Is another global recession round the corner?

Economists are reasonably good at analysing past economic events. At the same time, they are said to have a pretty bad record when it comes to forecasting. With this caveat in mind, what is the current thinking on the question: Is another global recession (the last was the Great Recession of 2007-09) likely in the near future?

Statistically, the probability of another global recession happening soon is increasing, especially if the current economic expansion continues. Already, the expansion in both the USand the EU has lasted longer than the average historical cycles. So, analysts are looking for reasons behind this apparent lengthening of the business cycle.

Some are saying that in the past most of the business cycles were ‘inventory cycles’, meaning that economic expansion eventually led to a build-up of excess inventories which, in turn, meant less production in order for inventories to return to normal levels. Thus recession inevitably followed expansion after a lag. But, in recent years, because of ‘just-in-time’ inventory control and other methods of quicker response to changes in demand (due to revolution in information flows, computerised production and control of supply chain), the length of the typical inventory cycle is expanding.

Low interest rates

The monetary policy pursued by the major central banks is also being held partially responsible. Overly loose monetary policy with policy interest rate hovering in the 0.5-1 per cent range, and in some cases even being negative, has been pursued for too long.

This process has been helped by the fact that despite unemployment reaching historically low numbers, the growth of wages and prices has remained below the target rates of central banks. Hence, the reversal of the interest rate cycle is taking much longer.

China, the second most important economy in the world, at the first sign of a slowdown in growth has turned to the time tested fiscal stimulus, of massive infrastructure spending even if it means exacerbating the already alarming public debt. Also, Chinese savings and resources are being used abroad as part of the country’s Belt and Road Initiative. Among other things, this is pushing up demand for Chinese made machinery and metals.

Another structural change is the declining share of manufacturing and a corresponding rise in the share of services in most economies. So, even when manufacturing activity has suffered due to factors like trade war, spending on R&D and advertising has helped stabilise the economies. Similarly, a fall in oil prices forced shale oil companies to reduce extraction but the ongoing research on alternative energies kept up the total spending by the energy sector.

Politically, faced with a trade-off, growth with moderate inflation is being preferred over recession and unemployment. Thanks to Keynesian economics, economists and policymakers have broadly mastered the art of preventing a recession from sliding into full-blown depression.

Rising debt with fiscal stimulus shifts the burden of extra taxes to service debt on future generations. Here, again, a distinction should be made between domestic debt and foreign debt. Servicing of domestic debt involves transfer from domestic taxpayers to domestic bondholders and is likened to a transfer of money from one pocket to another.

By contrast, a foreign debt has to be serviced by transferring ownership of a part of GDP to foreigners, which cuts into the standard of living of domestic residents. As it involves payment in foreign exchange, it is further subject to risks arising out of fluctuations in the exchange rate.

The US, even when it finances its fiscal deficit by using foreign money, does so usually in dollars and, therefore, escapes the exchange rate risk. China’s debt is predominantly domestic and is financed by state-owned banks, which, therefore, cancels out for the consolidated public sector. Hence, both the US and China are less deterred by their mounting debt problem and can afford debt-financed spending to a larger extent than many other countries.

However, the ongoing trade and technology war between the two nations, by disrupting global supply chains, is creating huge uncertainties for business in many countries. This is, currently, the single biggest factor which has the potential to start a global slowdown and, if not reversed, may snowball into a global recession.

The writer is a former Professor of Economics, IIM Calcutta

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