18 July 2017
The mood music around the global economy has improved palpably over the past year. However, while there has been a broad-based acceleration in global activity, the growth rates achieved are still underwhelming from a historical perspective. Our in-house measure of headline global GDP growth is expected to increase by 3.4% in 2017, representing a five-year high, but still well below the 5.3% recorded a decade ago. This reflects a structural slowdown in underlying potential growth across emerging and developed economies. Potential growth represents a speed limit at which an economy can grow without causing a rise or fall in the rate of inflation. This is determined by the growth in the capital stock, the labour force and the efficiency with which these two factors are combined (also known as total factor productivity). In the advanced economies there is strong evidence that potential growth rates started to decline well before the financial crisis struck, and continued to do so after the downturn. Potential growth rates in emerging markets were increasing before the crisis, but have since moderated.
There are some common culprits for weaker potential growth. One of the most well-known is deteriorating demographics, which have weighed on labour forces across developed markets and even in some emerging economies. The crisis itself is also likely to have been partly responsible. A deep and long-lasting downturn held back investment and raised the risk of hysteresis. Finally, we have seen an alarming and widespread deterioration in productivity. Lower potential raises a number of challenges for policymakers. Structurally weaker growth makes it harder to reduce high public and private debt ratios. Moreover, in advanced economies lower potential is likely to be associated with low equilibrium interest rates, making it more difficult for policymakers to stimulate growth should a shock materialise. Fortunately there is a range of policy responses to address the decline in potential. Labour reforms can bring more people into the labour force; the government can invest in productive infrastructure projects; and product market reform can raise productivity. Unfortunately there are few economies where these reforms are being pursued vigorously. The global economy might have to live with lower potential.