Preparing for the economic challenges ahead

With the world economy becoming increasingly complex and interwoven, those trying to understand it are faced with the classic ‘needle in a haystack’ scenario – amid an endless stockpile of data, they have to find a clue as to where global business is headed.

The latest attempt of predicting what may or may not be over the horizon has seen McKinsey’s Luis Enriquez and Sven Smith team up with Jonathan Ablett, an expert at the North American Knowledge Centre in Waltham, Massachusetts, to create what they call an “integrated framework” for understanding how macroeconomic trends interact with the processes that drive global growth.

The plan, according to Enriquez, was to detect some sort of long-term cause and effect pattern that may help us navigate an increasingly volatile global business environment and understand which role commercial road transport will play in it. To do so, they accessed more than a dozen major international databases from such institutions as the United Nations, the World Bank, the International Monetary Fund and the Bank for International Settlements, and created a range of long-term scenarios that look beyond the immediate future, which they argue has been given “oversized importance” as of late.

“We believe that three sets of forces will shape the global economy over the coming decade,” they say. “The first two are stimulus policies and shifting energy markets. These are near-term forces, whose effects are felt on a daily basis. The next two forces, urbanisation and aging, are powerful, inexorable trends aggravating on-going structural challenges. Finally, two forces are of uncertain and variable magnitude: technological innovation and global connectivity. All of these trends could intermittently disrupt and transform sectors.”

Touching on the first set, Enriquez et al. argue that the persistent problem of weak aggregate demand relative to overall economic capacity is one of the most pressing issues we are facing today. Referring to the International Monetary Fund, they estimate that production in the 10 largest advanced economies was two per cent “below potential” in 2014. While that gap was smaller than it had been in 2009 (3.3 per cent), for example, it was still significantly worse than the surplus of 0.8 per cent that prevailed in the early 2000s.

“All major economies except China experienced significantly weaker demand in the aftermath of the Global Financial Crisis (GFC). Many governments and central banks responded with fiscal and monetary stimulus programs that fostered the low real-interest-rate environments which have endured for over five years,” they say – adding that most advanced economies have increased rather than reduced their overall debt levels since the GFC.

With persistently low interest creating a breeding ground for asset bubbles and financial volatility, Enriquez et al. are concerned that unconventional monetary policies have distorted rather than bolstered the demand picture over the past half-decade. A case in point is the volatile oil price, which fell 50 per cent over the second half of 2014 and is still hovering below the five-year average. The trio found that only on two other occasions during the past 30 years, in 1985 and 2008, the oil price fell as steeply as it did in 2014.

“The recoveries from these two events were very different affairs and are instructive for today. In 1985, excess production capacity led to stable prices for nearly a decade after the initial price decline. The 2008 decline in prices was part of the financial crisis; prices dropped precipitously and then quickly rebounded as demand recovered, especially in emerging markets,” they explain, admitting that the current situation doesn’t allow for a precise prediction anymore. “Persistent demand weakness and falling oil prices are the stuff of daily headlines, but associated effects could drive alternative economic outcomes for the next decade. The complication is that deeper forces are at work.”

Touching on the second set of forces that may affect the world economy until 2025, and with it the global road freight task, the trio is more descriptive, though. “Unlike the variegated impact of demand stimuli and energy-market shifts, the effects of urbanisation and aging are predictable and are tilting the global economy in one general direction: toward emerging markets,” they argue.

In what could be negative news for road transport, they explain that increasing urban congestion and an aging labour force impose burdens on the world economy as a whole – among them lower productivity and falling demand. “The challenges are clear – the uncertainty lies in how economies will adapt to them,” they explain, with the message easily adoptable for trucking use as well.

Part of the solution could be a move east. McKinsey research indicates that 46 of the world’s 200 largest cities will be in China by 2025, a sign of the” eastward migration of the global economy’s centre of gravity”, as Enriquez et al. put it. And, with the Chinese heavy vehicle population estimated to reach 3.63 million by 2022 – growing at a compound annual growth rate of four per cent – the trailer building community could find ample growth potential in the wake of that historic migration – if a third set of factors including innovation and connectivity is sufficiently considered.

“Technological disruption has become a pervasive feature of the modern global economy, but its extent is uncertain. Especially important is the question of how much innovation will come from China, India and other emerging economies,” Enriquez at al. say. “The opening of markets has accelerated the growth of global supply chains and productivity, but will this growth continue?”

While the McKinsey team is confident that progress in robotics and 3-D printing has the potential to enable mature and emerging economies alike to boost labour productivity and rapidly expand industrial horizons, while also shifting global trade patterns, they are not sure to what extent innovation will occur more globally, and how rapidly will it spread across borders – even though trading relationships are now more dense and complex than ever, and the scope of trade agreements has widened. “The reservations [however] are more focused on the wider question of whether nations can agree on global rules that are appropriate and supportive for an evolving economy,” they explain – a potential setback that may also affect trucking, which is currently investing heavily in connected technology.

In merging all three sets of factors into one integrated framework, Enriquez et al. have developed four potential future scenarios – ranging from a divergent, slow growth one to a more convergent, rapid growth one – all of which will have severe implications for the commercial road transport sector globally. The common denominator, however, is problem solving. “Our global economic scenarios suggest that the major economies face significant structural challenges. To revive growth, these countries must tackle the challenges while navigating constant reverberations from an interconnected world economy,” they say.

While none of the scenarios will be able to give those in heavy vehicle manufacturing or road transport a definitive answer on what the future will look like, they are likely to assist them in breaking down complexity and help with long-term strategy planning, Enriquez et al. argue. “They have been designed as baselines against which different corporate strategies can be tested, to reveal how industry-specific dynamics may evolve in response to macroeconomic shifts. We believe that most companies will find that regular pressure testing of their strategies in response to both macroeconomic and industry shifts helps sustain growth in the face of challenging conditions.”

Under the first scenario, labelled ‘global synchronicity’, the world economy would experience the most robust long-term growth it has seen in more than three decades, reaching 3.7 per cent per year through 2025. As part of that high convergence/ rapid growth model, the United States, the Eurozone and Japan will be able to make the transition to more sustainable growth while exiting from their monetary stimuli with minimal disruption, Enriquez et al. proclaim. “Likewise, policy makers in China implement incremental changes and guide economic growth smoothly and gradually downward to a sustainable level. India emerges as the fastest-growing economy over this period as it rides a wave of reform, investment and robust demographics.”

The trio’s best case scenario would also see the lowering of barriers in critical service industries and a revival of global cross-border activity and technology transfer; with global interest rates returning to the “old normal” levels of the pre-crisis years and heavy vehicle manufacturing likely to benefit.

The second scenario, titled ‘pockets of growth’, would entail more divergence, with countries tackling structural challenges “in fits and starts”, according to Enriquez et al. Global growth would reach 3.2 per cent under the second option, with the US, China and India achieving satisfactory growth and the Eurozone and Japan struggling. “The unevenness of the expansion makes agreements harder to reach on international protections for investors, intellectual property and agricultural subsidies. As a result, trade growth starts to slow and remains effectively flat relative to GDP at 25 per cent,” they forecast.

Scenario three, ‘global deceleration’, is one where convergence would meet growth of about 2.9 per cent over the course of the decade, slightly below average for the past three decades. Under it, structural challenges remain largely unaddressed but are offset in the near term by partly successful efforts to revive demand.

Enriquez et al. see China avoid the worst effects of a “hard landing,” but say that confidence in the financial and fiscal system will still be shaken, further weighing on growth. “Near-term demand revives globally, creating an opportunity for Europe and the United States to make progress on financial services, privacy, and M&A activity, which becomes a benchmark for global emulation. Trade is a more important driver of growth in this scenario than in the previous one.”

The fourth and worst-case option, aptly named ‘rolling regional crises’, is the negative image of the global-synchronicity scenario. “Rolling regional crises describes a world where structural reforms broadly stall, and aggregate demand, especially in advanced economies, does not return in a sustainable way. Deleveraging remains a drag on household balance sheets, and corporate-debt levels continue to rise,” Enriquez et al. say.  “With not enough economic incentive, companies fail to invest in R&D and technological innovation remains confined to a few regions. The diffusion of technology also slows down as economies increasingly turn inward. Implicit and explicit restrictions on international M&A activity proliferate, as do regulations inhibiting the expansion of trade and technology.”

Under that final scenario, the world economy would remain much more vulnerable to economic shocks, they say, particularly from financial flows, with commercial road transport being in an even more reactive position than today.

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