Economist Saul Eslake on the worrying trends in the global economy

With cheap money declining and the working age population shrinking, 2019 could prove problematic for the state of the global economy.

The coming year may see three trends that have been underway for a long time come into much sharper focus, potentially creating significant challenges for the global economy, especially if they collide with a deteriorating geopolitical environment. The first is the slowing in the growth rate of working-age populations, particularly but not exclusively among advanced economies. From 1990–2010, the 15–64 year old population sectors of the advanced economies grew at an average annual rate of 0.6 per cent. Over the subsequent eight years, however, the growth rate of this age cohort has slowed sharply, and has now turned negative (see chart). A similar trend is apparent in China, Russia and Latin America.

The second trend is the slowdown in productivity growth in advanced economies. This began before the global financial crisis (GFC) of a decade ago, but has continued. There is no consensus as to the reasons why, but research suggests it may be due to a breakdown in the ways in which advances in productivity at “frontier firms” are diffused throughout the broader economy. The persistence of relatively large amounts of spare capacity in advanced economies — evidenced by high rates of unemployment/under-employment — in the years following the GFC, meant that neither of these trends had much impact on rates of economic growth.

Now that an increasing number of advanced economies — in particular the four largest (US, Japan, Germany and UK) — appear to have used all their spare capacity, the constraints imposed by these slow-downs in working-age population and productivity growth are becoming more binding.

It’s in this context that a third trend becomes more important. The era of “cheap money” instigated by the central banks of the world’s largest advanced economies in the aftermath of the GFC is drawing to a close. The banks’ priorities are shifting from stimulating growth and avoiding deflation to removing distortions in financial markets and ensuring inflation does not accelerate to destabilising levels as it has done in the past, whenever economies are pushed to grow at faster than their “potential” rates when they have used up all their spare capacity.

The US Federal Reserve has gradually raised its key policy interest rate since the end of 2015, and signalled it will keep doing so until monetary policy no longer provides any stimulus to the US economy. It is also gradually rolling off its massive holdings of government securities. The European Central Bank is likely to do the same in 2019. Rising US interest rates and the end of quantitative easing are likely to prompt more volatility in financial markets — as we began to see in 2018 — and could also disrupt heavily indebted emerging markets.

Deteriorating geopolitcal environment

The impact of these three developments could be magnified by a deteriorating geopolitical environment. The trade war between the US and China is likely to result in higher inflation and lower productivity growth in the US, and slower economic growth in China. It’s also likely to detract from business confidence, especially if trade tensions broaden into tensions in other areas of the US–China relationship.

Geopolitical tensions could also put further upward pressure on oil prices, the consequences of which will be more serious in an environment of rising inflation than they have been over the past decade when deflation was a greater concern.

Finally, there is at least some potential for developments in Europe, including a messy Brexit, disputes between Italy and the EU over fiscal policy, and the end of the Merkel era in Germany, to have adverse consequences beyond Europe’s shores. All this suggests more downside risks to global growth in 2019.

While Australia is far less challenged by its demographic profile than other advanced economies, we will still be affected by a slowing in global economic growth, greater volatility in financial markets and an increase in geopolitical uncertainty. We have less policy room to respond to external shocks than a decade ago and local headwinds to contend with, including declining property prices, weak growth in household incomes, and persistently poor productivity growth. And, of course, a federal election in 2019, which means the policy choices at stake may well be sharper than they’ve been for a long time.