In the first quarter of 2018, Japan’s economy recorded its first contraction in over two years. That slowdown assumes more significance as the global economic outlook worsens. Developments ranging from international trade tensions to domestic political developments and timelines spurred International Monetary Fund Managing Director Christine Lagarde to warn that “clouds on the horizon” are “getting darker by the day.” Policymakers must begin preparing for a downturn that appears ever more likely.
The IMF projects 3.9 percent global growth for 2018 and 2019, the fastest pace since 2011, but growth will weaken afterward. In its analysis, the World Bank echoes that assessment, and warns of “considerable downside risks” that threaten to upend projections. Despite low inflation, unemployment at the lowest level in over two decades and high corporate profits, the World Bank projects the Japanese economy will grow 1.0 percent in 2018, a drop of 0.3 percentage points from its January estimate, and growth will further slow to 0.8 percent in 2019 and 0.5 percent in 2020.
Japan’s prospects have been hurt by rising oil prices, a labor market that is at virtually full employment, and a consumption tax increase that will take effect next year. Even more worrisome are external developments that could shock the global economy and drag Japan down with it.
Topping the list of concerns are trade tensions that could trigger full-blown trade wars. The primary culprit is U.S. President Donald Trump, who has imposed unilateral sanctions on the United State’s trade partners and apparently believes that “fair trade is to be called fool trade if it is not reciprocal.” The tariffs he imposed on steel and aluminum imports, and the prospect of still more on automobile imports, has those exporters drawing up lists for retaliation against U.S. products. Japan has notified the World Trade Organization of its readiness to impose ¥50 billion worth of sanctions on U.S. exports, but has not yet done so, preferring to see if Washington can be persuaded to stay its hand.
Trump’s withdrawal from the Group of Seven communique issued last week is evidence of his suspicion of and hostility to the global trade order that the U.S. did so much to build. Lagarde warned that “The biggest and darkest cloud … is the deterioration in confidence that is prompted by [an] attempt to challenge the way in which trade has been conducted, in which relationships have been handled and in which multilateral organizations have been operating.”
Other decisions are contributing to economic headwinds. This week, the U.S. Federal Reserve raised its benchmark short-term interest rate a quarter percentage point, from 1.75 percent to 2 percent, and indicated that two more increases are likely this year. Chairman Jerome Powell said “The economy is doing very well … most people who want to find jobs are finding them. Unemployment and inflation are low. The overall outlook for growth remains favorable.” The move is smart, and creates space for action if there is a downturn. More immediately, however, it raises interest rates, which should moderate growth.
A day later, the European Central Bank announced that it will reduce the pace of its monthly asset purchases in its quantitative easing program by one-half — €15 billion — from Oct. 1, and end its quantitative easing program by year’s end. Interest rates are expected to remain at current levels until next summer. The decision is a vote of confidence in Europe’s economy, and a downplaying of risks posed by the new government in Italy, which has expressed skepticism about the ECB’s economic management. But it also removes a source of stimulus to the region’s economy.
Then there are indications that China’s economy is slowing, with the World Bank forecasting 6.5 percent growth in 2018, 6.3 percent in 2019 and 6.2 percent in 2020. Warning signs include five-month investment rates falling to a 22-year low of 6.1 percent, and industrial output and retail sales falling more than anticipated in May. The prospect of Trump’s tariffs raises concern. It’s telling that China’s central bank did not follow the U.S. lead and raise its interest rates, a move that it normally makes to keep exchange rates stable.
There are other potential shocks. Italy’s new government could indulge its populist impulses and call for a withdrawal from the euro. Britain’s Brexit negotiations could go more poorly still and undermine confidence in its economic prospects. The deregulatory wave that has engulfed the financial sector could lead to another crisis; a sharp tightening would produce a tsunami in emerging market economies that have assumed large amounts of corporate debt, often financed in foreign currencies. Then there are economic cycles. The global economy has experienced a downturn every decade since the 1970s. We are due.
Policymakers must be prepared to take action. Unfortunately, Japan’s stimulus program is running out of gas as economic problems prove powerful. The political system is struggling with scandal, and a huge debt burden makes fiscal stimulus — the typical response — more problematic. Integrated resorts and international competitions — the 2019 Rugby World Cup and the 2020 Summer Olympic Games — will not fill the gap. While much remains out of Japan’s control, we must build economic shock absorbers.