A recent report from research firm McKinsey & Company takes an in-depth look at the current challenges facing the global economy. The report, titled Shifting tides: Global economic scenarios for 2015–25, argues that low aggregate demand, coupled with aging demographics and the urgent need for structural reform in many emerging economies puts the global economy at a crossroads.
Authors Luis Enriquez, Sven Smit and Jonathan Ablett analyze current macroeconomic conditions and trends in developing four possible scenarios for the global economy in the future. The first scenario is called “Global Synchronicity,” the second “Pockets of Growth”, the third “Global Deceleration,” and the fourth “Rolling Regional Crises.”
Scenario 1 (Best) – Global synchronicity
The global synchronicity scenario projects robust long-term growth across the world. Enriquez et al. suggest that if the economic stars align, the global economy could see growth of 3.7% annually through 2025. They describe what it would take to make this rosy scenario come true: “The United States, the Eurozone,and Japan are able to make the transition to more sustainable growth while exiting from their monetary stimuli with minimal disruption. Likewise, policy makers in China implement incremental changes and guide economic growth smoothly and gradually downward to a sustainable level. India emerges as the fastest-growing economy over this period as it rides a wave of reform, investment, and robust demographics. By 2025, the global economy will have grown to $90 trillion in constant 2015 dollars, from $62 trillion in 2015.”
With continued growth, liquidity from the seemingly never-ending QE by the Fed and ECB is gradually absorbed. Moreover, new trade agreements lead to fewer barriers in service industries and high levels of cross-border activity and technology transfer. Rapid innovation and global trade arrangements will increase the share of exports in GDP for the G-20 from 25% in 2015 to 29% by 2025.
Significant reforms in emerging economies lead to the emergence of market-driven, solidly-grounded financial markets. Interest rates finally return to the “old normal” levels as inflation creeps back up. Oil and other commodity prices move up apace as “productivity-induced supply gains cannot keep pace with emerging-market demand.”
Finally, employment growth continues reasonably strong with unemployment rates generally falling across the globe.
Scenario 2 (Good) – Pockets of growth
In the pockets of growth scenario, growth is more uneven, as some nations tackle structural challenges more effectively than others. Global growth hits a respectable 3.2% a year, and by 2025 the global economy will hit a new record of $88 trillion (in 2015 dollars).
In this scenario, the U.S., China, and India manage to maintain reasonable growth levels, but the eurozone and Japan remain wired in weak growth.
Enriquez and colleagues offer some specific projections for the pockets of growth scenario: “The unevenness of the expansion makes agreements harder to reach on international protections for investors, intellectual property, and agricultural subsidies. As a result, trade growth starts to slow and remains effectively flat relative to GDP at 25 percent.
Some countries find it difficult to exit from unconventional monetary policies, which continue to distort credit channels and capital flows. The search of investors for higher or more stable yields quickens, adding to volatility. Oil prices gradually revive on higher demand, and producers of other commodities encounter more frequent supply constraints.”
Scenario 3 (Not so good) – Global economy deceleration
The lower-growth global economy decelerating scenario would see global growth clock in at 2.9% through the rest of the decade, slightly below average for the last 30 years. Note that this economic growth number does depend on largely positive outcomes in terms of reforms in emerging markets. The global economy might hit $86 trillion in 2015 dollars based on this scenario.
In this scenario, China avoids a “hard landing,” but confidence in the financial and fiscal system is shaken by a “not-so-soft” landing, hurting growth. China would still represent nearly 23% of global GDP by 2025 under this model.
Europe and the U.S. take advantage of a modest global revival of demand “to make progress on financial services, privacy, and M&A activity, which becomes a benchmark for global emulation. Trade is a more important driver of growth in this scenario than in the previous one. The lower growth curve is a constraint, but trade still accounts for 27 percent of the global economy.”
The demand for energy picks up modestly, but commodity prices recover slowly as additional supply comes on line.
Scenario 4 – (Bad) Rolling regional crises
In the rolling regional crises negative scenario, global growth weakens and the world economy only grows from $62 trillion today to $78.6 trillion in 2015. In this projection, structural reforms stall, and aggregate demand does not rebound sustainably. On a practical level, the deleveraging will continue to hamstring household balance sheets, and corporate-debt levels keep moving up.
In this scenario, global central banks rely heavily on “conventional and unconventional forms of fiscal and monetary stimulus. Real interest rates remain in negative territory, but the growth outlook fails to encourage renewed investment growth. Incremental fixed investment in the G-20 countries totals little more than half the level in the global-synchronicity scenario.”
There will also be negative follow-on effects, as many firms do not invest sufficiently in R&D and technological innovation is stifled and regionalized. That will likely be followed by growing restrictions on international M&A, and new national regulations limiting expansion of trade and technology. The McKinsey analysts suggest the net result will be that the share of exports in GDP for G-20 nations will only increase from 31% today to 34% a decade later.
Projections for this scenario call for slower employment growth and the G-20 nations creating 60 million fewer jobs than they would under the global-synchronicity scenario.
By the same token, barring major supply disruptions, the lack of growth and new supplies coming on line means energy prices will probably remain at low levels for the entire decade.