Global markets lurched into 2016 on the wrong foot, leaving many investors wondering if the recent slowdown in global growth is a sign of deeper troubles ahead. And while we naturally look at the most recent data points to establish our bearings, a longer-term look-back frequently serves as a useful reality check.
In the 1970s, as the US struggled through a deep recession, shopkeepers were constantly on the watch for stretched consumers looking to employ the so-called “five finger discount,” a euphemism for shoplifting. Today, central bankers around the world need to be mindful of five growth-robbing challenges threatening the global economy over the course of the next several business cycles. Stalling globalization, unfavorable demography, excessive leverage, a harsher regulatory environment and rising taxes are creating a five-finger discount that much of the world will be hard pressed to avoid.
After fueling corporate profits and personal income gains through international trade, capital and labor flows for the better part of thirty years, globalization appears, at a minimum, to have stalled. But contrary to conventional wisdom, globalization is not destiny, it’s a choice. At present, we seem to be stepping back from globalization and as a result, emerging markets have taken a significant hit. Robust growth in developing markets helped spawn an emerging middle class in these countries, which has been a meaningful catalyst for global growth. But it will be difficult to stay on this path if the free movement of goods, capital and labor continues to languish.
In terms of economic activity and dynamism, demography is increasingly less favorable in all developed countries than in the business cycles of the last three decades. And while many large emerging market economies are still in a demographic sweet spot, if current trends hold up over the next 10-15 years, many of them will likely be in the same position as most developed countries.
They too will face slowing growth in the supply of labor, higher dependency ratios, and perhaps a reduction in productivity growth.
Leverage is the next challenge. The world simply has too much debt. Although public sector debt has ebbed and flowed over time as a percentage of gross domestic product, we now have high levels of public, corporate and household debt across most of the world—a truly toxic combination. We can only acknowledge the futility of searching for a robust balance sheet to carry us forward and cushion against the next global downturn. Recent events in Chinese markets only amplify concerns that excessive leverage could set off another wave of global financial instability.
We’re also in a harsher regulatory environment today, whereas we spent much of the period since the early 1980s aggressively deregulating many industries. And whether they are intended to prevent another crisis in the financial system or are protectionist in nature, more stringent regulations are generally growth depleting in the short- to medium-term. Complying with additional regulations is time consuming and expensive for businesses, and it almost always restricts productive investment.
Moreover, when regulatory policy becomes internally inconsistent and ad hoc, or muddies “the rules of the game,” personal and corporate economic activity becomes calcified.
We’re also generally raising taxes on a global basis, where we spent the ’80s and ’90s cutting them.
More than twice as many Organization for Economic Co-operation and Development (OECD) countries have hiked personal income taxes than have cut them in the wake of the global financial crisis while value-added tax hikes outnumber cuts 18 to 1. At the margin, higher taxes tend to reduce incentives for employing capital and labor, distort domestic economic fundamentals through dead weight losses, and can prompt larger businesses to maximize returns for their investors by wasting resources to seek out lower tax bases for their operations. All else equal, higher taxes often interfere with the efficient allocation of scarce resources. The complexity of complying with the tax code, particularly in the US, also adds to the onerous regulatory burdens discussed above.
These five factors were once a boon, adding significantly to global growth each year. Now that they’ve gone from tailwinds to headwinds, that added growth is gone. From an investor’s perspective, we see lower inflationary pressure ahead, lower wage pressures, lower nominal growth, lower real growth and global interest rates that will stay “lower for longer.”
As a result of these dynamics, the US Federal Reserve – and other major central banks – faces significant challenges. While the Fed was finally able to raise rates from zero, the question is for how long? Remember, the European Central Bank, the Bank of Canada, the Reserve Bank of Australia and several others all raised rates at some point in the wake of the global financial crisis only to cut them again to a point lower than when they started to hike. The Fed could fall into the same trap.
Over a longer horizon, that five-fingered fist — globalization, demography, leverage, regulations and taxes - that helped grab all the economic activity it could get its hand on, will increasingly be forced to relinquish its grip, with a resultant drop in macro vitality and asset valuations.
Disclaimer: Erik’s comments, opinions and analyses are for informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analyses are rendered as of the date given and may change without notice due to market conditions and other factors. This material is not intended as a complete analysis of every material fact regarding any market, industry, investment or strategy.
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