Unforeseen geopolitical events have clouded the picture for the world’s economies in 2017. Political discontent has boosted anti-establishment forces in countries from the United Kingdom to the United States, potentially throwing the global trade agenda into turmoil.
U.S. President-Elect Donald J. Trump’s intention to reshape hemispheric trade relations makes Latin America’s economic prospects far from clear, writes CFR’s Matthew Taylor. After facing recession in 2016, the region could begin a slow recovery in the coming year. But uncertainty in Brazil and instability in Venezuela, as well as unpredictable elections across the continent, could hamper a resurgence.
In Europe, meanwhile, “aftershocks from the euro crisis continue to afflict the region,” writes Iain Begg of the London School of Economics. With downside risk from Brexit looming, and trade and economic integration threatened, there is no end in sight to the wave of political disaffection sweeping the continent.
For CFR’s Brad Setser, China’s ability to transform its economy will have global repercussions. He warns that deep concerns remain over imbalances caused by the country’s reliance on credit and its high savings rate, and further reforms are needed.
Lackluster global growth can be traced to “troubling signs of growing risk aversion in the private sector,” argues economist Dambisa Moyo. Unless companies start making productive investments rather than continue to increase dividends, higher growth rates will prove elusive for most of the world’s economies.
In 2017, Latin America hopes to slowly recover from a period of declining commodity prices, which has hobbled the region since 2010. But diminished global trade prospects, the complexity of needed reforms, and a volatile regional electoral calendar will contribute to economic uncertainty.
Of all the Latin economies, Venezuela is closest to the precipice after three years of recession. Devastating hyperinflation and food scarcities, matched by hefty debt obligations and a threatening political impasse with the opposition, suggest that the crisis will deepen in the year ahead.
The region’s largest economy, Brazil, may begin a tepid climb back from its worst recession in a century. But 2017 growth is forecast to be less than 1 percent, and even this anemic expansion will depend on the Temer administration’s ability to withstand potentially destabilizing corruption investigations and implement politically polarizing fiscal and pension reforms.
Argentina’s new president, Mauricio Macri, has spent his first year in office clearing away what he has called the "bombs in the economy" left behind by the Kirchner presidency. Argentina’s return to international capital markets and stronger investment flows, as well as the recovery of neighboring Brazil, could contribute to growth just shy of 3 percent in 2017. But falling wages, stubborn inflation, and a hostile Congress readying for October elections will provide headwinds.
The stability brought by Colombia’s peace deal with FARC rebels could yield economic dividends, but growth seems unlikely to budge beyond 2.5 percent. Much depends on the approval of tax reform in the waning days of 2016, and the complexities of making the peace agreement a reality in the new year.
"Discontent over slow growth, political stalemates, and widespread corruption means that these could be the most wide-open elections in a generation."
In Mexico, President Enrique Pena Nieto’s declining popularity, amid rising violence and corruption scandals, threaten his economic agenda. Abroad, the United States’ trade stance is likely to harden under President Donald J. Trump. Mexico faces a new world in which NAFTA and the tenets of free trade no longer seem sacrosanct.
This is only part of an ongoing regional realignment on trade. The Pacific Alliance economies—Chile, Colombia, Peru, and Mexico—are looking beyond the moribund Trans-Pacific Partnership; talks are underway with members of the Asia-Pacific Economic Cooperation (APEC) forum, and China seems eager to fill any void left by a trade-averse United States. Members of the South American Mercosur bloc, having cast aside Venezuela in 2016, are hoping to move forward on trade deals of their own.
Finally, nearly all of Latin America’s leading economies face significant elections by the end of 2018, including congressional elections in Argentina and presidential elections in Chile, Brazil, Mexico, Colombia, and Venezuela. Discontent over slow growth, political stalemates, and widespread corruption means that these could be the most wide-open elections in a generation. The resulting political turbulence could roil the economic outlook even further.
Europe faces a conjunction of tricky challenges in 2017. Aftershocks from the euro crisis continue to afflict the region’s economies. Particularly concerning is the instability of banks in countries such as Italy, where the stock of non-performing loans remain substantial. Greece, despite some progress, is still struggling to recover from its multiple crises and renewed tensions over implementation of its reform program can be expected.
"Europe’s leaders have yet to find convincing answers to the wave of political disaffection sweeping the continent."
Apart from these difficulties, slow economic growth is undermining confidence in the capacity of policymakers to respond effectively. The European Central Bank has arguably gone about as far as it can to shore up the economy, with interest rates effectively at the zero bound and showing little prospect of following the U.S. Federal Reserve in “normalizing” its monetary policy.
But while many have called for fiscal policy action to pick up the slack, there is very little scope for it. This is because the countries with stronger public finances, notably Germany, are close to full employment and see no reason to stimulate their economies. Meanwhile those that could do with a boost, including France and Italy, already have profound concerns about their public debt levels.
Then there is Brexit, seen by many in continental Europe as a deeply unwelcome distraction from efforts to solve other crises. Although the United Kingdom’s economy has so far proved more resilient than expected to the shock of the referendum result, the wider uncertainty engendered by the Brexit process is a downside risk for both the UK and the rest of the European Union. Negotiations are likely to focus on the extent to which the UK retains access to the EU single market, whether curbs on migration will be acceptable to the other EU countries, and the UK’s future contributions to the European Union’s finances. There seems to be within the United Kingdom too limited an appreciation of the magnitude of the task, while many policymakers across the English Channel are simply baffled about what the UK wants.
In the wake of anti-establishment referendum votes in the UK and Italy, Europe’s leaders have yet to find convincing answers to the wave of political disaffection sweeping the continent. With two of the EU’s largest members, France and Germany, facing general elections in 2017 and the Dutch populist party led by Geert Wilders ahead in the polls for the election due in March, further electoral earthquakes may be on the horizon.
All in all, 2017 promises to be a troubled year.
China demonstrated in 2016 that its "old" tools of economic stabilization still work, at least for now. China cut interest rates, loosened curbs on credit, relaxed standards on real estate lending, and authorized a new round of infrastructure investment. Officially, growth stabilized; in reality, growth likely accelerated, but from a weaker than reported level.
Nonetheless, deep concerns remain about the long-term health of the Chinese economy. For starters, China’s growth still depends on new borrowing and lending. Much of the lending comes from state institutions, and much of the borrowing and new investment done this past year came from state-owned and state-backed firms. The combination of rapid credit growth and imperfect incentives will likely lead to future losses.
But that is not the only problem. China’s heavy dependence on credit is the mirror image of its high level of domestic savings. Such savings have allowed China to finance a very high rate of investment without borrowing, on net, from the rest of the world—in fact, China has consistently saved more than it has invested.
High levels of national savings were important during the early phases of China’s development, when high savings allowed the high levels of investment needed for rapid catch-up growth. But the counterpart of high levels of savings is weak domestic consumption. With national savings still close to 50 percent of gross domestic product, Chinese growth is constantly at risk of stalling due to a lack of sufficient internal demand, which would build pressure for China to weaken its exchange rate and draw more on exports for growth. Today, high rates of savings increasingly imply either the accumulation of large domestic risks, as Chinese banks use the savings to finance risky investments at home, or the need to export savings surpluses to the rest of the world, raising global imbalances.
"The United States, like the rest of the world, has an obvious stake in the success of China’s domestic economic transformation."
Thus, China’s true challenge in 2017 is to start to implement policies that would help bring the Chinese saving rate down and help support domestic consumption in the process. All the talk of China’s excessive debt obscures a critical point: China’s central government actually has very little debt. The debt problem comes from borrowing by China’s firms and financial vehicles that are backed by local governments. The central government thus has plenty of capacity for an active fiscal policy. Think spending more on public health and basic pension benefits; reforming social services so less of the financial burden falls on local governments; and reducing China’s reliance on regressive payroll and consumption taxes in favor of income and property taxes.
The United States, like the rest of the world, has an obvious stake in the success of China’s domestic economic transformation. If China’s economy falters again, its already-large trade surplus would go up further and its government would likely conclude that it prefers a weaker exchange rate to boost exports. China is already bleeding foreign exchange reserves. It isn’t hard to see how this would put China on a collision course with the Trump administration.
Given the shocks that dominated the 2016 macroeconomic and geopolitical environments—including Brexit, the U.S. election, and the negative interest rate environment in Europe and Japan—all eyes will understandably be on global policymakers in 2017.
Yet decisions made by business leaders, especially with regard to capital allocation, will be vital for the prospects of the global economy. After all, corporations continue to play a central role in creating jobs, driving innovation, and raising living standards.
"Restoring risk appetite and capital investment to levels of prior years will be essential to driving continued growth and prosperity."
However, there are troubling signs of growing risk aversion in the private sector. Companies are increasingly choosing to return money to shareholders instead of making capital investments, such as building new factories or increasing research and development, to lay foundations for future growth.
According to research by WPP, a global communications firm, among companies listed on the S&P 500, share buybacks and dividends have exceeded retained earnings (that is, profits withheld by companies and generally earmarked for investment) in five of the six quarters up to June 2016. Moreover, the ratio of payouts and buybacks to earnings has risen from around 60 percent in 2009 to over 130 percent in the first quarter of 2016. This data signals that companies are choosing to scale back rather than grow.
This worrying trend comes at a time when forecasts for the global economy remain underwhelming, and growth is expected to slow in many regions. At the same time, policymakers face growing populist backlash from voters, as well as mounting skepticism from economists and technocrats about the effectiveness of traditional economic tools such as monetary and fiscal policy. And continued geopolitical uncertainty, with national elections slated for both France and Germany that could bring antiestablishment parties to power, will weigh on corporate investment decisions in 2017.
This could all contribute to a further drift toward investment inertia. There is an argument, after all, that it is prudent for businesses to choose to scale back during periods of heightened political and economic uncertainty. But as William Thorndike’s 2012 study of successful CEOs, The Outsiders, found, business leaders that prioritize capital allocation even in times of uncertainty consistently outperform both their peers and market expectations. This means that even if cautious companies want to hedge against market turbulence, they can do so most effectively by limiting the amount of dividends they return to investors—which has been steadily increasing—in favor of holding their capital ready for future investment opportunities.
Capital allocation decisions should of course factor in the short-term demands of shareholders, but they must also prioritize long-term growth, which is what the global economy so urgently needs. Ultimately, restoring risk appetite and capital investment to levels of prior years will be essential to driving continued growth and prosperity. President-Elect Donald J. Trump, if he is able to follow through on his plans for tax reform and deregulation, may be able to stimulate greater investment.