Will there be a new global recession?

Carlos Braga

Four megatrends in an uncertain economic climate.

John Kenneth Galbraith once said that the “only function of economic forecasting is to make astrology look respectable.” The temptation, however, is always there because of the high-stake social and political implications of economic downturns. Actually, there is a whole industry of economic consultancies, international organisations and “experts” that make a living off such forecasts.

Their track record is not particularly good. For example, the IMF, probably the most respected source of global economic predictions, released a forecast in October, 2008, predicting that the world economy would grow 3% in 2009. The reality, however, was an economic contraction of 0.6%.

To make things even more complicated, there is no consensus on the definition of what constitutes a global recession. Even national definitions, eg, two consecutive quarters of decline in a country’s real (inflation-adjusted) gross domestic product (GDP), are at best useful rules of thumb that are typically complemented by analyses of a broader set of macroeconomic indicators for establishing when a recession occurs.

Abstracting from the complexities of establishing a universal definition, this article simply adopts the rule proposed by IMF staff in 2009: a global recession entails a contraction in world real per capita GDP accompanied by a decline in other key indicators of global economic activity (eg, international trade, oil consumption, employment, industrial production, etc.). Against this benchmark, the probability of a global recession in 2013 is very low.

The regional picture
The rationale for such a prediction is simple: with world population growing around 1% per year, even anaemic growth in world output of around 2.9% (using market exchange rates), as currently predicted by the IMF for 2013, will provide enough cushion to dispel concerns about a global recession. Needless to say, aggregate numbers hide significant variance across nations. For example, weak macroeconomic performance in OECD countries will most likely continue to be the norm:

• European countries – and the Eurozone countries in particular – will in many cases grow at a much slower pace than the world economy, and in some cases (Greece, Spain, Italy), economic contraction is expected.
• The timid economic recovery of the United States could be significantly curtailed by the statutory borrowing limit for the US federal government, which is likely to be reached in early 2013. Political impasse around these issues may lead to significant headwinds, and could even take the US economy into a recession. The working hypothesis here, however, is that this issue will be addressed in 2013 and the debt limit will be raised, preventing additional tensions in the debt market.
• The prospects for the Japanese economy are not bright either, as the impact of the earthquake reconstruction efforts wind down, doubts about the resolve of the Bank of Japan to fight deflation remain, and geopolitical tensions in Asia continue to affect exports. All these factors conspire in favour of continued economic stagnation.

The good news is that, while high-income economies accounted for close to 75% of the world economy five decades ago, today their share is around 55%. In other words, the drag imposed by their weak performance on the world economy has been significantly reduced.  Actually, one can expect emerging economies to continue to provide the main sources of world economic growth in the years to come. For example, the four largest emerging economies (the BRICs) are currently among the 10 leading world economies, and they are all expected to grow at a much stronger pace (in the 3.5% to 8% range in 2013) than their industrialised counterparts.

Four megatrends
What does all this mean for business in 2013? Again, it is important to underscore that these broad macroeconomic trends represent only one piece of the puzzle facing the management of companies around the world. After all, there can be many dynamic niche opportunities in countries that are not performing particularly well. Still, the following megatrends, which are likely to prevail in the coming years independently of country-level accidents, should be considered in framing corporate strategies:

1. The importance of looking for growth opportunities beyond OECD markets: there has been a major structural shift in the dynamics of the world economy which is fostering a long-term trend towards international economic convergence. Although it should not be interpreted as implying a total decoupling between OECD countries and emerging economies, the reality is that emerging economies are expected to account for most of the growth opportunities in the future. The relevant question, then, is “how well prepared is your company to face globalisation?”
2. The imperative of being prepared for new financial shocks: non-traditional interventions by central banks, particularly in Europe and in the US, have bought time for governments to adjust their fiscal strategies and to support the required financial de-leveraging by the private sector. But we are not out of woods yet, and if evolving adjustment policies lack long-term sustainability, one cannot dismiss the possibility of new global financial shocks. In this context, companies need to continue to focus on cost reduction, while adjusting to the new competitive environment.
3. The importance of innovation: in difficult economic times, there is a natural temptation to postpone investments in R&D. History suggests, however, that companies which bet on innovation typically fare better over the long term. In the current economic climate, this is of particular relevance, not only because the competition for knowledge is likely to increase (with the diversification of centres of knowledge across the globe), but also because these investments offer significant growth opportunities in an environment characterised by low returns on financial investments.
4. The need to respond to the growing complexity of the regulatory environment at national and international levels: a new era of government activism in response to the Great Recession is here to stay. The chances of regulatory overreach based on negative perceptions about market-oriented solutions are nontrivial. Hence, it is important to engage both at the national and multilateral levels with a view to maintaining the “corporate space” for companies to do what they do best: promote innovation and growth.

In sum, a global recession in 2013 is unlikely. Still, it will be a challenging year, but those companies willing to embrace globalisation and continue to invest in innovation are likely to prevail.

Carlos Braga is Professor, International Political Economy, IMD and Director, Evian Group at IMD.