Events may diverge from The Economist Intelligence Unit’s forecast in ways that affect global business operations. The main risks are represented by the following scenarios.
Very high risk = greater than 40% probability that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%; low = 11-20%; very low = 0-10%.
Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%.
Risk intensity is a product of probability and impact, on a 25-point scale.
Negative scenario—Global trade shrinks as US steps up protectionist policies
Very high risk; Very high impact; Risk intensity = 25
Rising protectionist sentiment and a moderate slowing in world trade growth have long been part of our baseline forecast. However, there is a growing risk that this trend could become much more serious in the coming years, to the extent that global trade could actually decline, with major knock-on effects for inflation, business sentiment, consumer sentiment and ultimately global economic growth. The risk centres on the policy direction of the US president, Donald Trump. The sense that the US is “losing” under existing international trade arrangements is one of Mr Trump’s few strongly held ideological positions. In recent months he has steadily transitioned from rhetoric to action, including the recent decision to impose import tariffs on steel and aluminium, and two investigations into Chinese trade practices. The latter have the biggest potential for escalation and disruption. The US has imposed import tariffs on Chinese goods worth US$34bn a year, and China responded in kind. From now on the outlook for the trade dispute is muddier. At the heart of the dispute between China and the US is a disagreement over intellectual property and China’s technology transfer practices. Given the strategic importance of innovation to both countries, a mutually satisfactory bargain seems elusive, and there is a growing risk of an escalating chain reaction of measures that suck in other economies and spread beyond tariffs to include quota restrictions, licensing delays and outright bans. The Trump administration’s other trade disputes could also escalate. For example, the president has threatened additional tariffs on imports of EU cars, which we expect would result in a broader trade conflict as the EU attempts to defend its interests. Mr Trump may also attempt to withdraw the US from the North American Free-Trade Agreement (NAFTA). A rise in uncertainty over the continued participation of the US in NAFTA, let alone its full withdrawal, would create enormous ructions in one of the largest free-trade areas in the world. Should the US and another major economy become embroiled in a full-blown trade war, and other countries also seek to protect their industries, we would expect global trade to shrink, inflation to rise, consumers’ purchasing power to fall, investment to stagnate and global economic growth to slow.
Negative scenario—Proxy conflicts in the Middle East develop to disrupt global energy markets
Moderate risk; Very high impact; Risk intensity = 15
The rivalry between Saudi Arabia and Iran has been a multi-decade issue. Israel has also long viewed Iran as its biggest threat in the region, although this hostility has played out in confrontations with proxy groups such as the Lebanese Shia group, Hizbullah. However, there is a rising risk of outright conflict in the coming years as the wider region becomes more polarised. Historically, Saudi Arabia’s geopolitical actions in the region have been cautious and reactive. But in the light of the perceived threat from an expansionary Iran, combined with a much more assertive younger generation of policymakers led by the crown prince, Mohammed bin Salman al Saud, Saudi Arabia has become more assertive. The crown prince has led a military intervention in Yemen since 2015, and has participated in a boycott of Qatar for a year. Both moves were partly an attempt to crack down on Iranian influence. Saudi Arabia has also been emboldened by US policy in the Middle East. By withdrawing from the Iran nuclear deal, the US is inflaming tensions in the region and could provoke Iran into taking a more aggressive approach to the US and its regional allies. Any country in the region with conflicting interests in the rivalry between Iran, Israel and Saudi Arabia is likely to suffer from a destabilising proxy conflict in the medium term through either indirect military action or the funding of competing political groups. For the global economy, the biggest threat is that these proxy battles lead to wider conflict in the Gulf region, pitting Saudi Arabia or Israel against Iran and causing significant volatility in global oil and gas markets, and hurting global growth prospects.
Negative scenario—Prolonged fall in major stockmarkets destabilises the global economy
Moderate risk; Very high impact; Risk intensity = 15
As well as proving vulnerable to speculation on potential trade wars, global stockmarkets have been sensitive to potential shifts in monetary policy. This is due to uncertainty over how much of the long bull run seen in recent years has been attributable to quantitative easing (QE). Although company earnings have been increasing, which would augur well for stock price increases, this is in no small part attributable to the ultra-low interest rates available for company borrowing. The true impact of QE on company valuations will become known over the next two years as the Federal Reserve (Fed, the US central bank) gradually unwinds its QE programme and tightens monetary policy. There is a risk that share prices will crash in the US, which would lead to contagion around the world. An example of this sensitivity came in February, when a US data release on employment, which showed an acceleration in wage growth, triggered significant volatility in global share prices amid fears of a quicker than anticipated tightening cycle by the Fed. A more prolonged period of decline would trigger downward revisions to our forecast for global economic growth. Households would see a decline in financial assets, resulting in lower consumer spending. The credit channel that funnels loans to the private sector would be impaired (when banks experience sharp declines in their valuations, their ability and willingness to lend to businesses also falls). This effect would be most significant for highly leveraged small and medium-sized enterprises, resulting in lower investment and job creation. Overall, the global economy is moving into a new phase, where more and more central banks will begin to move away from emergency settings in monetary policy in response to vigorous growth rates, giving rise to significant uncertainty.
Negative scenario—Territorial or sovereignty disputes in the South China Sea lead to an outbreak of hostilities
Moderate risk; High impact; Risk intensity = 12
The national congress of the Chinese Communist Party (CCP) in October 2017 was a milestone in terms of China’s overt declaration of its pursuit of great-power status, setting the goals of China becoming a “leading global power” and having a “first-class” military force by 2050. The president, Xi Jinping, is keen to develop China’s global influence, probably sensing opportunity during a period of US retrenchment. How China intends to deploy its expanding hard-power capabilities in support of its territorial and maritime claims is likely to be a source of major concern for other countries in the region. In the South China Sea the sovereignty of a number of islands and reefs is in dispute. Several members of the Association of South-East Asian Nations (ASEAN) have sought to strengthen their own maritime defence capabilities amid increasingly aggressive moves by China to place military hardware on the disputed territories. A partial abdication of US leadership of global affairs is likely to embolden China to exert its claimed historical rights in the South China Sea. An acceleration of China’s island reclamation measures or the declaration of a no-fly zone over the disputed region are distinct possibilities. There is also a risk that an emboldened Mr Xi will step up his government’s efforts to unify Taiwan with mainland China, with the president having previously noted that the cross-Strait issue was one that could not be passed “from generation to generation”. Were military clashes to occur over any of these issues, the global economic consequences would be significant, as regional supply networks and major sea lanes could be disrupted.
Negative scenario—Supply shortages lead to a globally damaging oil price shock
Low risk; Very high impact; Risk intensity = 10
Oil prices have risen by more than 50% in the last year, with dated Brent Blend close to US$80/barrel at end-June. This has partly been a result of ongoing production quotas first agreed between OPEC and some non-OPEC producers in November 2016. The quotas have tightened the oil market, pushing up prices and leaving it more responsive to geopolitical risks and shifting market dynamics. However, there are now also a number of major supply disruptions unrelated to OPEC quotas currently influencing prices. A political dispute over the control of oil terminals in Libya has led to a near-50% cut (around 500,000 barrels/day) in national output since April, while Venezuela’s oil production is more than 500,000 b/d lower than its 2017 average; in both cases output could fall much further as respective crises deepen. Elsewhere, production is also declining in Nigeria, Angola and Canada. In this context, the impending re-imposition of US nuclear-related sanctions on Iran and the stated intention of the US administration to reduce Iranian oil exports to zero, from around 2.7m (b/d) at present, could send oil prices towards US$100/b. We still do not expect Iranian oil exports to fall below 2m b/d, given a lack of international support for US sanctions and outright resistance from some of Iran’s major oil importers, such as China. Moreover, OPEC has more than 2m b/d of spare capacity and has stated a willingness to increase supply. However, in a worst-case scenario, Iran’s oil exports (and therefore its production) could be restricted far more than we expect, possibly to below 1m b/d, as importers remain too wary of US sanctions, and countries such as Turkey and India bow to US pressure. Iranian officials have recently stated that in this scenario the Islamic Republic could shut off the Strait of Hormuz, a chokepoint for around one-third of the world’s seaborne oil trade. Even if the shutdown was only brief, we estimate that it would send oil prices soaring above US$150/b, driving up inflation and weighing on global growth.
Negative scenario—China suffers a disorderly and prolonged economic downturn
Low risk; Very high impact; Risk intensity = 10
In China a shift towards looser macroeconomic policy settings is under way ahead of a looming trade fight with the US. This will support domestic demand in the short term, but in the process previous goals of lowering unsold housing stock and corporate deleveraging are receiving less emphasis. There is a risk that, in the government’s efforts to support the economy, policy missteps are made. The stock of domestic credit stood at an estimated 214% of GDP at end-2017, a major vulnerability. Although it is likely that the authorities would make every effort to prevent a funding crunch in any bank, even a hint of banking sector distress could cause problems, given the boom in debt over recent years. Resolving these issues could force the economy into a sudden downturn. The bursting of credit bubbles elsewhere has usually been associated with sharp decelerations in economic growth, and, if this were accompanied by a house-price slump, the government may struggle to maintain control of the economy—especially if a slew of Chinese small and medium-sized banks, which are more reliant on wholesale funding, falter. If the Chinese government is unable to prevent a disorderly downward economic spiral, this would lead to much lower global commodity prices, particularly in metals. This, in turn, would have a detrimental effect on the Latin American, Middle Eastern and Sub-Saharan African economies that had benefited from the earlier Chinese-driven boom in commodity prices. In addition, given the growing dependence of Western manufacturers and retailers on demand in China and other emerging markets, a disorderly slump in Chinese growth would have a severe global impact—far more than would have been the case in earlier decades.
Negative scenario—There is a major military confrontation on the Korean peninsula
Low risk; Very high impact; Risk intensity = 10
There has been a flurry of diplomatic activity on the Korean peninsula in recent months, peaking with a historic summit in June between Mr Trump and the North Korean leader, Kim Jong-un, in Singapore. Decades of carefully planned approaches between the US and North Korea have failed, and there is a glimmer of hope that a more improvised tactic by two unorthodox characters could make progress. However, we maintain the view that there are irreconcilable differences between the US and North Korea on both the pace and the breadth of denuclearisation. Although recent statements by the US Department of State have hinted at a slight easing of demands for complete, verifiable and irreversible denuclearisation by 2020—the end of Mr Trump’s term—US goals nevertheless remain significantly at odds with the North’s long-term commitment to its nuclear programme. Any realistic denuclearisation (which would be a step-by-step programme) would require 10 20 years of sustained engagement. Such levels of bilateral trust are unlikely to be achieved under the current administration. Our core forecast is that the US will eventually be forced to revert to a containment strategy. However, should the diplomatic talks fall apart, the Trump administration could see this as justifying a more aggressive stance, including strategic strikes on the North. This option has been publicly favoured by some of Mr Trump’s close advisers, such as John Bolton, the national security adviser, who was at the summit on June 12th along with Mike Pompeo, the secretary of state. Under such a scenario, North Korea would almost certainly retaliate with conventional weaponry and, potentially, short-range nuclear missiles, bringing devastation to South Korea and Japan in particular, at enormous human cost and entailing the destruction of major global supply chains.
Negative scenario—Cyber-attacks and data integrity concerns cripple large parts of the internet
Moderate risk; Moderate impact; Risk intensity = 9
Public, corporate and government faith in the internet as a source for global good is under strain. Revelations of major data breaches across a range of social media, and the use of that data for propaganda, are likely to see social media companies facing tighter regulation in the coming years. Meanwhile, cyber-attacks continue apace. In March the US blamed Russia for a cyber-attack on its energy grid. At a similar time there was a sustained attack on German government networks. Although these attacks have been relatively contained so far, there is a risk that their frequency and severity will increase to the extent that corporate and government networks could be brought down or manipulated for an extended period. Cyber-warfare covers a broad swathe of varying actors, both state-sponsored and criminal networks, as well as differing techniques. Recent data breaches and cyber-attacks could well be part of wider efforts by state actors to develop the ability to cripple rival governments and economies, and include efforts to either damage physical infrastructure or gain access to sensitive information as a means to influence democratic processes. These breaches of security have shaken consumer faith in the security of the internet and threaten to put at risk billions of dollars of daily transactions. Were government activities to be severely constrained by an attack, or physical infrastructure damaged, the impact on economic growth would be even more severe.
Positive scenario—Global growth surges above 4%
Low risk; High impact; Risk intensity = 8
In 2017 economic data reflected strong fundamentals in many parts of the world, including Europe and a number of emerging markets, setting the stage for a robust 2018. It is possible that these could push global growth above 3%, but not to 4%, as in our central forecast we assume that capacity constraints in the US and China, growing protectionist sentiment, rising oil prices and monetary policy normalisation will weigh on any stronger performance. However, the possibility of faster growth cannot be ruled out. Our 2018 US growth forecasts have been revised up in recent months and although China has experienced volatility in its equity and currency markets, first-quarter growth was robust. Growth in India fell short of expectations in 2017 but the country’s performance also remains robust, while Brazil and Russia have both come out of recession. A change in political leadership in South Africa could give fresh impetus to another important emerging market and regional hub. Further growth in industrial commodity prices could also boost year-on-year economic growth in numerous major commodity exporters. Overall, there is a possibility of stronger global growth in 2018-19, driven by fiscal policy in the US, Europe and, to a lesser extent, China. Growth surpassing 4% would be the highest level since 2010, when the global economy was awash with post-crisis stimulus. A broad-based acceleration in growth would not only provide welcome relief to slow-growing countries elsewhere but could also assist in any longer-term economic rebalancing in China, making the whole process less painful. An improvement in global demand would provide further support for commodity prices, adding to an economically virtuous circle for commodity exporters in Latin America, the Middle East and Sub-Saharan Africa.
Negative scenario—Multiple countries withdraw from the euro zone
Very low risk; Very high impact; Risk intensity = 5
The ascendancy at the recent general election in Italy of parties espousing criticism of the EU showed a lack of faith in European integration and has seen speculation re emerge about the prospects for the wider euro zone. Although few in Italy are calling for the country’s departure from the currency union, support for such a move could rise if the new government does not adequately tackle the economy’s structural problems, which undermine competitiveness and make controlling the public finances difficult. Greece’s exit from the currency union remains a worrying prospect. Greece’s problems are largely country-specific, such as the ingrained corruption of its oligarchy, a lack of foreign investment (resulting from closed sectors, protectionism and hostility to foreign ownership) and a resultant lack of competitiveness. As such, Greece’s withdrawal would not pose a systemic risk to the bloc, especially as the European Central Bank would intervene to limit contagion. Nevertheless, a Greek exit could still provoke demands for greater autonomy elsewhere. Indeed, the economic difficulties across southern Europe have illustrated the fundamental problems posed by a single currency zone without a concurrent fiscal union. If multiple countries were to leave the euro zone, they would suffer large currency devaluations and be unable to service euro-denominated debts. In turn, banks would suffer huge losses on their sovereign bond portfolios and the global economy could be plunged into recession.