The global economy: prospects and challenges

We are past the halfway point in 2021 and it is apparent that a recovery is well underway for the global economy. Despite the burst in economic activity, it is still too early to call it a post-COVID era, as infections remain at high levels in some places and variants are still forcing authorities to place restrictions on key areas across the globe. Still, it is a full-fledged economic recovery, and the World Bank projects it will be the most robust in 80 years.

The recovery is not without problems, among them a rise in inflationary pressures. The rise of inflation has caused many global central banks to start winding back stimulus efforts or even starting to raise interest rates in some countries across the globe. This has caused investors to pause. Still, a recovery is here and likely to grow and sustain in a world that may finally shed the COVID era.

The World Bank projects that global growth will accelerate to 5.6% this year, led by the major economies like the United States and China. The World Bank warns that while growth for most every region has been revised upward for 2021, many continue to grapple with COVID-19 and what is likely to be a long shadow. Despite this year’s pickup the level of GDP is expected to be 3.2% below pre-pandemic projections and per capita GDP among many developing and emerging market economies will remain below pre-COVID peaks for an extended period. As COVID infections continue to flare, the disease will continue to shape the path of economic activity.

The United States and China are expected to contribute about one-quarter each to global growth in 2021. The U.S. economy has been bolstered by massive fiscal support and a high vaccination rate and real GDP is expected to reach 6.8% this year, the fastest pace since 1984.

Recent data from China shows the economy may have missed a step because of an emergence of a COVID variant. Growth in China’s service sector slowed sharply in June to a 14-month low weighed down by a resurgence of COVID-19 cases in southern China. The Caixin/Markit Purchasing Manager’s index (PMI) fell to 50.3 in June, the lowest since April 2020 from 55.1 in May. While slower to react than the manufacturing sector, the Chinese service sector was rebounding until a COVID outbreak of the more infectious Delta strain in the export and manufacturing hub of Guangdong since late-May and the imposition of restrictions weighed on business and consumer activity. Also, China’s car sales fell sharply in June, due to the global shortage of semiconductors. Still, we expect China to turn in a decent rate of growth this year and this will spark activity in other Pacific nations.

Growth among emerging market and developing economies are expected to accelerate to 6% this year, projected by the World Bank, helped by external demand and higher commodity prices. However, the recovery in many nations is constrained by the resurgence of COVID-19 and uneven vaccinations, and a partial withdrawal of government support measures. Excluding China, growth is expected to be a more modest 4.4%. In the long run the outlook for emerging and developing economies will be dampened by the lasting legacies of the pandemic. The erosion of skills and effect of lost work and schooling, a sharp drop in investment and greater financial vulnerabilities.

Among low-income economies, where vaccination has lagged, growth has been revised lower to 2.2%. Setting aside the contraction last year, it will be the slowest rate of expansion in two decades. The group’s output in 2022 is projected to be 4.9% lower than pre-pandemic projections. The low-income economies have been the hardest hurt by the pandemic and per capita income has been set back by at least a decade.

Despite the problems, the global economy is still in recovery mode, and conditions are improving at a decent rate compared to a year ago. Global trade has continued to rebound, as manufacturing has led the road to recovery. The shutting down of factories and key ports has caused large problems with supply chains that will likely linger into 2022. Recent data is also showing a shift in spending towards services. This will cool global manufacturing over the next few quarters. The World Bank projects that global trade will grow 8.3% this year and 6.3% in 2022, in part reflecting the slower manufacturing intensity of the global economy.

Commodity prices have seen a sharp rise in 2021, with many well above their pre-pandemic levels. Metals prices are projected to be 36% higher in 2021 before falling back in 2022. Future prices of some metals and wood appear to have hit their peak and there will likely be some relief as more production gets back on-line. Oil prices have increased sharply, with both Brent and WTI above the $74 dollar mark in recent trading. Shale production in the U.S. is coming back vey slowly as investors are asking for profits instead of new production. Oil is in a transition period, where many countries across the globe are envisioning phasing oil out of the automotive markets. Even freight transportation will be affected but the transition to electric and hydrogen trucks will take a prolonged period.

Risks to the global economy are still tilted to the downside. COVID-19 is still here. Roughly a fifth of the global population have received at least one vaccination dose. However, this rate conceals enormous disparity between the richest and poorest nations. Government and corporations amassed considerable debt as they weathered last year’s global recession, making many countries vulnerable to an increase in interest rates. We do not know even in some of the richest countries like the U.S. how the consumer will react when the fiscal stimulus runs dry. Shifting a country from over 6% GDP back to near 2% will be tricky. Consumers could turn conservative as the economy slows. On a global scale the recovery could falter once policy support is withdrawn, a situation similar to the experience following the global recession of 2009. If the pandemic lingers, growth could be stuck in a very slow lane.

On the other hand, the recovery could be more robust than anticipated. Policy supported growth, coupled with more equitable global vaccination, could catalyze a self-sustaining period of rapid growth. Productivity per capita jumped in 2020, as companies shed their offices and adapted digitization. The Federal Reserve thinks that much of the recent jump in inflation is temporary and the previous forces that held inflation back will emerge again. This could mean a low inflation, low interest rate future with strong productivity growth that sparks a period of rapid growth in developed economies that spill over to the emerging economies. Overall growth could average 4.4% in 2022-23, compared to the World Bank’s 3.7% base forecast.

A year ago, there were many unknowns, including the date of the first vaccinations. Now, we are in full recovery mode despite the rise of new variants. The question now is velocity. We could see a very robust long-lasting global recovery, or a much slower one. Either way, the future is brighter than a year ago.