Precarious perch: The global economy is not out of the woods

By Kenneth Rogoff

BEIJING: The global economy was full of surprises in 2023. Despite the sharp rise in interest rates, the United States successfully avoided a recession, and major emerging markets did not spiral into a debt crisis. Even Japan’s geriatric economy exhibited stunning vitality. By contrast, the European Union fell behind, as its German growth engine sputtered after China’s four-decade era of hyper-growth abruptly ended.

Looking ahead to 2024, several questions loom large. What will happen to long-term inflation-adjusted interest rates? Can China avoid a more dramatic slowdown, given the turmoil in its real-estate sector and high levels of local-government debt? Having maintained near-zero interest rates for two decades, can the Bank of Japan (BOJ) normalise rates without triggering systemic financial and debt crises? Will the delayed effects of the Federal Reserve’s interest-rate hikes eventually push the US into a recession? Can emerging markets maintain stability for another year? Lastly, what will be the next major source of geopolitical instability? Will it be a Chinese blockade of Taiwan, former President Donald Trump winning November’s US presidential election, or an unforeseen event?

The answers to these questions are interconnected. A recession in the US could lead to a significant decrease in global interest rates, but this may provide only temporary relief. After all, several factors, including extraordinarily high debt levels, creeping deglobalisation, rising populism, the need to increase defense spending, and the green transition, will likely keep long-term rates well above the ultra-low levels of 2012-21 for the next decade.

Meanwhile, Chinese leaders’ significant efforts to restore 5% annual economic growth face several daunting challenges. For starters, it is hard to see how Chinese tech firms can remain competitive when the government continues to stifle entrepreneurship. And China’s debt-to-GDP ratio, which surged to 83% in 2023, compared to 40% in 2014, constrains the government’s ability to provide open-ended bailouts.

Given that government support is crucial to addressing the high local-government debt and the over-leveraged property sector, China’s emerging plan appears to be to spread the pain. This entails allocating national funds to provinces, then compelling banks to extend loans to insolvent firms at below-market interest rates, and finally, curbing new borrowing by local governments.

But it will be hard to keep the Chinese economy firing on all cylinders while simultaneously imposing restrictions on new lending. Although China is already shifting away from real estate to green energy and electric vehicles (to the dismay of German and Japanese carmakers), real estate and infrastructure still account for more than 30% of Chinese GDP, as Yuanchen Yang and I recently showed, underscoring these sectors’ direct and indirect impact.

While Japan has maintained robust economic growth over the past year, the International Monetary Fund expects its economy to slow in 2024. But Japan’s ability to achieve a smooth landing largely hinges on how the BOJ handles the inevitable yet risky transition away from its ultra-low interest-rate policy.

Given that the yen has remained almost 40% lower than the dollar since early 2021, even as US inflation has surged, the BOJ cannot afford to delay this shift any longer. While Japanese policymakers may prefer to sit on their hands and hope a decline in global interest rates will boost the yen and solve their problems, that is not a sustainable long-term strategy. It is more likely that the BOJ will need to hike interest rates, or long-dormant inflation will start to rise, putting severe pressure on the financial system and the Japanese government, which currently maintains a debt-to-GDP ratio exceeding 250%.

Although the US economy, contrary to most analysts’ expectations, did not slip into a recession in 2023, the likelihood of one is still probably around 30%, compared to 15% in normal years. Despite the unpredictable long-term effects of interest-rate fluctuations, President Joe Biden’s administration continues to pursue an expansive fiscal policy. As a share of GDP, the deficit is currently at 6% – or 7%, if we include Biden’s student-loan forgiveness program – despite the economy operating at full employment. Even a divided Congress is unlikely to cut spending significantly in an election year. The high cumulative inflation of the past three years amounted to a de facto 10% default on government debt – a one-off event that cannot soon be repeated without severe consequences.

Amid an extraordinary confluence of economic and political shocks, emerging markets managed to avert a crisis in 2023. While this is largely due to policymakers’ embrace of relatively orthodox macroeconomic strategies, some countries have capitalised on escalating geopolitical tensions. India, for example, has leveraged the war in Ukraine to secure massive quantities of cut-rate Russian oil, while Turkey has emerged as a key channel for transporting sanctioned European goods to Russia.

As geopolitical tensions spike and polls suggest that Trump currently is the favorite to win the US presidential election, 2024 is poised to be yet another tumultuous year for the global economy. This is especially true for emerging markets, but don’t be surprised if 2024 turns out to be the rocky year for everyone.