22.12.2016

Will politics shake the global economy out of its torpor in 2017?

by Aberdeen

400The strains of a global economy mired in a low growth, low inflation and low interest rate regime are showing. Populist, anti-establishment and anti-globalisation sentiment is on the rise across the developed markets. If this leads to a marked deterioration in the quality of economic decision making, it could spell the end of a seven-year period of growth – however weak – for the global economy.

But there are alternative possibilities: a new wave of insurgent politicians could shake things up for the better; or incumbent politicians and central bankers could raise their game and deal with economic headwinds once and for all.

The most striking feature of the global economy as we head into 2017 is how weak GDP growth remains. This is despite exceptionally loose monetary policy in many economies, easing credit conditions, and the era of fiscal consolidation largely coming to an end. But while the immediate legacies of the global financial crisis have faded, structural headwinds remain: ageing populations, a long period of underinvestment in the capital stock, slowing technological change and subdued ‘animal spirits’ are all weighing on spending and investment, lowering the potential growth rate of the global economy.

Weak global economic growth is generating a populist, anti-establishment and anti-globalisation backlash that is likely to have a significant bearing on economies and financial markets in 2017. The US presidential election, the UK’s referendum on European Union membership and the Italian referendum on constitutional reform were heavily influenced by popular discontentment. In the year ahead, federal elections in Germany, the French presidential election and a general election in Holland are all likely to see popular discontentment play a prominent role in voting.

If 2017 brings further electoral success for populist, anti-establishment politicians, it could lead to rising protectionism, higher trade tariffs, crumbling free trade areas, reduced support for multilateral institutions, and less economic migration. These developments could all knock the global economy off the rails.

Many of the policy changes that populist politicians are calling for could feasibly support economic growth.

But this is not inevitable. The current policy mix – loose monetary policy, tight fiscal policy, and little in the way of much-needed structural reform – could hardly be called optimal, after all. Many of the policy changes that populist politicians are calling for could feasibly support economic growth: lower taxation; higher government spending; and a decreased reliance on loose monetary policy as the primary policy lever.

Alternatively, 2017 could mark the year that incumbent politicians and central bankers raise their game and deal with global economic headwinds once and for all. There is certainly much that could be done, if only the incumbents mustered the political will. A globally coordinated government investment push; a lowering of the labour tax wedge; an innovation-friendly overhaul of the patent system; corporate governance reform that encourages firms to spend and invest large cash hoardings; a more redistributive tax system; and the completion of the Eurozone banking and fiscal unions would all help.

One thing is clear: another year of low growth and a suboptimal policy mix will not satiate the widespread thirst for change.

Paul Diggle
Senior Economist -  Aberdeen Solutions

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