Daniel Russel: Prospects for the Economy in 2019
Remarks at the Asian Ports Business Forum in Kobe, Japan
I’ve been asked to speak about the prospects for 2019. Let me make a confession up front: I’m not an economist, a fortune teller, or a genius – but you don’t need to be any of these to recognize that 2019 will be a year of challenges and risks.
The Organization for Economic Co-operation and Development (OECD) reports that the prospects for the global economy in 2019 are deteriorating and has downgraded its assessment of global growth to 3.5% or lower, suggesting that “the expansion may now have peaked” and predicting slower growth in both advanced and, particularly, in emerging-market economies.
This is a baseline assessment based on conventional market indicators and business data. Beyond these indicators, however, the OECD strongly warns of the costs of the current shift away from market liberalization toward protectionism, and underscores the need to reinforce the global rules-based trading system.
Actually calculating the cost of a slide towards protectionism – let alone a full-blown trade war between the U.S. and China – is no easy matter. The International Monetary Fund (IMF) modeling predicts the economic, financial, and psychological impact of an intensified trade dispute could lower real GDP in Asia alone by a full 1%.
But we are entering uncharted territory, here, and as Wall Street is fond of pointing out, the past is not always a reliable predictor of things to come.
So I’d like to take a step back and invite you to think more broadly about the traditional and non-traditional factors that will shape 2019. I would divide those factors into three baskets:
First are the economic factors, which are generally familiar and to some degree quantifiable, even if there is a considerable degree of uncertainty driven by a number of political factors.
Second are the structural, global challenges that are altering the way we live and do business.
And third are the geopolitical or geostrategic risks, some of which may not be new, but may be newly threatening in 2019.
Let’s start with the economic factors.
Some economists are warning that the significant inflation in global asset prices, including in the U.S., is a signal that markets are overdue for a major correction. We have begun to see a great deal of volatility in the markets, with tech stocks no longer looking invulnerable. Whether we will see a correction or a bear market is the big question.
I’ve already mentioned the OECD figures that suggest global growth is slowing. The dollar is rising and the Federal Reserve is signaling there are more rate increases in store in 2019 to try to adequately price risk into financial markets.
Oil prices are sinking, and the prospects are for more volatility ahead, which carries risks for the global economy and has worrisome implications for international security and regional stability.
The effects of the huge Trump tax cut in my country are dwindling without the promised bump in corporate investment, while U.S. government spending – and therefore the massive U.S. budget deficit – is expanding. The U.S. is facing a “fiscal cliff” based on Congressional budget rules that could place binding caps on spending and reduce U.S. growth to 1.8% by 2020. The results of the U.S. midterm elections will likely make it harder, not easier, for Congress to deal with this problem.
And the U.S. is by no means the only major economy plagued with a ballooning debt-to-GDP ratio – Japan leads the pack. And China, which has a massive shadow banking problem, has itself run up an enormous debt load in the wake of the 2008 global financial crisis.
These are significant headwinds facing the world economy, but they are conventional in nature – all these are problems we have encountered before to some degree and in some combination. It’s particularly important that we also factor in the “unconventional” concerns that are less familiar and therefore more difficult to gauge.
As other speakers have noted, we enter 2019 in an atmosphere of overall uncertainty. This is in part driven by the frequently unorthodox and often unpredictable decision-making by Donald Trump.
Some of this uncertainty has been driven by the Trump Administration’s unilateralism - its withdrawal from the Trans-Pacific-Partnership (TPP), an attitude of disdain towards multilateral institutions and processes, and an unprecedented willingness to put alliance relationships at risk in the interests of “America First.”
We have seen this not only with Canada/Mexico on the North American Free Trade Agreement (NAFTA), but with Japan on steel and aluminum, and very likely automobiles next .
But the paramount “unconventional” concern facing the global economy in 2019 is certainly the U.S.-China trade dispute – which is increasingly shaping up to be a trade war – a tit-for-tat exchange between the world’s largest economies and trading nations.
At the fall World Bank meeting held last month in Bali, a senior IMF official described the combination of the various economic “headwinds” that I just mentioned, with the spillover effect from the trade war, as signaling “a perfect storm.”
And we all know that storms are not good for ports and shipping!
The Trump Administration is waging an economic battle with China along two fronts: one is the bilateral trade deficit, which Donald Trump cares deeply about, even though economists insist his logic is flawed because the trade figures largely reflect the structure of global supply chains, savings rates, and so on.
The second front is against unfair Chinese practices, and here there is broad international and private sector consensus that it is high time China abandoned self-serving tactics such as market-distorting industrial policies, forced technology transfer from foreign companies as the price of doing business, intellectual property theft, regulatory and other non-tariff barriers to market access, restrictions on foreign investors, prejudicial treatment of foreign firms, and preferential rules for domestic champions.
It is hard to find anyone who isn’t disappointed with the pace of reform following the ambitious promises laid out in the Third Party Plenum five years ago.
What we have seen is that China appears keen to make a deal with Washington to address the first problem – the trade deficit. This summer China reportedly put forward an offer aimed at cutting the deficit by as much as $200 billion per year.
But that proposal, and reportedly others, were rejected as inadequate. Just last week the United States Trade Representative (USTR) Lighthizer released a report saying that “China has not fundamentally altered its unfair, unreasonable, and market-distorting practices,” and he and others in the administration are on record insisting that there won’t be a deal unless and until China abandons strategies such as Made in China 2025 and creates a “level playing field” for foreign companies.
President Trump has announced that the tariffs already imposed on $250 billion of Chinese goods will jump from 10 to 25% on January 1st, and that he has begun the process to impose tariffs on the remaining $267 billion in Chinese imports after that.
So what about this second, larger set of problems – the unfair practices that foreign firms and governments complain about?
At the Shanghai Import Expo last month, Xi Jinping pledged to lower tariffs, change foreign equity ownership rules in certain sectors, and “sincerely committed” to proactively open Chinese markets further. In fact, China has taken limited steps to liberalize its markets and has established free trade pilot zones in major coastal cities to experiment with less-restricted foreign investment.
However, state-owned enterprises (SOE) still dominate most sectors and industries, and stiff resistance by vested interests to reform or opening makes it difficult to see progress in the near term. The overall regulatory system in China remains impenetrably complex. The authority and political control of the Chinese Communist Party (CCP) continues to outweigh any benefits from economic liberalization and limits the autonomy of the courts.
Moreover, top Chinese officials publicly insist they will not yield to foreign pressure or as recently stated, “American blackmail.”
What does all this mean for the prospect of a deal coming out of the G20 meeting in Argentina in the next few days?
Having served in the U.S. government and dealt extensively with Chinese counterparts as both a Special Assistant to President Obama and as Assistant Secretary of State – including through the first few months of the Trump administration, my observation is that the two sides have not conducted any of the extensive negotiations that would be required for the leaders to be able to announce a bilateral deal on trade when they meet.
One reason is that trade officials in Washington say they have lost patience with unfulfilled Chinese promises to reform and accuse the Chinese of using talks to buy time and muddy the waters. Another reason is that President Trump’s economic advisors are sharply divided, with Treasury Secretary Mnuchin on one side and USTR Lighthizer and presidential advisor Peter Navarro on the other.
It’s also worth remembering that tariffs are much harder to remove than they are to impose. My friend and former colleague Michael Froman used to point out that to this day the U.S. maintains 25% tariffs on light trucks as a legacy of a trade dispute with Europe over chicken parts...in 1963!
So in my view, the best case scenario for the U.S.-China Summit at the G20 would be for the two leaders to announce a “cease-fire” - a delay in executing the scheduled January 1st tariff rate increase in order for trade officials to explore a more comprehensive agreement, perhaps in exchange for the significant boost in imports from the U.S. that China has already put on the table.
Trump reached a similar ceasefire with European Union (EU) Commission President Junker in July, although now that U.S.-EU trade talks have begun, it’s unclear how much longer that truce will hold.
I’ll emphasize again that I’m describing the best case scenario, but even then the chances of this achieving a happy ending are not high. First, because of the scope of U.S. demands; second, because of Beijing’s resistance to structural reforms that might loosen the Xi Jinping’s control of Chinese society and economy; and third, because of the belief in both capitals that the other side is vulnerable and ultimately will have to concede.
These and other factors suggest that even if the Buenos Aires Summit were to generate a positive statement that pushed back deadlines and encouraged the stock markets to rally, that relief will prove to be short-lived and we will soon be faced again with the prospect of a major escalation in the cycle of tit-for-tat escalation … a destructive trade war.
Next on my list of considerations for the year ahead are the structural and global challenges that we face.
One of these is climate change, which may not yet be adequately factored into mainstream economic forecasts. We all seem perpetually surprised by the pace and the magnitude of extreme weather, of melting icecaps, and of global warming; the impact of sea level rise on ports can’t be a positive one.
Last month in Incheon, South Korea, the United Nations (UN) Intergovernmental Panel on Climate Change reported that the world only has barely a decade left to make the dramatic, costly, and far-reaching changes in transportation, industry, energy, cities, and infrastructure to prevent irreversible and disastrous impacts.
In the last few days, a Congressionally mandated scientific report found that damage from climate change is on track to shrink the U.S. economy by 10%, not just the growth rate but the economy itself, by the end of this century. The report assessed that climate change is already taking a toll on supply chains and international trade.
According to a climate think tank, the cost to the global economy is projected to reach $700 billion per year by 2030.
Climate change doesn’t only impact the agricultural sector as farmers are forced to deal with water shortages, the arrival of new pests and crop diseases, and declining crop yields as a result of reduced rainfall and changes to growing seasons.
The fishing industry, which is already struggling with overfishing, is at risk from accelerating ocean acidification from rising CO2 levels and the loss of coral reefs.
Labor productivity also declines when extreme heat or storms interfere with manufacturing, construction, and transportation.
The UN Secretary General António Guterres is on record warning that climate change may become the biggest driver of migration by displaced people, causing economic, social, and political disruption such as we are seeing in Europe but on a much larger scale.
Countries like Bangladesh, India, the Philippines, Indonesia, and yes, Japan, are already subject to floods, typhoons, landslides, and other disasters that are exacerbated by climate change. And while island nations and coastal cities are at serious risk from sea level rise and flooding, more frequent and severe droughts pose a serious threat to areas of India, China, Pakistan, Sri Lanka, and Iran.
Climate change is also a driver of infectious diseases like malaria, zika, and dengue fever. The devastating wildfires in California this month are indicative of the major fires we should expect as a result of global warming, according to the National Academy of Sciences.
A second structural, global challenge whose effects will impact the 2019 economy is the much-discussed “fourth industrial revolution” - the digital revolution. This includes the advances in machine learning and artificial intelligence, and robotics as well as transformational technologies like CRISPR that allow for gene splicing and other biotech capabilities.
On the one hand, the digital revolution is handing us wonderful innovations capable of lifesaving and timesaving systems that industries such as transportation, logistics, and shipping have already put to good use.
But on the other hand, in many cases, these new technologies are serving as disrupters that, as we’ve seen, can trigger unintended consequences like unemployment and underemployment. The political effects in Europe and the United States are painfully evident.
The impact in the developing world should not be overlooked because in the digital age, low wages no longer carry the same competitive advantage as in the industrial age, where they were the ticket to economic growth. Because increasingly it is data and talent, not labor, that are generating value and driving wealth creation along with extreme wealth disparities.
So, while productivity-enhancing technologies create many benefits, the adverse effects of technology may fall disproportionately on communities and countries that don’t have the skills to participate in or prosper from the digital revolution.
This is a recipe for instability and upheaval in many societies, particularly those that do not have the mechanisms to help their workforces adjust.
Another unintended consequence of the digital transformation is the new set of vulnerabilities in the cyber domain.
We are still in the early era of cybercrime and cyber terrorism; there have been relatively few large-scale or high impact instances so far. But national and global vulnerabilities – and industry-wide vulnerabilities - are growing exponentially as the world digitizes.
The “WannaCry” ransomware attack affected computers in 150 countries. FedEx and Maersk each reported losses of around $300 million from cyber-attacks in a single quarter of last year. Bangladesh lost $81 million to cyber theft in 2016, but the hackers, almost certainly from North Korea, came shocking close to stealing a billion dollars.
Southeast Asia, whose online economy is projected to reach $200 billion by 2025, is expanding internet connectivity faster than any other region in the world. It is probably not a coincidence, then, that Singapore is the #1 target of cyber-attacks in the world.
As critical infrastructure worldwide is increasingly networked through information and communications technology, including international ports, their vulnerability to cyber-attack increases. I don’t have to explain to this group how seriously an attack on ports in Asia could affect the safety, security, and economic interests of the people, business, and nations in this region.
Not only is it not hard to imagine that 2019 might see a major cyber incident, the World Economic Forum this month released a survey called “Regional Risks of Doing Business” that found cyber-attacks topped the list of risks cited by business executives in both East Asia and in North America.
Let me turn now to the geopolitical and geostrategic threats that loom over the landscape in 2019. I will mention four problem sets and potential crises.
The first is the perennial risk from international terrorism. In 2017 and 2018, we’ve seen bombings in Indonesia, large-scale battles with violent extremists in Mindanao in the Philippines, attacks and attempted attacks in Barcelona, Berlin, London, Paris, and attacks on pedestrians with vehicles in numerous cities including my hometown of NY.
It’s true that ISIS has been badly battered; it has lost most of its territory in Iraq, wave after wave of its leaders have been killed. But don’t forget that the same was true of Al Qaeda, yet no sooner had that threat been dealt with than ISIS emerged from its ashes.
In addition, while most ISIS units have been killed or disbanded, surviving fighter have slipped away to return home -to hide for the time being, or to join the fight: including in Southeast Asia and in South Asia. The risk of a major terrorist attack remains a very real concern.
The second problem set involves Iran. The struggle for primacy between Iran and Saudi Arabia, and between the Shiite and the Sunni worlds, has intensified in the past year and two developments have raised the stakes: President Trump’s repudiation of the multinational Iran deal and the re-imposition of U.S. sanctions, including possible secondary sanctions on U.S. allies and partners, is one.
Another factor is the murder of Jamal Khashoggi, which badly damaged the standing of Saudi Crown Prince Mohammed bin Salman and seriously unsettled the region.
As a result of U.S. sanctions, billions of dollars' worth of deals are now at risk, affecting banks, ports, and transportation-related companies that do business with Iran.
China, India, Japan, and South Korea together account for nearly ¾ of Iran’s oil exports. At the moment, waivers for China and seven U.S. partners will forestall some of the most serious problems, but the waivers, which will expire in 2019, also reduce the sanctions effectiveness.
This situation adds unpredictability to oil prices, creates friction between the U.S. and its partners, and generates pressure on other countries, including China, to find workarounds and alternatives to the U.S. dollar as the world's reserve currency and to bypass U.S. companies for shipping insurance.
The third problem set is North Korea, which is an issue I have worked on extensively in my career. Frankly, it is hard to see getting through 2019 without a crisis.
It is true that North Korea has paused testing nuclear weapons and ballistic missiles after an extraordinary series of provocative demonstrations in 2017, and it is also true that in a single year Kim Jong-un held three summits each with the Chinese and South Korean leaders and an unprecedented summit with the President of the United States.
But the high hopes for a speedy start to a process of denuclearization have been disappointed and we can see in the statements coming from Pyongyang a return to all-too-familiar North Korean brinkmanship.
North Korea has not even agreed to a single round of talks with the U.S. negotiator and canceled a planned meeting with the U.S. Secretary of State.
President Trump made a major concession to Kim Jong-un by meeting with him unconditionally in Singapore and canceling the annual U.S.-South Korean defensive exercises scheduled for the fall.
Those concessions, which caught America’s partners off guard, have not produced the denuclearization process that Kim is alleged to have promised. And while Secretary of Defense James Mattis announced last week that the U.S. would scale back the next round of exercises, Foal Eagle, in the spring, he did not cancel them. So how will North Korea react when the U.S. resumes its “provocative war games?”
Given the stalemate over Pyongyang’s demand that the U.S. relax sanctions and agree to a Peace Treaty, and American insistence that sanctions will remain in place until North Korea has revealed and abandoned its nuclear program, we may well be on a collision course for a crisis in the spring of 2019.
The fourth and probably the most consequential geopolitical challenge in 2019 is the accelerating strategic rivalry between Washington and Beijing.
The trade and tariff battle is only one component of that problem. We are seeing a fundamental shift in the bilateral relationship. Each side’s view of the other has shifted.
In the past, the working model for both countries was a relationship that combined competition and cooperation. I often heard former-President Obama say that the U.S. had more to fear from a weak China than from a prosperous China. But beginning in 2017, the U.S. government labeled China as a strategic threat and an adversary.
I know from my conversations with Chinese counterparts that Beijing increasingly perceives the United States as a hostile power determined to undermine China’s development and work against China’s interests.
The normal bilateral mechanisms of cooperation have largely shut down and what we recently saw at APEC and the ASEAN Summits is a zero-sum competition between rival powers that increasingly is pushing third countries to choose sides.
Now, I am speaking to you as a recently retired U.S. diplomat who has spent more hours than I care to remember negotiating, arguing, competing, and debating with my Chinese colleagues. I am a realist, not a romantic.
But I am also of the generation of U.S. policymakers who believed that the right policy towards China was engagement at all levels; cooperation on issues of real importance to our countries, the region, and the world; and a serious effort to candidly deal with our differences, narrowing them where possible and managing them to avoid conflict where we simply could not agree.
We were fully confident that the United States could compete with China, and in fact out-compete China, on a level playing field. And we worked hard to address the host of issue where we felt the Chinese side was not playing fairly; including many of the issues that have been cited by the Trump administration.
There is plenty to complain about in the actions of the Chinese government.
I’ve already mentioned the regulatory and non-tariff barriers to market access; the discriminatory treatment of foreign firms; closed government procurement; forced transfer of technology and intellectual property theft; distortions created by SOE’s; industrial policy and cultivation of national champions; lack of transparency and a credible judicial process; the list goes on.
And there is plenty to complain about in terms of China’s policies in the South China Sea, East China Sea, Tibet and Xinjiang, the Taiwan Straits...
China’s Belt and Road Initiative (BRI) projects have in some cases helped to create needed infrastructure but have also been marred by corruption, environmental damage, poor labor standards, and unsustainable debt.
China’s human rights record: persecution of religious and ethnic minorities, draconian penalties for political expression, and intrusive security controls are all deeply distressing.
Probably none of us believe that these problematic economic practices, or China’s mistreatment of its citizens or its violations of international rules and norms, should be overlooked. These are objectionable behaviors and we should collectively push back.
But to declare China a strategic adversary risks condemning ourselves to live in an era of great power rivalry and actually weakens the prospect that China will modify the behavior that troubles us all.
The challenge that we face in 2019 is how to stem the downward spiral towards zero-sum strategic rivalry that risks the so-called “Thucydides Trap.”
Competition is one thing, typically it brings out the best in both sides. If we agree on the rules and are confident our competitors are abiding by them, competition serves to make us more efficient, more innovative, and more successful in the long term.
Rivalry, however, is something very different. It tends to bring out the worst in both sides. It fosters a zero-sum approach that aims at undermining an opponent, rather than improving our own game. This is something that we should work to avoid.
My own view is that China bears a significant share of the responsibility for the current situation and for getting this right in the year ahead. Beijing’s unfulfilled promises and lack of follow-through on important promises has eroded trust. There is a dramatic “say-do” gap that is damaging to China’s credibility.
Remember the Third Party Plenum of the 18th Communist Party Congress in 2013 where China set out a bold path for market-oriented reforms through 2019? These included a decisive role for the markets in allocating resources; restructuring China’s investment regime, both inbound and outbound; and the creation of a “Leading Group” that was supposed to drive reform efforts.
Remember the Fourth Party Plenum meeting in 2014 that committed China to respect the Rule of Law.
Remember the 2015 State visit to Washington where Xi Jinping promised not to militarize the South China Sea.
Remember Davos 2017 where he positioned China as the champion of multilateralism, free trade, and globalization.
China’s friends have been routinely disappointed at the lack of follow-through on these important pledges.
As a Chinese-American businessman pointed out to me recently, if the Chinese leader could effectively tackle the endemic corruption throughout the system in China that had become a way of life; if he could successfully take down powerful “tigers” in the Communist Party to show that the old ways must change, then surely he can tackle these critical economic reforms.
If he doesn’t, perhaps people can be forgiven for concluding that this is not really something that the Chinese leadership is genuinely committed to.
Ok, well where does all this leave us in thinking about the world economy and the overall environment in 2019?
I realize that I have given a somewhat worrisome picture of what may lie ahead in 2019, but I’ll close with the following points.
First of all, the U.S. has an uncanny knack for resilience so please don’t lose faith. Winston Churchill got it right when he said that the United States “always does the right thing… but only after trying all the other alternatives!”
Second, the era of free trade is under great stress but it is not over. The fact is that centrally planned economies and protectionism are simply inferior to free markets as long as the markets are fair.
Third, the logic for cooperation between the world’s two wealthiest and most powerful countries is extremely strong, and the political costs of strategic rivalry for both sides — and for the world — will become increasingly clear.
Fourth, the U.S. and China are not operating in a vacuum. Japan is an influential actor with an immensely important role to play in promoting free trade, supporting multilateral institutions, and working for a rules-based region.
The bottom line for the year ahead is this: a descent into nationalism, protectionism, and a trade war or even cold war serves the interest of no party.
We all share a responsibility to try to help our nations deal effectively and collaboratively with the daunting mix of economic, structural, and geopolitical challenges facing us in 2019.