Why a global recession isn’t inevitable

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum. Author: Beñat Bilbao-Osorio, Senior Economist, European Commission’s Directorate-General for Research and Innovation

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The end of this week will showcase two important events for global economic governance. First, central bankers, leading academics and representatives of international organizations from around the world will meet in Jackson Hole, Wyoming starting Thursday. Then, over the weekend, leaders from the Group of Seven (G7) will gather in Biarritz, France. High on both agendas will be an analysis of the latest economic indicators that seem to point to an acceleration of the global economic slowdown and the risk of a looming global recession.

The leaders will be confronted with difficult questions – including whether the fears of a recession are duly justified. They will also reflect on the consequences of a potential recession, not only in the short-term, but also in the long-run for our economies, societies and political systems.

Last week, an array of economic indicators set off alarm bells for investors that a new global economic crisis could be at hand. Germany, the economic engine of Europe, recorded a drop in its gross domestic product during the second quarter of 2019; expectations are that its economy will contract again in the third quarter and enter into technical recession. Meanwhile, earlier this month the US bond yield curve turned negative – that is, the cost of borrowing money for the US government was lower over the longer- than the shorter-term. This is an obscure financial construction, but it is broadly regarded as a good predictor for future economic recessions in financial markets.

Nonetheless, a new global economic recession does not need to be the end result. Our economies can build on some important strengths. Currently, most economies continue to grow, and employment rates in the US and Europe are at record-high levels. Wages, notably in the US, have started to finally rise, and many companies have large amounts of cash that should help them navigate any short-term storms.

Still, we should not underestimate the severity of the looming risks in terms of a global trade and currency war, a disorderly Brexit process or financial vulnerabilities in certain companies due to high levels of accumulated debt. If these risks intensify or materialise, we could enter a new global recession. The consequences could be dramatic – not only for economic activity and the long-term competitiveness of our economies, but also for widening the inequality gap. During economic downturns, those segments of the population that are already more vulnerable tend to be disproportionately affected because they may lack the necessary skills to adapt, access to new opportunities or the financial resilience to cope with temporary headwinds. This danger is particularly acute today as our societies have not yet recovered from the consequences of the 2008 financial crisis, which added to already unsustainable levels of inequality in many of our economies.

Avoiding a new global recession will require a concerted effort from governments and businesses around the world. Governments will need to coordinate their monetary and fiscal policies to stimulate demand in the short-term, even though many of the tools at their disposal were exhausted during the previous recession. Measures to continue ensuring the flow of cheap money and fiscal stimulus programmes through an increase of public spending or a reduction of taxes, depending on the fiscal space of each country, are potential options. Depending on the severity of the risks ahead, governments may be pushed into unchartered waters in terms of monetary and fiscal policies. In addition, governments should not fail to take a long-term vision and continue to invest in those productivity-enhancing assets that will allow them to reap the long-term benefits of the Fourth Industrial Revolution and safeguard their competitiveness.

Businesses, within their ability, will need to avoid overreacting and cutting investments too much and/or too fast, affecting their long-term survival, or unnecessarily firing employees. Mechanisms to increase flexibility – such as reducing the numbers of hours worked per employee, instead of reducing the number of employees, as Germany did during the recession of 2008 – can help to achieve this.