Davos and the fundamental health of the world economy

Davos and the fundamental health of the world economy

Thoughts from Davos 2016

Director

KPMG in the UK

Contact

Also on KPMG.com

Davos is again upon us. As world leaders gather in Switzerland to discuss the main economic and business issues of the day, attention will inevitably turn to increasing worries about the Chinese economy and to prospects for emerging markets more broadly.

Renewed stock market volatility at the start of this year, coupled by a growing realisation of the immense challenges faced by the Chinese authorities as they attempt to steer the economy towards a new era, have put China firmly on the agenda as one of the key unknowns for this year. One that could instigate a significant dent in the performance of the world economy.

 

The new reality of low commodity prices and rising US interest rates presents a harsher environment for many emerging economies, in particular as in recent years many have increased their exposure to both debt and foreign exchange (see my 3rd December insight discussing this issue 1 ).

 

It is right for business leaders and investors to worry about vulnerabilities in the current cycle, but at the same time one shouldn’t lose sight of the long term fundamentals. We have recently launched our Variables for Sustained Growth (VSG) Index, which tracks the progress in some of the most important factors that support long term economic performance in 181 countries, covering areas such as macroeconomic stability, openness to catch up, infrastructure quality, human capital, and the strength of public institutions 2.    

 

Two themes from the Index could offer broader context for the sensible concerns above:

 

1. Fundamentals are resilient in many developed economies, which should help support economic performance

We have seen improvements in economic growth across most developed economies over the past two years, and while concerns are mounting over prospects in many emerging economies, the outlook for the developed world remains largely benign.  

 

Despite lower growth in some of these markets, their sheer size and their economic resilience, as measured by the VSG Index, should provide a buffer for the world economy and opportunities for businesses and investors. 

 

The top performers in the VSG Index are dominated by Western Europe, with Luxembourg ranked in first place this year, followed by the Netherlands and Switzerland.  Singapore, New Zealand, and Hong Kong were the only non-European countries to make it to the top 10. Germany and the UK made it into the top 20, with Germany in 12th place and the UK in 16th place, followed in 17th place by the United States.

 

Performance in the Index has varied over time, another factor to watch out for, with countries such as Spain and Italy showing minimal overall improvement over the past ten years, while countries like Ireland have seen a significant uplift thanks to progress in technology readiness and a strong rise in FDI stock. Elsewhere in Europe, the turmoil in Greece has taken its toll on the country’s economic growth potential, with higher government debt and slightly weaker public institutions causing its VSG Index score to stagnate since 2005. The UK performed relatively well, with its VSG Index score rising by the same amount as Switzerland and Luxembourg over the same period, thanks in particular to improvements in technology readiness.  

 

2. Emerging markets have the potential to make significant inroads into better economic performance despite the difficulties ahead

Our VSG Index shows many emerging economies are improving their prospects and continue to gradually catch up with developed countries. While developed economies fare relatively well in our Index, some developing countries such as Malaysia and Chile are not far behind, illustrating how less mature economies could reach relatively high economic potential. 

 

Performance on the VSG Index has been mixed across emerging countries and regions. Latin America performed worse on average over the past five years than developing Asia, although it improved relative to the world average between 2007 and 2013, with the gap then widening again over the past two years. 

The gap between the average African VSG Index score and the world average widened further over the past five years, in contrast with overall developing countries (see chart above). This was despite large African countries such as Nigeria experiencing important improvements in their VSG Index score.  

 

The worry now is that lower commodity prices will curtail further progress in many of these countries. But that need not necessarily be the case. Even countries like Nigeria, whose public finances have been significantly dented by plummeting oil prices, could see further progress, with our analysis showing that substantial improvements in the strength of its public institutions could drive GDP per capita over 30% higher by 2050.  

 

1 See https://home.kpmg.com/uk/en/home/insights/2015/12/lift-off-finally-.html 

2 For a copy of the full report visit: https://home.kpmg.com/uk/en/home/insights/2016/01/variables-for-sustainable-growth.html  

Connect with us

 

Request for proposal

 

Submit

KPMG’s new-look website

KPMG’s new-look website