06.10.2016
Turbulence ahead
All the indications are that the global economy is heading for big trouble, writes Michael Roberts
The weekend of October 7-9 sees the start of the semi-annual meetings of the International Monetary Fund and World Bank in Washington. This is an opportunity for the world’s economic strategists to review the state of the major world economies.
But it is not good news. Last month, the Organisation for Economic Cooperation and Development, which looks after the world’s top 30 economies, reported in its ‘interim economic outlook’ statement that global GDP growth (including India and China) would be flat at around 3% in 2016, with only a modest improvement projected for 2017.1 Overall, the OECD reckoned that the world economy “remained in a low-growth trap, with persistent growth disappointments weighing on growth expectations and feeding back into weak trade, investment, productivity and wages”. Catherine Mann, chief economist at the OECD, said that action was needed to “lift the global economy out of a low-growth trap”. She added: “The spiral is not upwards: it is downwards. Downwards on trade, downwards on productivity, downwards on global growth.”2
As for world trade, IMF economists have published a chapter from its upcoming World Economic Outlook, in which they argued that one of the features of the current slow growth (depression) was the unprecedented decline in world trade growth:
Since 2012, growth in the volume of world trade in goods and services has been less than half the rate during the preceding three decades. It has barely kept pace with world GDP and the slowdown has been widespread.
They calculated that this slow trade is mostly a symptom of the sluggish economic recovery: “Indeed, up to three-fourths of the shortfall in real trade growth since 2012 compared with 2003-07 can be traced to globally weaker economic growth, notably subdued investment.”3
Unctad - the division of United Nations economics that looks at so-called developing economies - issued a report which concluded that the world is on the verge of “entering a third phase of the financial crisis”. Alarm bells have been ringing over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion, meaning that “Damaging deflationary spirals cannot be ruled out.”4 According to Unctad, many ‘developing’ countries are doing no such thing (ie, developing). There is no investment in the productive sectors to be found. Many countries have fallen further behind the rich world than they were in 1980, despite ‘opening up’ their economies to multinational capital flows. While the profit share of GDP in emerging economies has risen to an historic high of 36% of GDP, from 30% in 1980, private investment has slumped to 17% from 21%. In other words, much of the profit made has left the country or been invested in unproductive sectors like real estate or financial speculation.
Also, as global interest rates have fallen, corporate debt in emerging markets has risen from 57% to 104% of GDP since the end of 2008, posing a real risk of financial collapse if a new global recession should appear or if interest rates jump sharply and national currencies plunge against the dollar or euro.
Profitability
‘Weak investment’ is the cry of all these international agencies. And it has also been the message of private-sector economic strategists like McKinsey, the management consultants. In a new report, called Turbulence ahead: renewing consensus amidst greater volatility, McKinsey outlines why global trade and growth has slowed to a crawl since the end of the great recession in 2009: “The shock of the 2008 global financial crisis triggered the first recorded drop in global GDP and the hangover has since persisted, with many countries struggling with unexpectedly weak recoveries.” And it is not going to get any better, McKinsey projects:
More worryingly, long-term growth prospects are serious cause for concern. Annual GDP growth from 2014 to 2064 is projected to effectively halve, falling to 2.1% globally and 1.9% for developed countries.5
Existing policies adopted by governments have not worked: private and public investment remain “unresponsive” to this cheap credit and “Even the much anticipated policy of quantitative easing has done little to change this.” Investment growth has slowed significantly since 2008. It collapsed outright in the European Union, declining by $330 billion. Although gross investment in the US has picked up, net investment as a percentage of GDP has halved since 2007. Companies have invested in more short-lived assets, but failed to compensate by raising gross investment. Without the state-directed investment by China, the global figures would be even worse:
China has propped up global investment, constituting 79% of the rise in investment since 2008. But this will not last: annual investment growth in China is expected to fall from 10.4% between 2008 and 2015 to 4.5% between 2015 and 2030.6
Indeed, the very latest data from the US - up to mid-2016 - show that US fixed investment has ground to a halt.
I have discussed the cause of this poor investment record elsewhere.7 In my view, it is not due to ‘poor consumer demand’ stopping companies from stepping up investment. Growth in consumer spending has been relatively robust since 2009. Indeed, when consumer spending is excluded, the rest of the US economy is already in negative territory.
Nor is poor or even negative investment due to ‘uncertainty’ or regulation, etc. It just comes down to profitability. I have cited an increasing number of studies that confirm this. For example, mainstream economists Kothari, Lewellen and Warner wrote a paper called The behavior of aggregate corporate investment.8
The authors find a close causal correlation between the movement in US business investment and profitability. They find that
... investment growth is highly predictable, up to 1½ years in advance, using past profits and stock returns but has little connection to interest rates, credit spreads, or stock volatility. Indeed, profits and stock returns swamp the predictive power of other variables proposed in the literature.
They add: “Profits show a clear business-cycle pattern and a clear correlation with investment.”
The data show that investment grows rapidly following high profits and stock returns - consistent with virtually any model of corporate investment - but can take up to a year and a half to fully adjust. This was exactly the conclusion that I reached in my own study and jointly with Guiglelmo Carchedi.9
And in a recent report, JP Morgan economists point out that capital-to-output ratios are above their historical average, and capital productivity has trended lower over the past decade. In Marxist terms, the organic composition of capital is rising and the returns on capital stock are declining.
Let me repeat the work of a senior economist at the Cleveland Federal Reserve:
A simple correlation analysis shows that the correlation between the change in corporate profits and the contemporaneous change in industrial production is 54%, but the correlation goes up to 66% if I use the one-quarter-ahead change in industrial production. Similarly, the correlation between the change in corporate profits and the contemporaneous change in gross domestic private investment is 57%, but the correlation goes up to 68% if I use the one-quarter-ahead change in investment. More formally, a Granger causality test indicates that the quarterly change in profits leads the quarterly change in production by one quarter, but the change in profits is independent of the change in production. A similar relationship applies to the quarterly change in profits and investment. Thus, firms seem to adjust their production and investment after seeing a drop in their profits.10
New recession?
According to Dubravko Lakos-Bujas at JP Morgan, since 1900 there have been 27 instances of two straight quarters of corporate earnings decline, similar to what we have now. Lakos-Bujas goes on: “Declining corporate profits, as measured by US equity EPS, have been closely followed by, or coincided with, a recession 81% of the time since 1900.”11
The economists at Deutsche Bank have also reached similar conclusions.12 They cite four indicators that popped up before the recessions in 1990, 2001, and 2008. And they are showing red now. First, there is already a recession for US profits.13 They have been sliding since they peaked in the second quarter of 2014. Second, the Fed’s Labor Market Conditions Index - a tracker of multiple indicators - turned negative in August. A sub-zero reading was followed by a recession five times in the last 40 years. Third, capital-expenditure growth has turned negative - down 2% over the past year. And fourth, corporate default rates are rising.
There was only one year (1986) in the last 60 when US corporate margins declined without this leading to a recession. It was also the only period in 40 years when a recession did not happen, even though capital-expenditure growth declined. So usually, where profits go, investment follows. And the very latest US figures show just that.
As the IMF and the World Bank meetings take place, the global economy remains in a weak state. The IMF economists are calling for global, coordinated action to “counteract renewed slowdowns”. In a new paper, they claim that the right policies can “debunk widespread concerns that little can be done by policymakers facing a vicious cycle of (too) low growth, (too) low inflation, near-zero interest rates, and high debt levels”.14 They call for fiscal action (government spending and investment); and ‘structural reforms’ of labour markets and stronger banks and financial systems.
Apart from the question of whether any of these policies would work, there is no sign that the governments of the major economies are prepared to coordinate globally any policy action. Government investment to compensate for weak business investment is still being cut in most countries to try and ‘balance the budget’ and keep government debt down. Structural reforms (namely privatisation and reductions in labour rights) are facing serious opposition from workers. And there are now new signs that the banks are back in trouble (Deutsche Bank in Germany; Italian banks, etc).
Real GDP per capita growth is slowing in both the advanced capitalist economies and the so-called emerging ones, while the big beast in global expansion, China, is also slowing. Now, if the US economy should falter from its already snail-like pace, all bets are off for avoiding a new global slump. The indicators are starting to turn red. So, as McKinsey puts it, there is global “turbulence ahead”.
Michael Roberts blogs at https://thenextrecession.wordpress.com.
Notes
1. www.oecd.org/eco/outlook/OECD-Interim-Economic-Outlook-September-2016-handout.pdf.
2. www.theguardian.com/business/2016/sep/21/oecd-does-a-u-turn-over-brexit-warning-as-it-revises-growth-forecast-for-britain.
3. www.imf.org/external/pubs/ft/weo/2016/02/index.htm.
4. http://unctad.org/en/PublicationsLibrary/wesp2016_en.pdf.
5. www.singaporesummit.sg/downloads/SS2016%20MGI%20report_Turbulence%20ahead%20-%20Renewing%20consensus%20amidst%20greater%20volatility.pdf.
6. Ibid.
7. https://thenextrecession.wordpress.com/2015/11/24/marxians-marxists-profitability-investment-and-growth.
8. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2511268.
9. http://gesd.free.fr/robcarch13.pdf.
10. www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/2016-economic-commentaries/ec-201609-recession-probabilities.aspx#U6.
11. http://uk.businessinsider.com/us-economy-profit-recession-2015-10?r=US&IR=T.
12. http://finance.yahoo.com/news/deutsche-bank-recession-indicators-flashing-165228200.html.
13. http://uk.businessinsider.com/corporate-profit-recession-indicator-2016-2?r=US&IR=T.
14. www.imf.org/external/pubs/ft/SDN/2016/sdn1609.pdf.