Growth in an uncertain 2017

Rafael Pampillón. Professor. IE Business School

31 January 2017

The new year has brought uncertainties that effect the entire planet, but  it has also brought revised forecasts that point toward greater economic growth.

The year 2017 will see higher rates of growth for the global economy, higher levels of inflation, and rises in interest rates and in the price of oil. The latest data published on the evolution of the world economy are rather more positive than those of a few months ago. Last week, the OECD revised its forecasts for world growth in 2016 upwards, to 2.9%, and predicts rates of 3.3% in 2017 and 3.6% in 2018.

This is also because in spite of Brexit, economic variables are improving in Europe. The Economic Sentiment Indicator, prepared in November by the European Commission, has grown once again, reaching a new annual high. Consulting firm Markit confirmed signs of economic recovery in Europe. In November the Purchasing Managers Index (PMI) of the Eurozone (EMU)’s manufacturing sector registered its highest ever level since it was first created in 2014, thanks to exports driven by the weak euro and rising internal demand.

There are also signs of improvement in the US. In the third quarter of last year, its economy grew by an annual rate of 3.2%, compared to an average of 1% in the three previous years. In its recently published report on global economic outlook, the OECD revised its forecast for next year’s GDP of the US upwards, to 2.3% (a rise of two tenths) and to 3% for 2018.

Increase in public investment

This growth is partly due to budget reactivation plans promised by Donald Trump. The new president will try to strengthen investment in infrastructures with an injection of 550,000 million dollars (equivalent to half of Spain’s GDP), and to cut corporate tax, all this while encouraging more public spending on training programs for the unemployed. But this positive stimulus could be neutralized by protectionist barriers. Blocking trade exchanges would make global GDP growth fall by a few tenths, given that it would reduce the efficient assignation of resources in the world production value chain.

Hence international organisms are proposing that there be greater levels of public investment in Europe too, in order to reactivate the world economy, something which is considered to be possible due to the low rates of interest that exist at the moment. Especially in Germany, and particularly in quality infrastructure. Because, as we have said, in spite of the fact that indicators are showing signs of improvement in EU countries’ economies, the OECD forecasts that for 2017, the following European countries will still have low rates of Growth: Germany (+1.7%), France (+1.3%), UK (+1.2%) and Italy (+0.9%).

Moreover, the OECD foresees higher rates of growth for 2017 not only in Spain but also in other emerging economies like India, which is expected to have exceeded 7.4% in 2016 and to have a rate of 7.6% for 2017, and 7.7% in 2018. The opposite will happen to China, whose GDP is expected to have reached 6.7% in 2016, 6.4% in 2017 and 6.1% in 2018.

Oil prices will go up

Great rates of growth in the world economy in 2017 could drive rises in the price of oil, aiding recovery in countries that export raw materials, some of which need oxygen to overcome setbacks of the last two years (e.g., Russia, Venezuela and Nigeria).

Hence the outlook for 2017 for OPEC countries looks promising. They have agreed to reduce production by 1.2 million barrels a day, with the aim of getting oil prices to rise. However, for this measure to have the desired effect, oil producing countries that do not belong to OPEC, such as Russia or the US, would also have to reduce production by some 600,000 barrels a day. The news of OPEC’s decision sent the Brent oil price up by 9% to 54.5 dollars, which has increased the share value of all companies in the sector.

In light of the above, analysts are predicting that during the first half of 2017, the price of oil will remain at 55 dollars a barrel, although Goldman Sachs are saying that during the second half of the year the price will change due to new oil wells being reopened.

Changes in the political scenario

New alliances will probably appear in 2017 between Russia and the US, or rather, between Putin and Trump. These alliances might take some pressure off the Syrian conflict, which for its part is causing a) massive political instability in the region, b) the serious refugee problem which has Europe divided, c) the deaths of limitless numbers of people or their displacement.

In spite of the possible lowering of tensions in the Middle East, Europe, which is increasingly weaker, is not going to escape from the continuous threats of being broken up. First there is Brexit, clearly the result of nationalism, which will bring more protectionism and lead to the creation of barriers to the movement of people. What is needed In 2017 is meticulous and delicate negotiation between the UK and the EU, but it also needs to be diligent so as not to prolong more than necessary the uncertainty about the future of complex economic relations between both, particularly given that they are so closely linked.

In this same geographic region we have elections set to take place in 2017 in two of its strongest economies, namely France and Germany. The battle between François Fillon and Marine Le Pen for the presidency of the French Republic could have catastrophic consequences for the future of the EU. Fillon proposes radical change in terms of the tax system, working hours, retirement age, and relations with Russia, while Marine Le Pen is more nationalist and will come down hard on hiring foreigners. In Germany it will be the fourth consecutive elections with Angela Merkel as the strongest candidate for the position of Chancellor, with the support of 60% of the population. Nevertheless, the populist Alliance Party is attracting increasing numbers of followers.

Spain’s pending tasks

In spite of all the uncertainty surrounding the world economy, growth forecasts for Spain are also being revised upward. In 2017, Spain’s economy will continue in an expansive phase, although economic growth and job creation will be less intense than in 2016. The government and research agencies are still raising their estimates for growth for 2017, which now stand at 2.8%, which is far higher than the average forecast for other Eurozone countries (+1,6%).

In order to maintain this good pace of growth, and taking into account the uncertain global scenario, what should the Spanish government do in 2017? The answer is that they should continue to grow the economy’s production capacity. How can they do that? 1) By insisting on the need for an education system that rewards excellence and which improves productivity in the workplace, 2) by equipping Spanish firms with more innovation (increasing, for example, investment in R&D, given that the last four years in Spain have seen a reduction in the ratio of R&D to GDP), 3) by favoring foreign direct investment 4) by eliminating the public deficit, 5)  By securing cheaper energy, 6) by achieving greater market unity and 7) by giving Spanish firms the support they need to embrace digitalization – robotics, 3D printing (manufacturing), augmented virtual reality, artificial vision, the Internet of Things, data storage in the cloud, cybersecurity, Big Data, logistics, etc.).

These measures will transform the Spanish economy in the long term by laying down truly solid foundations for sustainable growth. It is about adopting a focus that improves the productivity of companies by fueling the expansive cycle on a long term basis.

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