Global economy: fragmented but on the mend

As we approach the end of the third quarter of the year, although not in recession the global economy has been weakened by fragmented growth as wide regional performance disparities have desynchronised countries’ growth cycles. 

At one end of the spectrum is the US, with the strongest economic activity among developed countries. Its firm domestic demand and labour market have offset the pressure from strong inflation and heavy monetary tightening. Even though a slowdown is expected in the coming quarters, we expect growth to be higher in the US than in other developed countries both in 2023 (US: 2.2%; G7: 1.4%) and in 2024 (1.6% vs. 1.1%). At the other end of the scale, China has failed to keep up its second-quarter post-lockdown rally. Its tight monetary policy revealed the cracks in its real estate market and fuelled bankruptcy jitters. As a result, China’s growth is likely to slow down again in the third quarter (3.8% year on year forecast), while the outlook for 2023 has been revised down (we are expecting 4.8%) and the targeted 5% for the coming years seems doubtful without a more aggressive economic policy. China’s engine has stalled, and this is slowing down exports from developed countries and commodity-producing emerging countries.

Meanwhile, Europe’s activity is not far above recession level while its inflation is not easing the way it has in the US. On the other hand, income has been boosted by wage rises and improved employment, and aided by government handouts to make up for higher energy prices. Disparities between eurozone countries have widened while the UK has had to contend with Brexit-related barriers to trade and recruitment. The high inflation in Europe has only just peaked and it is still unclear whether further monetary tightening is to be expected.

Sectors have also shown diverging trends: services held up well until the third quarter while manufacturing was in recession, struggling with excess inventory and sparse order books.

Disparities linked to strategic choices

This global cycle upset is more than just the usual arrested rebound that tends to happen after a crisis. The fragmenting has as much to do with budget policy-makers’ headlong rush to make up for setbacks like the pandemic and the energy crisis as with the structurally shaky growth models chosen by some countries.

Certain strategic choices need to be reconsidered, for example Germany’s industrial specialisation and reliance on imports of cheap energy; China’s dependency on its real estate sector, which has become a major risk; and relations between developed and emerging countries – both commercial (trade of commodities, electronic components or pharmaceuticals) and geopolitical – which have come to pose more risks than they offer opportunities.

Added to that, governments are seeing their scope for action being restricted by the costs of their stimulus. Their widening budget deficits are building mountains of debt that it will take many years to work through, yet they keep delaying spending cuts. After dipping in 2022 with the help of strong economic activity, deficits are on the increase again in 2023, a trend which is expected to continue in 2024. Meanwhile public debt keeps growing, as does the interest expense, although central banks in developed countries are starting to wind up their monetary tightening cycles.

Starting a fresh cycle through investment

The first action needed for kick-starting the world economy is solving the most pressing domestic issues like the real estate crisis in China and energy supply disruptions in Europe. Answers for China are expected in the coming months, and steps have already been taken in developed countries towards resolving the fragmentation. Then capital investment will have to resume for a more balanced cycle to take shape. A wise strategic move recently made by several countries has been prioritising fiscal support for investment in new technologies, infrastructure and adaptation to climate change. This should contribute to normalising economic activity, reducing performance disparities between regions, and probably boosting competition. In the medium term, it should also raise global growth potential and productivity gains, which had become weak before the pandemic.

This investment in new technologies and the spread of artificial intelligence across industrial sectors may cause a productivity shock of the same magnitude as when the internet took the world by storm. Eventually though, the fragmented economy should gradually resynchronise in 2024 and 2025 as growth drivers rebalance and rally around productive investment.

+ Check out our Daily Macroeconomic Digest