OECD Economic Outlook 2016 sees global economy stuck in low-growth trap unless policymakers act now to keep promises
Continuing the cycle of forecast optimism followed by disappointment, global growth has been marked down, by some 0.3 per cent, for 2016 and 2017 in the 2016 OECD Economic Outlook since the November 2015 OECD Interim Economic Outlook and the global economy is set to grow by only 3.3 per cent in 2017. This reflects a combination of subdued aggregate demand, poor underlying supply-side developments, with weak investment, trade and productivity growth, and diminished reform momentum.
OECD GDP growth is projected to be just under 2% on average over 2016-17, broadly in line with outcomes in the previous two years. Supportive macroeconomic policies and low commodity prices should continue to underpin a modest recovery in the advanced economies, assuming that wage increases and business investment growth both start to pick up and tensions in financial markets do not reoccur. However, weakness in external demand stemming from the emerging economies remains a drag on the advanced economies.
The potential exit of the United Kingdom from the European Union (Brexit) is a major downside risk. Brexit would have much stronger spillovers if it were to undermine confidence in the future of the European Union. In such a scenario, equity prices would drop further and risk premia for euro area sovereign and corporate bonds would increase by more, slowing GDP growth more substantially. Together with a fall in the euro, this would add to pressures on private and public finances, especially in countries where debt remains high. This risk would compound the existing political tensions in the European Union related to high refugee inflows and ongoing financial efforts to stabilise Greece. Other downside risks to global activity relate to a possible escalation of conflicts, including in Ukraine and the Middle East.
The prolonged period of low growth has precipitated a self-fulfilling low-growth trap. Business has little incentive to invest given insufficient demand at home and in the global economy, continued uncertainties, and a slowed pace of structural reform. In addition, although the unemployment rate in the OECD is projected to fall to 6.2 per cent by 2017, 39 million people will still be out of work, almost 6.5 million more than before the crisis. Muted wage gains and rising inequality depress consumption growth.
In per capita terms, the potential of the OECD economies to grow has halved from just below 2 per cent 20 years ago to less than one per cent per year, and the drop across emerging markets is similarly dramatic. It will take 70 years, instead of 35, to double living standards.
Global trade growth, at less than 3 per cent on average over the projection period, is well below historical rates, as value-chain intensive and commodity-based trade are being held back by factors ranging from spreading protectionism to China rebalancing toward consumption-oriented growth.
In trying to revive economic growth with monetary policy alone, with little help from fiscal or structural policies, the balance of benefits-to-risks is tipping. Financial markets have been signalling that monetary policy is overburdened. Pricing of risks to maturity, credit, and liquidity are so sensitised that small changes in investor attitude have generated volatility spikes, such as in late 2015 and again in early 2016.
Fiscal policy must be deployed more extensively, and can take advantage of the environment created by monetary policy. Governments today can lock in very low interest rates for very long maturities to effectively open up fiscal space. Prioritised and high quality spending generates the capacity to repay the obligations in the longer term while also supporting growth today. Hard infrastructure (such as digital, energy, and transport) and soft infrastructure (including early education and innovation) have high multipliers. The right choices will catalyse business investment, which, as the Outlook of a year ago argued, is ultimately the key to propelling the economy from the low-growth trap to the high-growth path.
Potential output per capita growth for the OECD as a whole is estimated at 1% in 2016, which is between ¾ and 1 percentage point below the average in the two decades preceding the crisis. Two main factors have contributed to this decline: weak capital stock growth accounts for around one-half of the slowdown, and the rest is accounted for largely by declining total factor productivity growth.
Sluggish demand and productivity growth, low inflation, substantial downside risks and, in some areas, high unemployment call for sustained well-balanced macroeconomic policy stimulus and productivity-enhancing structural reforms. Policy needs differ across countries, reflecting differences in their cyclical position, past policy measures and resulting policy space. Adopting a more co-ordinated and comprehensive policy approach both within and across countries offers the prospect of breaking out of the low-level global growth environment.