that it is difficult to make conclusions. Still, the two surveys are moving in a similar direction. Moreover, the commentary from the authors of both surveys point to similar concerns, especially related to trade.
Many investors were pleased following the recent election in the United Kingdom, hopeful that a period of greater certainty is imminent. Yet the reality is that Britain’s manufacturing sector remains especially weak. The PMI fell sharply from 48.9 in November to 47.5 in December. The index has not been lower than this since 2012.16 The PMI has been below 50 for eight consecutive months. In addition, the sub-index for output hit the lowest level in seven years. Output of capital goods fell at the fastest pace in the same time period while output of intermediate goods fell at a more measured pace. There were steep declines in new orders and export orders. Overall, it was a gloomy report. The business sentiment improved, however, with 43 percent of companies expecting higher output a year from now. Meanwhile, although the election established that Brexit will happen at the end of this month, the future of trading relations with the European Union remains uncertain.
The eurozone remains the weakest link in the global manufacturing sector, with Germany especially weak. The PMI for eurozone manufacturing declined from 46.9 in November to 46.3 in December.17 This is a level reflecting a sharp decline in activity. The PMI has been below 50 for 11 consecutive months. Germany continued to have the lowest PMI in the region at 43.7, a level indicating a very sharp decline in activity. Meanwhile, the PMIs for the Netherlands (48.3) and Italy (46.2) fell to an 80-month low. Spain’s PMI was also low at 47.4. Among major eurozone economies, only France had a favorable PMI at 50.4. For the region, the sub-index for output fell at a rate not exceeded in seven years. New orders fell at one of the fastest rates in seven years. Thus, Markit concludes that “a return to growth remains a long way off.” Markit also noted that “only households provided any source of improved demand in December, underscoring how the consumer sector has helped keep the economy out of recession in recent months.” This may explain the relative strength of French manufacturing which is disproportionately dependent on the production of consumer goods. Germany’s weakness reflects the troubles in Europe’s capital goods sector. That, in turn, is largely due to trade concerns and weakness in the global economy.
In China, the manufacturing PMI fell from 51.8 in November to 51.5 in December.18 This is a level indicating modest growth in activity. Output continued to grow at a healthy pace and business sentiment improved. The latter is likely due, in part, to the new trade deal between the United States and China. Growth of new orders decelerated sharply, although it remained positive. New export orders were weak, but not much changed from the previous month. Evidently domestic demand weakened faster than export demand. This may explain why the central bank has chosen to stimulate credit market activity.