James McCann, senior global economist at Aberdeen Standard Investments
The G7 meetings are taking place against a backdrop of greater trade tensions, which are casting a cloud over the global macro environment at present. Although the measures announced thus far are not large enough to have significant macroeconomic effects, the risks of a further, more damaging escalation have increased. In particular, the relationship between the US and China is in focus, given the prospects for rising tariffs, but also non-tariff measures such as restrictions on bilateral investment. While the reciprocal costs of a deeper trade conflict suggest that the bark around trade rhetoric may be worse than the bite, investors are having to factor in greater uncertainty about the future.
Alongside these trade skirmishes we have seen some other worrisome developments in the global economy; supply disruptions have pushed oil prices higher; populism in Italy is raising concerns over stability in the region and tightening dollar liquidity is creating strains in certain emerging markets. All in all it has certainly been a bumpier ride in economies and markets, compared to the smooth sailing last year.
However, while these headwinds have been building, they are not yet severe enough to interrupt still broadly healthy global fundamentals. Indeed, while we have cut our headline forecasts this year slightly, global GDP growth is still expected to be the strongest seen since 2011, before cooling as the cycle matures. One caveat is that this growth may be risker, bumpier and more uneven across economies and sectors, highlighting the increased need to differentiate between markets and asset classes.
Markets are primarily focused on the immediate implications of increased trade protectionism and other geopolitical risks for sustainability of the current expansion. But it is equally important to consider the consequences for longer-term growth and living standards.
The rise in protectionist sentiment poses longer term questions around the path for globalisation, which has already shown signs of slowing of recent years. A retreat from integrated economies and markets is something that would provide a drag on already dwindling longer term growth prospects. Indeed, the 3.8% GDP growth forecast for the global economy this year looks less spectacular when compared to the 5.1% delivered on average in the five years before the crisis.
These shifting benchmarks reflect an already observed deterioration in potential growth across developed and emerging markets over recent decades. This malaise has been caused by a range of factors including demographic trends and weak labour productivity growth, partly on account of less capital deepening. A roll back of globalisation would exacerbate these trends by preventing countries from specializing in areas where they hold comparative advantages.
Diminished potential growth provides another reason for policymakers to tread very carefully around trade negotiations. However, there are other tools which can help alleviate this malaise. Aggressive labour market reform aimed at boosting participation could limit the demographic drag, but there are few signs of policymakers taking these steps. On productivity, governments should pursue aggressive product market reforms to increase competition and spur both innovation and the diffusion/adoption of these breakthroughs through economies. It can also take direct action by spending more on long term growth boosting infrastructure (if well targeted) and education/training programmes. The payoffs from these measures have the potential to be large, through higher real incomes, employment and stronger fiscal positions.
While some progress has been made in narrowing the wage gap – the OECD median gender pay gap has come down from 19.4% in 1995 to 14.1% in 2016 – it has not been eradicated, in spite of high rates of tertiary education among women relative to their male counterparts. Solving the gender pay gap is not only a social justice issue; it is also economically inefficient because where abilities and effort are systematically under-rewarded, resources tend not to be distributed and used optimally. CEPR research suggests that a wider gender pay gap results in lower output per head, due partly to lower levels of participation. The OECD estimates that a halving of gender participation gaps by 2025 would add 0.2 percentage points to average annual GDP growth rates across the OECD during the period.
The challenge for policymakers is that there are multiple complex and deeply entrenched reasons for gender inequality in the workforce, including career interruptions, gender segregation in education and work, and conscious and unconscious bias; not to mention the large chunk of the gender pay gap that remains unexplained empirically. While policy that targets minimising career disruption and facilitating more flexible working tend to be associated with lower gender pay and participation gaps, deeper underlying beliefs around gender and work in different cultures will take time to change even after such policies are adopted.
The Canadian government was right to put these issues on the G7-agenda but little progress is being made in the current political environment. Indeed, there is a real risk that arguments over trade policy will crowd out vital discussions about how governments can promote they type of policies that deliver stronger, more sustainable and more equitably distributed growth. It is only by tackling these challenges cooperatively that the underlying drivers of increased populism can be addressed.
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