When the finance ministers of the world’s largest economies gathered in Washington over the weekend they had in front of them IMF analysis of the global economy that for once was quite up-beat. The growth forecast is higher, financial markets are buoyant, and a long-awaited cyclical recovery is underway in many economies.
But the IMF’s assessment - set out in its biannual World Economic Outlook report - contains a catch. This is that risks to the outlook are firmly to the downside. Moreover, it is politics and the “pervasive uncertainty” surrounding policies that takes much of the blame.
The report is full of examples of where politics is impacting on growth. Here are some:
- In Mexico, uncertainty about future trade relations with the US will take 1.2 percentage points off growth over the next two years.
- In Turkey, the outlook is “clouded” by policy uncertainty and security concerns, with debt burdens rising as the currency has depreciated.
- In Ukraine, growth is expected to “soften” as industrial production has been disrupted by a trade blockade in the eastern part of the country, which is still under Russian-backed rebel control.
- In India, the growth rate remains impressively high, but has been dented by the cash shortages and payments disruption created by the government’s demonetization initiative last November.
- In Brazil, by contrast, the political news is better, with reduced political uncertainty contributing to a gradual recovery from “one of its deepest recessions”.
There are the usual concerns about Europe, with the political uncertainty heightened by elections this year. And while the UK economy has been “resilient” following the Brexit vote, the IMF is still worried about the future relationship with the EU, with uncertainty expected to “weigh” on activity.
But there is no mistaking the biggest source of political risk, which is the US. It’s on this that the IMF’s analysis is most interesting. Aside from familiar concerns about rising protectionism under a Trump administration, there are three intriguing examples of how US policy choices could have unintended consequences, which are adding to global political anxiety.
The first is fiscal policy. The IMF argues that a spending stimulus that does not increase supply potential could raise inflation and require the US Fed to increase interest rates more sharply. This would push up the dollar and widen the US current account deficit, exacerbating one of Trump’s most pressing and politically-sensitive policy concerns. It could end up making protectionist policies more likely.
The second is tax reform. A destination-based cash flow tax (aka a border adjustment tax) could impact on other countries through several channels. The proposal is designed to incentivise firms to shift profits and production back to the US. But that is precisely why it may also prompt other countries to adjust their tax systems to offset these incentives. The result could be harmful tax competition, rather than meaningful reform.
The third area is financial deregulation. Unwinding US regulation might boost financial stocks in the short-term, but it would also increase the probability of a costly crisis in future that would inevitably impact on other countries. Moreover, it could provoke deregulation elsewhere, increasing risks in the international financial system.
The impact of politics on policymaking and the economic outlook is not new. There is, after all, a legitimate political dimension to many of these policy choices, which should not just be left for technocrats to decide.
But what the IMF is charting - and has done for some time - is a clear shift to more politicised policymaking, increasing political uncertainty that is complicating policymaking, and the potential for serious conflict over policies across countries that extends beyond trade protectionism.
There is no simple solution. But there is a way to minimise the risk of unintended consequences from policy choices, which is for policymakers - such as the finance ministers gathered in Washington - to speak to each other. It is not so much what they say in public that matters, but what they say to each other more candidly in private. That is the main benefit of the IMF meetings.
The views expressed in this note can be attributed to the named author(s) only.