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The global economy is on the mend — unless debt dooms the recovery
(Reprinted from The Washington Post) The global economy is on the mend — but will the recovery be quashed by too much worldwide debt?
Just last week, the International Monetary Fund raised its forecast for world economic growth to 3.9 percent for both 2018 and 2019. Most advanced societies — the United States, Japan, Europe — grew faster in 2017 than expected, and the momentum has carried into 2018.
Consider: In October 2017, the IMF predicted 2.3 percent growth for the U.S. economy in 2018; now the forecast is 2.9 percent. For the world, growth in 2018 is expected to be nearly one percentage point higher than in 2016.
Superficially, this seems small potatoes. It isn’t. By some estimates, the size of the world economy is $130 trillion in 2018. An extra one percentage point of production translates into nearly $1.3 trillion more of clothes, cars, computers, tractors, tourism, health care — and much more.
To explain the growth surge, the IMF cites multiple causes. Businesses began to exhaust surplus production capacity, so they invested more in new plants, computers and machinery — an area of lagging spending. International trade has accelerated. The Trump tax cut will temporally spur growth. Credit conditions remain easy, despite higher interest rates. That is, the rates are still historically low.
Against this backdrop, many private economists are equally optimistic. Karen Dynan of Harvard and the Peterson Institute says the global economy is entering a “cyclical boom.” But risks remain. Both Dynan and IMF chief economist Maurice Obstfeld warn of dangers to the recovery.
One possibility is a trade war between the United States and some trading partners, including China, Mexico, Canada and Japan.
“That major economies are flirting with trade war at a time of widespread economic expansion may seem paradoxical, especially when the expansion is so reliant on [business] investment and trade,” Obstfeld said at a press briefing. Even more disruptive might be a shooting war on the Korean Peninsula or elsewhere.
Perhaps the biggest danger is debt. If the world economy is overly dependent on debt — loans to households, businesses and governments — and debts are reaching (or have already reached) unsustainable levels, then there’s obviously a huge contradiction at the core of the recovery.
Glance at the table below. It shows worldwide debts in trillions of U.S. dollars for 2001, 2007 and 2016. The data come from the IMF and (again) cover businesses, households and governments. “Emerging market” countries include China, India and other developing nations with sizable economies. Low-income developing countries are very poor — for example, Bangladesh.
No one knows the “right” level of debt. It varies among borrowers and may change abruptly, depending on shifting economic and financial circumstances. What seems prudent Tuesday may become inadequate Wednesday.
As the table shows, total global debt is still growing. From 2007 to 2016, it expanded by 41 percent; China’s fivefold increase is noteworthy. According to the IMF, worldwide debt is now at a record high as a share of the global economy (gross domestic product), about 12 percentage points more of global GDP than in 2009 during the Great Recession.
The great fear of high debt levels is that given a recession, a runup in interest rates or some other financial surprise, business and household borrowers won’t be able to service their debts. Some will default; to avoid default, others will cut their spending. The economic consequences will be harsher recessions.
As for governments, they may face higher interest rates that crowd out other spending. (Of course, the strategic use of higher deficits to defuse recessions also is possible.) Still, governments, including the U.S., have trouble raising taxes or cutting spending to reduce their borrowing needs.
What would be ideal now is for the worldwide pickup in economic growth to continue so the most exposed borrowers could slowly reduce their debts while their incomes increased. The crucial question is how much the global recovery depends on more debt. If the answer is “a lot,” we are courting trouble.
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