The outlook for the world economy is challenging as both advanced and emerging economies predict uncertain growth and increased market volatility. In this extract taken from the forthcoming review of The Geneva Association’s Annual Round Table of Chief Economists, Mr Daniel Hofmann from the Association gives his take on long-term global macro-economic developments.
At the beginning of 2016, financial markets were in a severe funk. Share prices fell sharply, interest rates declined yet again, and market volatility was as high as in 2008, at the nadir of the financial crisis.
To be sure, commentators were quick in pointing to likely culprits. Oil and commodity prices had fallen to nearly unprecedented lows. China’s rebalancing act looked increasingly fragile. And there was a loss of confidence in the track record of policymakers in advanced and emerging market economies alike. All of these factors contributed to heightened uncertainty about global growth.
Six economic paradigms
How do we make sense of such developments? To answer this question, one needs to look beyond mere trends and short-term cyclical fluctuations and shed light on structural factors that are likely to affect developments for a longer time. Failure to do so leads not only to misguided economic policies (as can be observed in real time) but also to poor strategic choices in the world of business.
Unfortunately, there is no universal explanation for the current predicaments. Instead, we offer an eclectic framework built from six economic paradigms that allow us to discuss macro-financial developments and their implications for the insurance sector.
The paradigms and their implications are summarised in Table 1.
Growth in Eurozone continues to be sluggish
Some of these paradigms result – at least at first sight – in similar economic outcomes. Slow growth, for example, can be explained by the secular stagnation paradigm, which is driven by excess savings both globally (manifested by current account surpluses in Asia and parts of northern Europe) and within countries, but also as a result of continuing headwinds triggered by the global financial crisis and thus governed by the second paradigm. The latter seems to be particularly relevant in the Eurozone.
In contrast to the US, policymakers in the EU failed to aggressively recapitalise their banks, and most European banks in turn failed to aggressively write-down their toxic assets. As a result, most banks in the Eurozone are still undercapitalised, and they continue to be saddled with a growing proportion of non-performing loans. This explains to a large part why bank lending in the Eurozone has been on a downward trend until most recently and why growth in the Eurozone continues to be sluggish.
Of course, this does not rule out the importance of other factors. Policymakers in the EU seemed to display a slightly exaggerated obsession with austerity, leading to excessive savings in the public sector. This means that weak growth in Europe can also be explained with elements drawing from the first paradigm. For these reasons, a judicious analysis of current and future developments must always build on a blend of paradigms.
Low growth prospects or rising prosperity?
While most paradigms are not mutually exclusive, growth pessimism and growth optimism cannot exist simultaneously.
Either low productivity and low growth prospects are here to stay because the world has run out of transformational innovations. Or we are at the advent of a Golden Age with rising prosperity fuelled by what’s alternatively been described as the Second Machine Age or the Fourth Industrial Revolution.
Worrying rise of populism
Finally, a more worrisome paradigm describes the rise of populism. It is represented by a group of PELOTs, such as Vladimir Putin, Recep Erdogan, Marine Le Pen, Viktor Orban, and Donald Trump.
That a Russian president and likely presidential candidates in the US and France can be mentioned in the same breath, indicates that we are faced with a global issue (the list could easily be lengthened).
These politicians are driving on confrontation and polarisation. They are mobilising the electoral base by exploiting sentiments of distrust and widespread feelings of having been cheated out of the fruits of economic growth. And they embody Lenin’s belief that “politics must take precedence over economics.”
The issue is not so much the power they consolidate or may yet achieve. The concern is rather about the weak political centre and the loss in constructive problem-solving capacity associated with it, a weakness that has been observed in the wake of large financial crises throughout history.
Four medium-term scenarios
The six paradigms developed in the table above give rise to four medium-term scenarios describing the likely developments over a five-year time horizon (See Table 2).
Like the six governing paradigms, the four scenarios are not mutually exclusive (that’s why the probabilities assigned to them add up to more than 100%).
The most likely outcome is weak growth and low interest rates for the foreseeable future. It means that insurers will continue to see subdued demand for life and non-life products, a challenging investment environment, declining profitability, and – over the long run – a steady erosion of solvency.
Potential digital transformation
That said, one should not entirely neglect the potential of the digital transformation. It is an old adage that one tends to overestimate the impact of IT in the short run, but underestimate its long-term consequences.
For that reason, the likelihood of a new Golden Age enabled by IT descending on us may be much bigger than the 5% assigned for the medium term. Insurers better prepare for a disruptive transformation and the growth potential it may entail.
Mr Daniel Hofmann is The Geneva Association’s Senior Advisor, Financial Stability and Insurance Economics.