The tepid Twenties

After a spell of soaring prices and steep interest rates, Christine Lagarde this week allowed herself a moment of optimism.

“We are clearly seeing signs of recovery,” the European Central Bank president said on Wednesday. A “phenomenal” job market would be matched by a rebound that, although “timid” at first, would pick up speed over the course of 2024, she added.

Her relieved tone — reflected elsewhere in a sunny Washington during the IMF and World Bank’s spring meetings — was understandable. A buoyant US economy, soaring domestic demand in India and waning price pressures elsewhere have reduced the chances of a much-feared global recession to near zero. The IMF now foresees the world economy growing by 3.2 per cent this year, up from the 2.9 per cent projected six months ago.

“The mood this time was a bit more positive,” says Masood Ahmed, president of the Center for Global Development think-tank and a former IMF and World Bank official. “The near-term economic outlook is a little better.”

Yet any celebrations over the apparent soft landing among the central bankers and ministers in Washington were heavily mitigated by two factors.

The first was the mounting possibility that sticky price pressures in the US will keep Federal Reserve interest rates, and thus global borrowing costs, higher for longer. That will hammer emerging markets with large amounts of dollar debt, and complicate plans for the ECB and other central banks to cut their own rates, even if they insist they will not be swayed by deliberations in Washington.

The larger cloud on the horizon was an increasingly gloomy prognosis for the outlook for global growth over the rest of this decade. The world economy was at risk of falling into “the tepid Twenties”, warned IMF managing director Kristalina Georgieva ahead of the meetings, if policymaking did not dramatically change.

The medium-term projection in the fund’s World Economic Outlook, which shows where officials think growth will be five years from now, are the lowest in decades. By the end of the 2020s global growth would slide by more than a percentage point compared with the pre-pandemic average, the fund found.

What lies behind the gloom is a mixture of weak productivity, a retrenchment in globalisation — and its corollary, frequent bouts of geopolitical turmoil.

Together this toxic combination would drag growth down to paltry levels and, in so doing, sow the seeds of “popular discontent” with mainstream politics, Georgieva warned. The risk is especially pronounced in some of the world’s poorest countries, which are likely to fall further behind their counterparts in emerging markets and advanced economies.

The trend — and how to address it, the IMF chief added on Thursday — is “what I think [about] when I wake up in the middle of the night”.

The fund’s pessimism is built around a view that years of low interest rates following the 2008 global financial crisis led to a misallocation of capital that kept inefficient zombie companies in business and stopped investment being deployed into more promising and profitable activities.

With investment low, the outcome has been sluggish productivity growth in several big economies, notably in the EU. Officials’ fear is that countries, especially those with ageing populations and less budgetary wriggle room, will struggle to reverse the trend.

Donald Kohn, a former vice-chair of the Fed now at Brookings, says the global backdrop is likely to remain rockier than more benign conditions seen in recent decades. “There were a whole series of positive supply shocks through the 1990s and 2000s, for example the fall of the Iron Curtain, the integration of eastern Europe, China’s entry into the WTO, and so on,” he says.

Now those positive shocks are no longer coming. Instead, the world economy is being buffeted by upheavals including the pandemic and wars. “That’s clearly bad news for the global economy.”

In addition, the big increase in the global labour supply seen in earlier decades has waned, leading to upward pressures on costs and prices. “That will need to be countered by central banks,” Kohn adds.

Another big source of concern for attendees is a fragmentation of the global trading system, with nations — including the world’s two largest economies, the US and China — increasingly resorting to tariffs and subsidies to protect domestic interests.

Industrial policies, once anathema in global economic policymaking circles, are back on the agenda. By IMF calculations there were more than 2,500 policy interventions worldwide last year. The world’s three big economic powers — China, the EU, and US — account for almost half of the total.

Gita Gopinath, the IMF’s first deputy managing director, warned in December that global losses from trade fragmentation could be as much as 7 per cent of gross domestic product.

The fear for those who oppose this kind of interventionism is that, in a year when more than half the world’s population is heading to the polls — including in the US and in Europe — politicians will be tempted to erect ever-larger trade barriers to win votes.

Presumptive Republican US presidential nominee Donald Trump plans to impose a 10 per cent tariff on all imports, a proposal criticised by World Trade Organization director-general Ngozi Okonjo-Iweala on Tuesday.

“I hope sincerely that will not happen,” she said at a Peterson Institute event, “and that if it does happen other members will keep a cool head and not retaliate so we can preserve the world trading system.”

But the mood in Washington is hawkish on both sides of the aisle. Joe Biden, the president, said this week that he wanted to triple tariffs on Chinese steel.

On the sidelines of the meeting, others accused the likes of the IMF and the WTO of neglecting the losers from the post-second world war push to create a global economic order that favoured elites.

“The problem over the past 50 years was not globalisation, it was globalism,” says Ian Bremmer, the founder of Eurasia Group. “It was decisions being made by a small number of beneficiaries, that were very powerful, that said, ‘We’re not going to pay attention to the fact that the social contract is eroding.’”

Plugging the productivity gap will require fresh thinking, the fund has warned. Steven van Weyenberg, the Dutch finance minister, echoes its message that governments have to “find new drivers of growth”. Those could include making it more attractive for workers to spend longer hours in their jobs, he tells the Financial Times.

More immigration — a factor that, politically controversial as it may be, many at the meetings said lies at the centre of the US economy’s impressive performance — was also touted in Washington as a way of restoring global growth. Others here suggested efforts to bolster investment in key skills and women’s participation in the labour market might boost productivity, along with the time-saving potential of generative artificial intelligence.

Yet the view at the spring meetings was that there might not be much time or space left for finance ministers and central bankers to turn the tide.

People read that there’s a massive US deficit and think that’s true. But then just get on with their lives

What makes the situation so difficult is the paltry fiscal firepower that so many countries have at their disposal. Central bankers in the US and beyond, scared by the worst bout of inflation in generations, remain cautious about cutting rates and lowering governments’ borrowing costs.

Combining the “incredible amounts of investment” needed for future growth with “sound and sustainable public finances requires choices”, van Weyenberg says. “There is quite a challenge ahead here.”

The US was at the centre of many senior policymakers’ fears. It is expected by the fund to record a fiscal deficit of 7.1 per cent next year — more than three times the 2 per cent average for other advanced economies — while the Congressional Budget Office believes its net interest payments will top $1tn after 2026.

Many economists believe the budgetary position will continue to worsen, with a class of policymakers that displays no obvious appetite to rein in borrowing irrespective of the outcome of the presidential election.

The concerns do not stop with the US. China, which is combating the threat of deflation and weak growth, is set to record a deficit of 7.6 per cent in 2025 — more than double the 3.7 per cent average for other emerging markets.

The danger, some believe, is that in an environment of frequent shocks — ranging from wars to pandemics — the authorities may have become more adept at ignoring mounting budgetary hazards than tackling them.

“There’s a tolerance and willingness to live with these risks,” says Ahmed, of the Center for Global Development. “People read that there’s a massive US deficit and think that’s true. But then just get on with their lives.”

Anxiety about the economic prospects has diminished further given the absence of a long-feared hard landing driven by vertiginous interest rate increases. “People are less worried about the near term now,” Ahmed adds.

Yet given the forces standing in the way of robust growth in the coming years, the current economic respite may prove discouragingly fleeting. The downward trajectory in the IMF’s longer-term growth forecasts looked like a “Swiss ski slope”, said Georgieva. “I don’t want that for the future.”