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Tuesday, January 7, 2014

Economic outlook for 2014: domestic policies will be paramount

The economic outlook for the world in 2014 is the brightest since the crash of 2008-2009. Global GDP growth will be at least as high as in 2013. However, unemployment will remain stubbornly high, especially in the European periphery, and the expansion will be constrained by the struggle to control government indebtedness. Unlike in previous recoveries, there is no identifiable “locomotive” to drag the rest of the world on to a high growth path. So it is imperative that every country tackle its own obstacles to growth, especially by investing in human capital.

In the second half of the 20th century, the United States was the global consumer that alone could pull the world economy forward by increasing imports of manufactured goods. The US was responsible for the post-war revival of Europe, through the Marshall Plan, and for Japan’s developmental take-off in the wake of the Korean War. US demand also helped revive economies hit by the Asian economic crisis of 1997-1999. The US led the world economy into recovery in the business cycles of the 1970s, 1980s and 1990s. 

The US is no longer in a position to do this because of the collapse of confidence in seemingly limitless consumer credit. Before 2008, Americans were bombarded with offers of credit cards and mortgages. Lenders are now far more wary, as are borrowers. Consumers have less to spend. Demand growth will be moderate, and increasingly satisfied by domestic production as the automotive and other major manufacturing sectors continue to recover and "re-shoring" starts to take place as a result of cost increases in recent years in former targets of offshore outsourcing like China.

As China’s economy catches up and prepares to overtake the US economy, Chinese demand has played a key role in buoying up raw materials markets, following its earlier gift to the world economy in the form of cheap exports that helped keep down the cost of living (and therefore demand high) in the developed world. Nevertheless, China is not currently in a position to become the “locomotive” pulling the world economy that it is likely to be in future business cycles. While economic restructuring in China will take many more years to complete, GDP growth is gradually decelerating.

After a quarter of a century of stagnation, the Japanese economy is reviving as a result of fiscal and monetary stimulus. To ensure that this recovery is not a mere flash in the pan, the government needs to complete long overdue structural reforms. It also needs to allay fears that this economic strengthening is motivated by militarist designs.

The lack of a single leading economy may be a good thing to the extent that it promotes self-strengthening in all countries. Although the “BRIC” economies (excluding China) are not large enough to have a major impact on the world economy — and the “MINT” economies (Mexico, Indonesia, Nigeria and Turkey) even less so, each of them is showing signs of starting to fulfil their potential. The key to growth in all of them will be government leadership. Where this is threatened by endless political infighting (India) or sectarian politics (Turkey), reform and growth will suffer.

This is particularly the case in Africa, where GDP growth is now higher than in the developed world. This welcome trend is likely to continue in 2014, but some of the most promising countries are threatened by renewed violence, as in South Sudan. Africa needs to get its act together and keep the peace so that the hard work of its inhabitants can bring the continent out of poverty.

While the outlook is reasonably bright, there are potential storm clouds on the political front. 

Maritime military jostling for position between China and its neighbours, especially Japan, could spill over into open conflict. While this is likely to be limited, it could deter investment and trade for a short time. Investors need to be reassured that the worlds second and third largest economies are co-operating peacefully with each other.

In Britain, the referendum on Scottish independence is a potentially destabilising factor. The British government is not taking this as seriously as the Scottish National Party (SNP), which is mounting a vigorous campaign to win over the majority of Scots who do not support its proposal to set up an independent Scotland. If Scotland were to secede, there would be a strong negative impact on growth in both Scotland and the rest of the former United Kingdom. Scotland would not be accepted as a member of the European Union (Spain would veto it), so this would also mean secession from the EU, making Scotland less attractive as a production platform for foreign investors seeking to access to European market. 

If gradual recovery is to be turned into a sustainable expansion, major economies need to become solvent. They also need to provide conditions in which the exciting new technologies that will fuel the next boom can develop to the fullest extent. That means improving dysfunctional education systems, making them available to those with talent who are prepared to study hard. It also means reforming them so that they provide the skills necessary for the developing knowledge economy. Governments also need to ensure that healthcare systems, public or private, are up to the job of using the latest advances in medical science to provide a healthy workforce. These imperatives, along with population ageing, present a major challenge to government finances which will need to be addressed by imaginative thinking instead of constant spending cuts.

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