The Global Economy: Heading Toward a Dark Winter?

The global economy is poised for a difficult period. The largest economies in Europe are shutting down for a second time. The benefits of the U.S. stimulus are starting to fade. Asia should be in a better place, given its health statistics—but its recovery to date has relied in part on the rest of the world’s demand and thus it isn’t fully insulated from renewed global weakness.

Europe: More Stimulus Needed

Both the United States and Europe reported strong recoveries in the third quarter. The euro area grew a bit faster than the U.S. economy in the third quarter, but that is misleading since the strong rebound in the third quarter stemmed from a bigger fall in the second quarter. Output in the euro area remained a little more than 4 percent below its prepandemic level, while output in the United States is down by around 3.5 percent. 

It is already clear that Europe is set for a weak fourth quarter. European Central Bank (ECB) President Christine Lagarde was diplomatic: “The euro area economic recovery is losing momentum more rapidly than expected.” Even if the current round of lockdowns is somewhat less disruptive than in the spring, it will set the recovery back—or rather, the resurgence of the virus has set the recovery back, since, even absent formal restrictions, households tend to take steps to limit the risk of transmission. 

The ECB almost certainly will need to provide more support for Europe’s recovery at its meeting in December—and Europe’s fiscal stance will need to be recalibrated. 

Europe should get credit for its aggressive fiscal response to the COVID-19 shock. But now it seems too optimistic to expect that effective containment of the virus will allow for a natural rebound in activity that will generate a rise in revenues and bring down fiscal deficits in 2020. Absent a quick public health breakthrough, more fiscal support likely will be needed in 2021, something that the ECB recognizes.

United States: A Weak Recovery Looms Without More Policy Action

The apparent strength of the U.S. recovery in the third quarter is also deceptive. The economy—as a chart of estimated monthly gross domestic product (GDP) shows—was already losing momentum in August and September. The reported increase in the average level of activity in the third quarter relative to the second quarter is largely because it was much better in May and June than in March and especially April.

It isn’t hard to figure out why. The fiscal support that Congress provided in the spring supported household incomes, and it provided the foundation for a strong rise in the consumption of goods even as demand for many services remained subdued. This has not been a typical downturn: most downturns are led by a fall in investment and investment goods, but this downturn has been driven by a fall in demand for services. The large increase in U.S. demand for durable household goods has not been enough to drive a strong recovery in U.S. industrial production, since U.S. industry is more geared toward the production of large capital goods for businesses—such as aircraft—than household goods.   The trade deficit has soared on the back of increased demand for consumption goods and still weak exports.

The lack of recent momentum, combined with the failure to agree on a preelection stimulus package, portends a weak U.S. recovery at best. The uptick in COVID-19 cases poses further downside risks. Even in the best-case scenario, where an effective vaccine is approved in the near future, it will take time for a large portion of the population to be vaccinated. There is no real doubt that the U.S. economy needs more fiscal support. The chairman of the Federal Reserve, Jerome Powell, has been admirably clear on this point.  

Asia: Drawing on the Rest of the World for Demand

Asia should be the engine of the global recovery. The virus originated in China, which is now one of the few countries globally where reported output is more or less back to its prepandemic trend. South Korea and Taiwan have exceptionally good health records, and their economies are up year-over-year. Under normal circumstances, China’s strong recovery would be pulling in imports, including manufactured imports. (Its output is up by close to 5 percent year-over-year, while output of many of its trade partners is down by roughly the same percentage.) China’s outperformance, in turn, would normally reduce its trade surplus.

But these are not normal times. China has benefited from the shift in global demand away from services and toward the medical kits, home appliances, and laptops it produces in great quantities. But it has not done much in terms of policy to support its own consumption. As a result, the recovery in industrial production has outpaced the recovery in consumption, and China’s trade surplus is setting records. But there is a downside here: China’s own recovery remains vulnerable to falloff in global demand, as it has not been entirely homegrown.

Emerging Economies: Not Yet Turning the Corner

Finally, if China is set aside, the world’s emerging economies are not doing well. Most of them have provided a smaller fiscal stimulus than most advanced economies, and most emerging markets are now running substantial trade surpluses, which means their savings are helping to finance the fiscal deficits of advanced economies.  African countries have injected smaller amounts of fiscal stimulus than they did back in 2008, according to the International Monetary Fund, since they entered the COVID-19 shock with depleted coffers after the big fall in commodity prices in 2014–15. Low interest rates in advanced economies have not translated into low borrowing costs everywhere. That is why the Group of Thirty is calling for a substantial mobilization of international support to help poor countries finance pandemic-related shocks. It could be done without large new budget outlays in the advanced economies, and it would help the entire global economy recover from a once-in-a-generation crisis.

Editor's Note: The author has been advising the team supporting Democratic presidential candidate Joe Biden. He was also a project director for the Group of Thirty report on a COVID-19 recovery.