What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
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The Bank for International Settlements (BIS), which is an umbrella organization of the world’s leading central banks, says that climate change could be the cause of the next major financial crisis.1 Moreover, it wonders whether the world’s central banks are ready to handle such a crisis. Leading central banks are already thinking about how they might contribute to climate change mitigation. It has been reported that the European Central Bank (ECB) is exploring how the way in which it invests its portfolio can influence private sector decisions and, consequently, influence the climate. Yet in addition to examining how central banks can help deal with climate change, the BIS has examined how central banks could to respond to crises brought on by climate change. For example, if climate change leads to higher water levels and consequent destruction of large amounts of property, this could have a hugely disruptive effect on financial institutions over which central banks have supervisory responsibility. If new regulations require that carbon-based assets remain underground, then energy companies might see a sharp drop in the value of their shares and damage to their ability to service their debts. That, too, could hurt the financial system. Regarding energy companies, the BIS said that “the risk related to stranded assets is not reflected in the value of the companies that extract these assets.” Thus, financial markets might not currently be accurately assessing climate-related risk.
The BIS warned that “exceeding climate tipping points could lead to catastrophic and irreversible impacts that would make quantifying financial damages impossible.” Consequently, it suggested that governments not take a wait-and-see stand. Instead, it called on them to take “immediate and ambitious action [toward] a structural transformation of our economies, involving technological innovations that can be scaled but also major changes in regulations and social norms.” This is a tall order and is beyond the remit of the central banks that are part of the BIS. Moreover, the BIS noted that it is difficult to plan for climaterelated risk. Most risk mitigation strategies involve examining past experience and determining the degree of risk based on past trends. Yet climate change is new territory. The degree of risk cannot easily be known. It has been called a “green swan.” Thus, central banks, in particular, are in a difficult position as they face potentially big risks. The BIS said that “pursuing the current trends could leave central banks in the position of ‘climate rescuers of last resort,’ which would become untenable given that there is little that monetary and financial flows can do against the irreversible impacts of climate change. In other words, a new global financial crisis triggered by climate change would render central banks and financial supervisors powerless.” This is a rather grim assessment.
Meanwhile, the corporate world is already in the midst of significant efforts to mitigate climate risk. Many big companies have pledged to move toward carbon neutrality. S&P Global estimates that 60 percent of the companies in the S&P 500 index of public US companies “hold assets that are at high risk of at least one type of climate-change physical risk.” It says that these companies face risk from “heatwaves, wildfires, water stress, and hurricanes.”2 It is not clear how corporate activity will evolve or what impact it will have. What is clear, however, is that climate is rapidly becoming a bigger issue in business, finance, and the policy arena. Moreover, it is going far beyond mere efforts to assuage the concerns of environmentally minded consumers.
The European Union (EU) threatened to impose trade restrictions on Chinese goods if China fails to properly price carbon emissions.3 Specifically, the EU threatened a carbon border adjustment tax on imports from countries that don’t address carbon-related issues. The problem for the EU is that, although many of its member states have taken significant steps to reduce domestic carbon emissions, this will have little impact on global emissions if other countries fail to act. Thus, acting alone, the EU will merely reduce its own competitiveness while not having an impact on the global environment. That said, if the EU restricts trade with other countries, this is seen as a tool for compelling those countries to reduce emissions. European Commission President Ursula von der Leyen said, “There is no point in only reducing greenhouse gas emissions at home, if we increase the import of CO2 from abroad. It is not only a climate issue; it is also an issue of fairness towards our businesses and our workers. We will protect them from unfair competition.”
Specifically, the EU proposes that other countries impose a carbon price on their producers. For example, if the price of Chinese steel were to include the carbon cost of that steel, the EU would be satisfied. Otherwise, it might impose a tax on Chinese steel to account for the carbon impact. Von der Leyen said that China has, in fact, taken some modest steps in this direction. She said, “If this turns into a global trend, we will have a global level playing field where no carbon border tax will be necessary.” Meanwhile, the EU has begun to explore the mechanics of a border tax that would be consistent with the rules of the World Trade Organization. The end result could be a requirement that foreign companies participate in Europe’s cap-and-trade scheme for dealing with carbon emissions. To implement this proposed scheme, von der Leyen will have to obtain the support of a majority of the EU’s 27 members as well as a majority of the European Parliament. Already, German Chancellor Merkel has expressed skepticism.4 Her concern is that EU action might invite retaliation from trading partners, such as the United States and China.
Meanwhile, this European initiative could be emblematic of a new trade in global trading relations. Moreover, it could indicate the kinds of tools that governments might utilize to address global environmental issues.
Since the United States and China agreed on a phase one trade deal, there has been a high degree of skepticism among many investors about whether the goals of the deal can or will be met. China’s pledge to boost imports from the United States by US$200 billion over the next two years might not be feasible. A new analysis of the deal by the Peterson Institute for International Economics, a leading think tank, suggests that this skepticism is warranted.5 It notes that although China has promised to dramatically increase imports from the United States, it has not pledged to cut tariffs on US imports that had risen sharply in retaliation to US tariffs. Indeed, high tariffs remain on 56 percent of Chinese imports from the United States.
Thus, any boost to imports will require that the Chinese government engage in a form of managed trade in which the government decides what and how much is imported from specific countries. Yet the Chinese government has been explicit in saying that it will rely on market forces to generate higher imports from the United States. That appears to be nearly impossible. Also, the deal involves a Chinese pledge to boost imports of specific products. The Peterson Institute analysis suggests that if China boosts such imports, it could also cut imports of other products, thereby doing harm to US exporters in industries not covered by the agreement. The analysis report notes that the Chinese pledge requires that imports of the covered products rise by 92 percent over a four-year period, even as Chinese economic growth has significantly decelerated. It demonstrates that the agreement calls for US exports of key products to rise at unprecedented rates. At the same time, the United States is imposing new export controls on technology products, limiting the ability of the US to export to China products for which there is strong demand.
The Peterson Institute concludes that “the deal may be doomed from the start” and that, once this becomes apparent, trade tensions and hostilities are likely to reemerge. Yet it notes that evidence of failure will not be available until after the US election. Thus, the United States can highlight the deal during the campaign without having to demonstrate its success. As such, the deal could be considered cosmetic rather than substantive. The danger is that once it is clear in 2021 that the terms of the deal have not been met, the United States might resort to new tariffs or other trade barriers as punishment for China’s failure to meet its targets. Indeed, under the terms of the deal, failure to meet targets would result in the US side unilaterally determining whether to boost tariffs, rather than the traditional method of referring disputes to the WTO. Also, under the terms of the deal, China can withdraw from the deal if it decides that the United States has not acted fairly. As such, the deal does not actually include any formal enforcement mechanism.
Finally, the analysis shows that, if China were to significantly boost imports of certain products from the United States, it would likely be at the expense of imports from other countries. This kind of trade diversion could have serious consequences for some of the United States’ traditional allies including the EU, Australia, Japan, and South Korea. All this stems from a shift toward managed trade and away from market forces. The deal relies on government commitments rather than market forces (such as tariff reductions) and, in the process, invites inefficiency, distortions, favoritism, and possibly corruption. The deal does involve Chinese commitments to protection of intellectual property and removal of forced technology transfers, but these commitments mainly involve promises to abide by existing Chinese laws. The deal also includes a Chinese commitment to avoid currency manipulation, but such manipulation likely ended several years ago.
The global volume of foreign direct investment (FDI) declined in 2019 for the third consecutive year, reaching the lowest level since 2010.6 This suggests that the globalization that was the hallmark of the early years of this century is either in reverse or, at least, decelerating. The United Nations Commission on Trade and Development (UNCTAD) published data indicating this slowdown. Moreover, UNCTAD said that some FDI in the past year was undertaken by companies in order to shift supply chains in response to trade conflict, not for the purpose of boosting capacity. Thus, the slowdown in capacity-driven FDI was even sharper than the numbers suggest. An UNCTAD official said, “Overall, the current trend is more of investment diversion, rather than investment expansion. Multinationals are not significantly expanding their global operations, due to regulatory uncertainty and trade tensions. They are restructuring their global-value chains by relocating some segments for geopolitical-risk aversion.”
UNCTAD also noted increased efforts by some governments to limit inbound FDI due to concerns about the national security implications of some technologies. By region, inbound FDI was flat in China, down modestly in the United States, and down sharply in the Eurozone as well as the United Kingdom. However, there was a sharp increase in inbound FDI into Southeast Asia.
What does this mean for the global economy? The globalization of the last several decades likely contributed to stronger global growth because it cut the cost of production, boosted competition, fueled technology transfers that boosted productivity, and expanded the size of the market that global companies can target. A deceleration in such globalization will likely reduce economic growth. Meanwhile, UNCTAD predicts no significant boost to FDI in 2020, based on investment plan announcements.
The volume of world trade continued to decline in late 2019 according to World Trade Monitor data that is published by the Netherlands Bureau for Economic Policy Analysis.7 It reports that in November 2019, the volume of world trade was down 0.6 percent from the previous month and down 1.1 percent from a year earlier. It was the sixth consecutive month in which the volume of trade had fallen from a year earlier. It must be emphasized how unusual this is. After all, the volume of trade normally only falls during recessions. Indeed, trade fell sharply during the 2008-09 financial crisis. But the recent decline, which took place even as major economies continued to grow, reflects the impact of a sharp change in trade policy in the United States and the consequent reaction of other countries, especially China. Trade between the United States and China has fallen sharply due to current tariffs and uncertainty about future tariffs. In addition, countries that feed into China-led supply chains have also seen a decline in trade.
The data from World Trade Monitor indicate that the global volume of exports fell 1.4 percent in November versus a year earlier. Exports from the United States fell 0.2 percent, from Japan 2.2 percent, from the Eurozone 0.8 percent, from China 1.2 percent, from other emerging Asian economies 1.3 percent, from Latin America 5.6 percent, and from Africa 8.3 percent. The only region in the world to see an increase in trade volume was Eastern Europe where export volume was up 1.9 percent. The severe drop in exports from Latin America and Africa likely reflects the negative impact of trade wars on the demand for mineral commodities.
Going forward, the performance of trade volume will depend on how trading relations evolve and on how fast the global economy grows. As for trade relations, the new US-China trade agreement and the completion of the replacement for NAFTA suggest the possibility that trade volumes could stabilize. That said, the new US-China deal leaves in place relatively onerous tariffs. Thus, the likelihood of a rebound in trade is small. Rather, it appears likely that the situation will not worsen further in 2020.
After frequently being touted as the next China and with the fastest-growing large economy in the world, India is experiencing a slowdown. Moreover, there is reason to worry that this is not merely a temporary setback. India could be entering a somewhat prolonged period of slower growth due, in part, to policy errors and due, in part, to external headwinds. In the current fiscal year, the government is projecting GDP growth of only 5.0 percent, much slower than in recent years and the slowest in 11 years.8 And although there has been a synchronized deceleration in global economic growth, India’s slowdown is not entirely due to external factors. After all, India is less exposed to the global economy than most countries given that trade is a relatively small share of GDP. Rather, India suffers from several internal challenges.9
First, the financial system has been plagued with troubles, especially in the shadow banking system that provides a large amount of credit to the consumer sector. Plus, banks have a large volume of nonperforming loans. The result is that even as the central bank has cut interest rates, it has failed to boost credit creation commensurately. In addition, a perception that the government is reducing the independence of the central bank has led to higher expectations of inflation and, consequently, higher borrowing costs for businesses. Second, the government implemented two policy changes in recent years that turned out to be far more disruptive than expected. These were the demonetization (high-value currency bills were withdrawn from circulation) and the implementation of a national goods and services tax. Third, inflation has accelerated, in part due to rising oil prices. This, in turn, has boosted bond yields, thereby hurting credit market conditions. Fourth, the government continues to run a large budget deficit, largely due to subsidies, leaving it little fiscal space to provide help to a decelerating economy. Finally, although the government has cut taxes on businesses, it has lately been more focused on social rather than economic issues. The controversy about legislation on citizenship has led to massive and, in some cases violent, demonstrations.
In any event, some Indian business leaders are frustrated that the current administration is not more focused on economic reforms.10
Germany’s economy avoided recession in 2019, but just barely.11 For the year, real GDP was up only 0.6 percent from the previous year, the slowest growth since 2013 and far slower than the 1.5 percent growth in 2018 or the 2.5 percent growth in 2017. And yet, despite slow growth, unemployment remained historically low and wages accelerated strongly. The problem for Germany was principally related to its industrial sector. Trade uncertainty and slower global growth took a toll on manufacturing output. Business investment faltered, and trade declined. Germany’s production of capital goods was hurt by the global investment slowdown. And regulatory changes related to automotive emissions were hugely disruptive to the vast automotive industry. At the same time, although the government has not yet published data on fourth quarter GDP growth, it did say that there are “signs of a light recovery.”
What will it take to revive economic growth in Europe’s largest economy? Clearly, the answer is not monetary policy that already involves negative interest rates. Nor can Germany expect a change in the global trading environment anytime soon. Rather, a heated debate about fiscal policy continues. The government just announced the largest budget surplus since reunification, at 1.5 percent of GDP. Many critics contend that Germany’s government has room to boost borrowing and spending in order to stimulate demand, especially given that government bond yields are now negative. The governing coalition is resisting this idea. Many business groups in Germany have called for greater government investment in infrastructure, something that is seen as potentially boosting productivity growth.
While the US-China trade dispute has largely been about US protectionist actions and Chinese responses, the reality is that China is moving in an inward direction itself. The so-called “Made in China 2025” campaign, which the Chinese government has lately downplayed in order to assuage US concerns, remains a de facto policy. The government is keen to wean Chinese industry from dependence on imported components and wants to boost the domestic content of Chinese industrial output, especially in the technology sector. China currently spends more money on imported integrated circuits than it does on imported oil.12 It lacks the ability to produce a wide range of critical components, but wants to change this. As such, the government says it will invest to create 29 new “national manufacturing innovation centers.”
In part, China is responding to new restrictions on high-tech exports imposed by the US government. The United States has also limited the scope for interaction between Chinese and US researchers, and has banned some Chinese technologies in the United States. Thus, China’s protectionist bent is, in part, a response to US efforts to stifle Chinese technology development. Plus, the Chinese policy is consistent with the Chinese administration’s goal of making China a powerhouse in technology rather than a mere assembler of foreign products.
China’s government reported that the Chinese economy grew 6.1 percent in 2019, the slowest rate of growth in 29 years,13 although within the government’s target of growth between 6.0 and 6.5 percent. In the fourth quarter of 2019, the economy was up 6.0 percent from a year earlier, the slowest quarterly growth since 1992. Why the slow growth? It can be argued that China faced a perfect storm of challenges. These included the trade conflict with the United States, slower growth in multiple markets around the world, a high level of debt, excess capacity in industry that has stifled investment, cautious behavior on the part of consumers, and a declining working-age population. Moreover, the last demographic problem is likely to intensify over time. The government reported that the birth rate in 2019 was the lowest on record—even though the government has ended the one-child policy.
Critics complain that official GDP numbers in China are suspect and suggest that actual economic growth is even slower than what is reported. While no one is sure exactly how fast the economy is growing, data on other economic indicators confirm that the economy has decelerated. China also released data on industrial production, retail sales, and fixed asset investment. The retail sales and investment data confirm the trend, although December numbers improved from recent months. Industrial production suddenly rebounded in December, although growth remained well below levels frequently seen in the past.
China’s government reports that overall exports accelerated sharply in December, although export growth was weak for all of 2019. Overall imports were up, but imports from the United States continued to decline. Specifically, China’s exports increased 7.6 percent in December versus a year earlier, the first increase in five months and the biggest increase in ten months. For all of 2019, exports were up only 0.5 percent.14 Yet this included a 12.5 percent decline in exports to the United States offset by a significant increase in exports to other countries. Thus, the trade dispute with the United States has hampered the growth of exports.
It remains unclear what led to the surge in December. Meanwhile, China’s imports surged in December, rising 16.3 percent from a year earlier.15 This was likely fueled by a sharp rise in commodity prices. However, imports for all of 2019 were down 2.8 percent from a year earlier, led by a 20.9 percent decline in imports from the United States. China’s imports from the United States have fallen so far that, if it is to boost imports by the amount promised in the phase-one trade agreement, it will have to double imports from the United States over the next two years. That is a tall order and would likely come at the expense of China’s other trading partners. Many analysts are skeptical about China’s ability to make such a large adjustment. Even if it meets only half the target, this would still involve a 67 percent increase in imports from the United States in 2020. Such a leap is implausible without a concerted intervention in markets by the Chinese government. The irony is that the United States has complained that China’s government has intervened too much in the market economy.
China’s government reported that, in 2019, there were 14.6 million babies born—the least since 1961,16 a year when China was going through the devastating famine of the Great Leap Forward. Still, the population continued to rise last year, topping 1.4 billion people in 2019 for the first time. It is interesting that the number of births, which had previously been relatively steady, plummeted after the government announced the end of the one-child policy in 2016. Nonetheless, critics claim that the data is not necessarily reliable and believe that the data was overstated prior to 2016 in order to reduce support for loosening the one-child policy. In any event, the low level of births suggests that China faces a challenging demographic situation in the years to come. Already the working-age population is declining and the elderly population is rising, creating a problem of distributing the pie in a way that meets the needs of the elderly without creating an onerous burden on workers.
The “over 65” share of the total population increased by 0.7 percentage points last year alone, hitting 12.6 percent. Some Chinese provincial pension plans have already exhausted their reserves.17 Moreover, the number of women of child-bearing age is rapidly falling as a result of the past impact of the one-child policy. Thus, unless there is an increase in the average number of babies per woman, the number of births will continue to decline. The decline in the working-age population implies slower economic growth unless there is an offsetting acceleration in productivity growth.
China faces a future similar to that which Japan has already experienced in that China will ultimately have a declining overall population with the resulting slow economic growth, excess capacity, very low inflation, and a shortage of labor.
The new US-China trade agreement, which was signed last week, will not likely have a big impact on the United States or Chinese economies. However, it could have far-reaching consequences elsewhere. There is concern in several countries that the Chinese commitment to boost purchases of US goods will necessarily entail reduced purchases from other countries. For example, Brazil faces a potential loss of soybean exports, several countries face a loss of exports of liquid natural gas, and Europe faces a potential loss of exports of Airbus planes. Although China has committed to a significant increase in purchases of US goods, many analysts are skeptical that China will be able to make such a large adjustment in a relatively short time frame. Then again , Chinese Vice Premier Liu said that the increased Chinese purchases of US goods will be based on market forces and “won’t hurt any third parties.” Still, it is hard to see how China can commit to a big increase in purchases and expect market forces to do the heavy lifting.
Meanwhile, the head of the EU Chamber of Commerce in China said that the deal threatens to re-write the rules of international trade.18 Joerg Wittke said that the agreement represents a form of “managed trade, meaning the US tells China what it should buy from the United States.” The goal of trade liberalization in much of the post-war era has been to avoid managed trade and allow market forces to determine trade flows and volumes. Indeed, the collapse of Communist regimes in Europe 30 years ago undermined the last vestiges of managed trade. Thus, there is concern that the trend is being reversed.
Former EU Trade Commissioner Cecilia Malmstrom said of the new US-China agreement that “de-escalation is good but very few tariffs are actually being reduced. Managed trade is not in line with multilateral norms and not really good for the economy either.” The EU is not only worried that the US-China deal will divert trade from Europe, but it is also concerned that the Trump Administration will now turn its attention to the EU, possibly imposing new tariffs on imports from Europe. Analysts have noted that the United States has already completed trade deals with China, Japan, Korea, Mexico, and Canada. That leaves the EU as the only major trading partner for which the it has not completed a new trading regime. The EU Trade Commissioner Phil Hogan said that the EU will examine the US-China deal thoroughly and decide if it violates World Trade Organization (WTO) rules. If it does, the EU might file a formal protest at the WTO. However, the WTO Appellate Body is currently unable to function because the United States has blocked the appointment of new members.
Finally, for those observers who cheered on the United States in its effort to compel China to make structural changes, there is now concern that the phase-one deal will remove pressure on China to address structural issues, such as protection of intellectual property and subsidies for state-owned enterprises. From the perspective of China, the deal temporarily removes the risk they faced of higher US tariffs and, in exchange, merely requires them to divert trade from other countries and boost purchases from the United States. Although the deal involves a promise by China to address structural issues, it does not require any specific actions with respect to structural issues that were top of mind to many US companies doing business in China. The United States promises that the phase-two deal, to be negotiated next year, will address these issues more fully. But for now, China can evidently relax. Then again Chinese Vice Premier Liu said that the new deal allows China to move ahead with reform.
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.”19 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.20 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.21 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.22 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.23 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.24 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.25 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,26 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.28 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.29 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.30 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.31 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.32 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.33 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 2012.34 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.35 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.36 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.