Leading Indicators: A rising tide to lift all boats?

Notwithstanding the ongoing tragedy of COVID-19 across the world, there has been more positive macro news from which to draw comfort over the past few weeks. Material upgrades to economic forecasts for the next eighteen months have been accompanied by sharp jumps in high-frequency business activity indicators. The closely watched global composite Purchasing Managers Index (a sentiment metric), which has climbed to a seven-year high, is just one such example.

Meanwhile, the volume of world trade in goods has risen back to pre-pandemic levels according to the latest data from CPB (Netherlands Bureau for Economic Policy Analysis). Our own suite of RICS market surveys have also turned more positive: the headline results from the most recent Global Commercial Property Monitor make for encouraging reading. Feedback from real estate investors and occupiers has continued to edge upwards – though we are yet to reach the levels of positivity reported at the tail end of 2019. Alongside this, the development sector appears to have gathered momentum in the past few months. The RICS Global Construction Monitor for Q1 2021 reports workloads picking up speed in most surveyed countries.

Unsurprisingly, the effective rollout of the vaccination programme in many of the more advanced economies has played a key role in this newly upbeat mood music. That has been accompanied by further supportive fiscal interventions, including President Biden’s US$1.9tn American Rescue Plan, which is worth some 9% of US GDP. Elsewhere around the world, budgetary measures initially enacted to soothe the worst of the pandemic pain have been extended. Significantly, this has fuelled the belief not just that growth will be higher but also the adverse impact on labour markets from the pandemic will be less pronounced. Unemployment, for one, seems to be peaking at lower levels than previously anticipated. This has, in turn, encouraged optimism that a global consumer spending spree could be in the offing. Excess saving balances accumulated in the household sector during the lockdown are burning big holes in newly deep pockets and should provide a further boost to global demand. One estimate by Oxford Economics has suggested this could amount to a hefty US$4.7tn in aggregate across the advanced economies. Given this prospect, it is perhaps unsurprising that some have begun to talk of a second “roaring twenties” on the horizon.

With big spending initiatives to the fore, it is, according to most analysts, the US that has witnessed the sharpest upgrades in growth projections. The IMF, for example, lifted their estimates for 2021 by 1.3% with the 2022 number revised up by a further 1%. But Europe, Japan and China have also seen forecasts move in the same direction – even if the uplift has been more modest. Some commentators, it is true, are now concerned that the economic stimulus could threaten the sustainability of the recovery. Larry Summers, former advisor to presidents Clinton and Obama rather vividly expressed this fear thusly: “The amount of water being poured in vastly exceeds the size of the bathtub.”

I would be reluctant to dismiss this concern lightly. I am, though, reassured by much of the work I have read on spare capacity or ‘output gaps’ in the global economy. The estimates seem to suggest that the fiscal injection, despite being substantial, is unlikely to result in the emergence of bottlenecks and a material rise in inflation. The picture in the US is likely to be a little tighter – particularly if the president is successful in pushing through the next stage of his programme, the $2.3tn American Jobs Plan. It’s a sprawling proposal taking in infrastructure, manufacturing, and health care outlays, as well as tax credits for housing and green energy investments. However, the impact on inflation may be mitigated in part by both the extended timeline for delivery and the potential for offsets through higher taxes.

That said, while the more advanced economies may be looking forward with cautious optimism to a return to normality, the same can’t be said for many of the world’s poorer states. There will be some spill over benefits from the stronger global picture, but they are unlikely to adequately address the very many legacy challenges faced by these countries. Particularly striking in the latest IMF report was its assessment of contrasting fortunes in terms of ‘long term scarring’ from the pandemic. This can arise for a number of reasons, including skills deterioration and delayed labour market entry for young workers as a result of higher unemployment. It may also be visible through depressed productivity and slower technology adoption caused by reduced capital expenditure. Critically, while the long-term scarring in advanced economies is now put at around 1% of GDP, in low-income countries (LICs) that figure is estimated to be closer to 7%.

Addressing these fundamental issues, which are likely to exacerbate pre-existing inequalities and poverty, will require concerted global action. To meet their UN Sustainable Development Goals by 2030, LICs will need support to the tune of US$3tn, or 2.6% of global GDP. Key to the success of meeting such ambitious targets will be the willingness of the higher income economies to provide funding complementary to the support of multinational agencies. Whether any appetite for such action exists across the developed world, in the current environment, remains to be seen.

Public sector debt-to-GDP ratios in most advanced economies have increased by roughly 20 percentage points as a result of COVID-19. That’s equivalent to around US$7tn, which has inevitably lead to much governmental deliberation around how resources should be deployed. Debt servicing costs remain manageable and interest rates are stubbornly, extraordinarily low. But if inflation does begin to rise in line with fears voiced by Larry Summers, et al, things could change quite quickly. Furthermore, the poorer economies will face their own challenges around debt servicing and borrowing – especially if the debt is denominated in foreign currencies.

With this in mind, it is understandable that a debate around tax is percolating – even if many politicians are understandably reluctant to broach the subject openly with virus-weary voters. The IMF has rather boldly suggested that “advanced economies can increase progressivity of income taxation and increase reliance on inheritance/gift taxes and property taxation” to help improve public finances. They also raised the idea of so-called “COVID-19 recovery contributions” and wealth taxes, with emerging economies advised to “focus on strengthening tax capacity to finance more social spending.”

Whether this advice will be heeded is anyone’s guess. It may be that strong growth in advanced economies will, on its own, address fiscal issues and limit the need for new tax measures. But even if this more optimistic scenario were to transpire, a meaningful commitment to spread the benefits of recovery will be necessary. Without it, existing economic disparities and geopolitical fault lines will only widen.