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If Leo Tolstoy were writing about today’s business conditions, he might have noted that happy economies are all alike but every unhappy economy is unhappy in its own way.
China’s growth prospects have been hammered by strict Covid-19 lockdowns in a bid to quell its Omicron outbreak; the US Federal Reserve risks turning an American boom into bust; Europe’s households are enduring a cost of living crisis; and the situation is worse in many poorer emerging markets, where food crises and even famines beckon.
These four different but imposing problems each stalk the global economy as it recovers from the pandemic and it is not surprising the mood is darkening.
According to Robin Brooks, chief economist of the Institute of International Finance, the confluence of these shocks suggests the world economy is already in trouble. “We’re in another global recession scare now, except this time we think it’s for real,” he says.
Financial markets have taken fright. The MSCI world index of equities fell more than 1.5 per cent in the past week, more than 5 per cent in May and more than 18 per cent since a peak in early January. Dhaval Joshi, chief strategist at BCA Research, notes that on top of a torrid time for stocks, there has been a sell-off in bonds, inflation-protected bonds, industrial metals, gold and crypto assets.
“The last time that the ‘everything sell-off’ star alignment happened was in early 1981 when Paul Volcker’s Fed broke the back of inflation and turned stagflation into an outright recession,” Joshi says.
Defining a global recession is no easy task. For individual countries, some economists define a “technical recession” as two consecutive quarters of contraction in gross domestic product. The Financial Times prefers a more flexible definition as does the US, where the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months”.
At a global scale definitions become still more difficult. The IMF and World Bank prefer to characterise a global recession as a year in which the average global citizen experiences a drop in real income. They highlight 1975, 1982, 1991, 2009 and 2020 as the dates of the previous five global recessions.
While the official global growth forecasts for 2022 still seem far off this definition — in April the IMF expected annual growth of 3.6 per cent this year — this figure relates as much to the recovery in the second half of 2021 as to expectations for 2022. When the fund looks at the growth it expects during 2022, it has already cut its forecast from 4.5 per cent in October last year to 2.5 per cent in April.
Brooks reckons that the news since this forecast was published has been sufficiently bad to lower the growth projection to just 0.5 per cent during 2022, less than the expected increase in population. “Mounting global recession risk is top-of-mind for markets, which has important repercussions for investor psychology,” Brooks says.
China is the big economy that most economists are worried about and the past week has seen new data reinforcing concerns about its prospects. Accounting for 19 per cent of the world’s total output, China is now so large that when it catches Covid the rest of the world cannot ignore its pain, especially because of its impact on global supply chains and its demand for goods and services from other countries.
Severe strains are showing. With lockdowns rippling through the country, ships queue outside Chinese ports and the country’s manufacturing and retail sectors have started to contract. Retail sales fell 11 per cent year on year in April, while industrial production was down 3 per cent. China’s home sales also dropped more last month than in early 2020, when its economy went into reverse, despite the People’s Bank of China loosening monetary policy to encourage borrowing and spending. Unemployment is rising.
Kevin Xie, senior Asia economist at the Commonwealth Bank of Australia, says that China’s economic data in April was consistently disappointing. Although the outlook depends crucially on the spread of Covid, he adds, “falling employment and weakened confidence among business and households will curb spending and bode poorly for the growth outlook”.
In the US, the other global economic powerhouse, the economy is suffering from the pandemic’s legacy and, in particular, excessive fiscal stimulus that arguably ran the economy too hot and generated high inflation even with modest energy price rises. Alongside a very tight labour market, the Fed has been forced to concede an error and has now moved decisively into a phase of tightening monetary policy to slow growth and bring inflation down.
The Fed chair Jay Powell was crystal clear this week that the central bank would continue raising interest rates until it saw “clear and convincing” evidence that inflation was returning to the 2 per cent target. He was not concerned about unemployment rising “a few ticks” from the current low level of 3.6 per cent.
Powell added that he was aiming at a soft landing for the economy, but many in financial markets think that might be hard to achieve. Krishna Guha, vice-chair of Evercore ISI, warns there is a much higher than normal risk that the tough talk from officials, economists and market participants would become a self-fulfilling prophecy and generate a downturn.
“To say a softish landing is possible is not to say it is inevitable or even particularly likely,” Guha says. Although he is not predicting a US recession, Guha says, “bringing inflation under control without a recession and large increase in unemployment . . . will be challenging”.
On the other side of the Atlantic, Europe’s equally difficult problem is different. Apart from the UK, inflation stems almost universally from higher energy prices rather than an overheating economy and can be traced directly to Russia’s invasion of Ukraine.
Unfortunately for the EU, understanding the cause of Europe’s woes does not diminish its consequences. With inflation of 7.4 per cent in April, eurozone prices are rising much faster than its citizen’s incomes, imparting a hit to living standards that will limit spending and the recovery from the pandemic. New forecasts from the European Commission this week were scaled back sharply and implied stagnation in the second quarter of 2022.
The commission expects the economy to get over this difficult period and return to reasonable growth of about half a per cent per quarter by the summer, but many private sector economists think the hit to incomes will have longer-lasting effects. Christian Schulz, an economist at Citi, says that the official forecasts appear too optimistic and it is more likely there will be “virtually no growth for the rest of the year”.
If Europe’s difficulty is in adjusting to much higher energy prices, poorer countries have the even harder task of dealing with the rapid rise in the price of food, which account for more than 30 per cent of expenditure in emerging economies.
With the Black Sea ports that Ukraine uses for exporting grains shut, fears of a food crisis later this year are mounting. António Guterres, secretary-general of the UN, said on Wednesday that the conflict in Ukraine, coming on top of existing pressures on food prices, “threatens to tip tens of millions of people over the edge into food insecurity followed by malnutrition, mass hunger and famine”.
Although it has its own domestic political and economic crises, Sri Lanka epitomises the dire choices faced in many of the world’s poorest countries when it decided this week to default on its foreign debt for the first time. This, it said, was necessary to use its hard currency for importing fuel, food and medicine.
India, meanwhile, intensified the problems in other emerging economies by reneging on a pledge not to ban the export of grain this week. Wheat prices rose again and are up more than 60 per cent this year.
Naturally, as recession risks rise, the best news for the global economy would be a Russian withdrawal from Ukraine and an end to the zero-Covid strategy in China. This is not in the gift of economic ministers and officials, so instead, they will again have to fine tune their response to the difficult situations they face.
In Europe and emerging economies, this will involve alleviating the consequences of higher food and energy prices — raising benefits and subsidising food and energy in countries with sufficiently strong public finances. The US and UK could accelerate the tightening cycle of monetary policy, while China will seek to limit the negative effects of the Omicron coronavirus wave in China.
The majority view among economists is that the defence against global recession will still win in 2022. But economists are increasingly hedging their bets in the face of relentless bad news.
Innes McFee, chief global economist at Oxford Economics, says there is little question that the global economic expansion is close to a peak, that it is slowing and that policymakers will need to work out how much tightening is needed. But, he says, a recession is still unlikely for now because policymakers still have the tools to back away and stimulate if things get worse.
“Recession risks rise into next year, but they are not that high at this time,” McFee says.
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