Global Growth Outlook 07/2021

Juni 2021 July 2021 GLOBAL GROWTH OUTLOOK

U.S. engine is propelling global economy North buoyant, risks prevail in south

▪

Under Biden’s leadership, the United States has become the engine of the global economy. The massive U.S. spending package is fuelling high growth.

Europe is also recovering, while the south is still grappling with the pandemic.

▪

The Chinese economy already recovered in 2020 and global demand is stabilising. Next year, Chinese GDP is set to be 17 percent higher than in the preCOVID year 2019, the U.S. economy six percent higher, and the EU only one percent.

▪

A fifty-billion-euro global vaccination programme is needed to overcome the pandemic and avoid the risk of mutations worldwide.

Die amerikanische Lokomotive der Weltwirtschaft ▪

The German economy is set to grow 3.5 percent this year. Lively investment

Aufschwung Norden, Süden activity, strongim foreign trade andRisiken a catch-upim phase for private consumption are all providing economic momentum, with industry leading the way.

▪

Inflation risks are back on a global scale but should prove containable.

Inflation is likely to be higher in the United States. Within the Euro area, one-off factors are pushing up inflation.

▪

Fiscal policy is excessively expansionary in the United States but suitably scaled in Europe. Measures to provide economic support and stimulus are still needed. The EU lacks a strategy to finance its climate objectives, strengthen digital competitiveness and reinforce sovereignty.

▪

Europe’s economic recovery is being propped up significantly by recovery packages. The combination of reform and investment is proving effective.

U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Content Robust recovery in the industrialised nations while problems persist in the south ................... 3 Regional outlook: diverse pace of recovery................................................................................... 12 Financial policy still supporting recovery, but on a lesser scale................................................. 14 Central banks flanking recovery ...................................................................................................... 16 Inflation in the euro area on similar path, but lower ...................................................................... 19 Financial markets undergoing turbulent adjustment .................................................................... 19 Global industrial production drops for the first time in ten years ............................................... 20 Global trade........................................................................................................................................ 22 Foreign direct investment ................................................................................................................ 22 United States ..................................................................................................................................... 22 Strong start into 2021 in China ........................................................................................................ 26 Euro area and EU .............................................................................................................................. 28 United Kingdom ................................................................................................................................. 31 Japan .................................................................................................................................................. 31 Germany ............................................................................................................................................. 31 Sources .............................................................................................................................................. 34

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Robust recovery in the industrialised nations while problems persist in the south Over the last fifteen months, the spread of coronavirus infections and resulting restrictions imposed on economic activity and daily life have been dominating growth and employment levels across the globe.

The end of the second quarter this year should mark the beginning of an uneven post-pandemic recovery phase, with North America, continental Europe and Japan catching up with China’s early recovery. However, only parts of the southern hemisphere will be swept along by these powerful trends in the north. Many developing and emerging countries will need at least one or two years to reach herd immunity within their populations through vaccination and bring the pandemic under control. In the next two years, the south will continue to experience considerable economic volatility. The resulting risks to growth, financial stability and the social situation in these countries must be addressed promptly and on a multilateral basis to avoid large-scale damage to these countries and the global economy as a whole.

The highly expansionary fiscal course adopted by the United States also presents a risk. The extremely powerful upturn in 2021 may well trigger a period of unexpectedly high inflation in 2022 which could irritate the global financial markets and force the Federal Reserve System to take countermeasures, thus possibly risking recession in the United States and the world. A relatively large financial and debt crisis in the south coupled with a recession in the United States in 2022 and 2023 is not the most likely scenario but should certainly be regarded as a risk.

Pandemic gradually under control The pandemic is still the dominant factor on the economic front and will remain so for the rest of the year. Economic momentum will be mainly determined by infection rates and the ability of governments to pursue a strategy of testing, tracking, and isolating infected people instead of having to impose severe restrictions on public life and economic activity to contain the spread of the pandemic. The United Kingdom and the United States should be able to take large steps towards economic normality this spring, paving the way for a robust recovery. Canada and Mexico have also made headway in containing the pandemic. Most countries of continental Europe should come close to reaching herd immunity this summer, enabling restrictions on public life to be lifted gradually from the middle of the second quarter. This should bring the self-imposed spending reticence of consumers back to normal levels by the end of the year. Continental Europe will therefore lag around three to six months behind the United States and more than one year behind China in terms of economic recovery. Japan has seen infections rise since March but these are still at a low level so the impact on economic momentum should be limited. Restrictions imposed in Tokyo to safeguard the Summer Olympics are nonetheless putting a damper on economic activity. The vast majority of developing and emerging countries will only reach immunity through vaccination in 2022 or 2023 despite intensified efforts to make vaccines widely available. More focus should be placed on the issue of how to provide rapid assistance to these countries. The IMF recently published proposals on how to reach a 40 percent level of vaccination in all countries by the end of the year and 60 percent by the end of June 2022 and thus bring the pandemic to an end. The total costs of this campaign would only be 50 billion U.S. dollars (IMF 2021c).

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Number of confirmed cases (daily) WHO Region American Region African Region

750,000

Eastern Mediterranean Region European Region South East Asia Region Western Pacific Region

American Region

500,000

South East Asia Region European Region

250,000 African Region

Western Pacific Region

Eastern Mediterranean Region 0

Jan 20

Jul 20

Jan 21

Jul 21

Source: WHO

Stringency of public health measures, June 2021

Source: Hale, Thomas, Sam Webster, Anna Petherick, Toby Phillips, and Beatriz Kira (2020).

Oxford COVID-19 Government Response Tracker, Blavatnik School of Government.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Stringency values of public health measures in selected countries

120

100 90

100

80 70

80

60 50

60

40 40

30 20

20

10 0

0

China Japan Russland

Deutschland Italien V. Königreich

USA Brasilien Indien

Frankreich Spanien Datenreihen6

Source: Hale, Thomas, Sam Webster, Anna Petherick, Toby Phillips, and Beatriz Kira (2020).

Oxford COVID-19 Government Response Tracker, Blavatnik School of Government.

Proportion of population with first dose of vaccine, in percent 60

U. Kingdom United States Italy Germany Spain France EU

50

40

30 Brazil 20 India Russia

10

0 Jan 20

Jul 20

Jan 21

Jul 21

Source: WHO

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Global economic activity slumps The hefty economic slump in 2020 was ultimately less pronounced than had long been anticipated.

The global economy nonetheless shrank on an historically unprecedented scale by 3.4 percent. With global economic output at almost 88 trillion U.S. dollars, this means the loss was equal to the economic output of a country like France, for example. It is certainly too early to put a final price tag on the economic damage of the pandemic, but we should nonetheless be aware that developing countries, not including China, lost a total of 20 percent of their income per capita while industrialised countries lost less, but still eleven percent. The pandemic eradicated five percent of jobs in developing countries.

Industrialised countries outside the EU experienced similar levels of job loss. In the EU, 2.5 percent of jobs were lost. Across the various countries, it was the often low-skilled labour in the high-contact and hard-hit service industries as well as young people and women who were disproportionately affected economically. While industrialised countries were able to prop up their industries with massive support measures to stop economic output slumping at least twice as much, developing countries lacked the funds to do the same. The international economic organisations estimate the permanent impact of the current pandemic-induced recession to be only about half that of the recession following the global financial crisis, but there will still be persistent losses in productivity, above all in the hardest-hit industries. The long-term damage for education, investment activity and research is also severe in many countries. The IMF puts the permanent damage at around three percent of economic output (compared to over ten percent for the global financial crisis), and at around four percent for emerging countries and six percent for developing countries.

The recovery process begins After a weak start to the year in the United States and Europe, the global economy is expected to grow by 5.75 percent this year. Industrialised countries should expand by around four percent and developing and emerging countries by over six percent. In the first quarter, global activity only picked up by half a percentage point but it should gather momentum now. Despite the weak start to the year with negative growth in the first quarter in individual countries including Germany, Japan and Spain, the pre-crisis level of global economic output should be regained in the summer. The course of recovery will, however, vary greatly across the individual major economies.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Index development of real GDP 117

117

102 111

China

100

111 99 98

95

106

100

104

95

102

95

103

100

101

96

111

100 Japan

United States 102

India

101

Germany

U. Kingdom

98

102 99

Brazil 96 Russia 92

90

Euro area 93 2019

2020

2021

2022

2019

2020

2021

2022

2019

2020

2021

2022

Sources: IMF; own calculations for Euro area and according to Eurostat based on IMF forecast (IWF 2021a)

Growth of real gross domestic product in 2021 compared to previous year (in percent) Global economy

+ 5¾

Euro area

+ 4¼

World trade

+ 8½

EU

+ 4¼

United States

+ 6½

Germany

+ 3½

China

+8

Japan

+ 2¾

Source: BDI

Investment stronger than anticipated, but structural impact still uncertain Global investment activity has been positive, regaining pre-crisis momentum in the fourth quarter in the G7 countries. Investment in plant and equipment is benefiting from pandemic-induced shifts, digitalisation and accelerating global trade. Construction investment has also increased in some countries as additional savings of private households are being spent above all on buying residential property and buildings. Corporate expenditure on research also appears not to have been significantly cut.

The swift recovery of investment levels has come as somewhat of a surprise. The pandemic caused earnings to slump, the debt rate to increase and a lower interest coverage ratio in many industries in the OECD countries (OECD 2021). Companies, however, generally acquired more favourable financing thanks to monetary policy and banking supervisory measures and were able to accumulate a liquidity buffer. Companies in the energy industry and industries which were hardest hit by the

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

pandemic (high-contact services, tourism and hospitality, etc.) lost an average of 30 percent of their income and saw their earnings before tax, interest, depreciation and amortisation (EBITDA) halved.

Revenues also plunged steeply in the automotive and transport industries. As so often, SMEs suffered particularly. Companies in healthcare and the digital sector swam against the trend with revenues and earnings increasing on a moderate scale. It is too early to say how well the problem industries will recover and whether there will be a tangible number of insolvencies in these areas. The rate of insolvencies has so far been atypically low, cushioned until now by the rescue measures. Slumps in earnings and rising leverage rates generally curb corporate investment levels for a period of several years. It is therefore too early to sound the all-clear here.

Consumption expenditure still trending laterally While consumption expenditure has recovered from the steep plunge in spring last year, the latest figures show still do not show much momentum. It is hardly surprising then that global retail sales trended laterally during winter and spring but have nonetheless been back to pre-crisis levels since late autumn. In most OECD countries, the opportunities for consumption in many industries remained restricted well into May, with distancing regulations, enforced closures, and precautionary measures on the part of consumers all curbing spending. The sentiment indicators are improving, however, and the lifting of restrictions is having an effect, but spending patterns are likely to take some time to adapt to the new situation.

One factor that is making it particularly difficult to forecast expenditure is the extra savings of private households, i.e., the pent-up purchasing power (United States: seven percent of GDP; Japan and the United Kingdom: six percent; Euro area: four percent; Germany: four percent). The general view is that as the economy opens up, consumption patterns will revert to normal relatively swiftly. It makes a big difference if the extra savings of the last one and a half years are also tapped into for additional purchases of goods and services. This is however almost impossible to predict due to the lack of historical precedents. The forecasts below are all based on the assumption that this will only happen very gradually and the one-off extra savings will largely remain saved up for now, particularly as relatively well-off households are unlikely to overcompensate for missed holiday trips and concerts now. The OECD (2021) and the European Commission (2021) have concluded, on the basis of detailed studies, that the additional funds of prosperous households will more likely be spent on buying capital assets than on catching up on consumption, while the additional savings of low and medium-income households are more likely to be spent on catching up on purchases, but this will play a lesser role.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Forecast summary: Growth in real GDP 2021/2022 in percent 2021

IMF1

OECD2

2022

EUCOM3

IMF1

OECD2

EUCOM3

World

6.0

5.84

5.6

4.4

4.44

4.3

United States

6.4

6.9

6.3

3.5

3.6

3.8

China

8.4

8.5

7.9

5.6

5.8

5.4

Japan

3.3

2.6

3.1

2.5

2.0

2.5

EU

4.2

4.4

Euro area

4.4

4.3

4.3

3.8

4.4

4.4

Germany

3.6

3.3

3.4

3.4

4.4

4.1

France

5.8

5.8

5.2

4.2

4.0

4.2

Italy

4.2

4.5

4.2

3.6

4.4

4.4

Spain

6.4

5.9

5.9

4.7

6.3

6.8

U. Kingdom

5.3

7.2

5.0

5.1

5.5

5.3

India

12.55

9.9*

10.5

6.95

8.2*

6.5

Brazil

3.7

3.7

3.4

2.6

2.5

1.8

Russia

3.8

3.5

2.7

3.8

2.8

2.3

1: IMF (April 2021) 2: OECD (May 2021), Forecast for India for fiscal year beginning April 3: European Commission (May 2021) 4: Forecast on basis of 70 percent world GDP (PPP of 2013) 5: Information on India for the fiscal year in current prices

Recovery led by industry, some services still suffering Manufacturing and the industrial sector recovered quickly already last year and have continued their upward trend this year. The great majority of service industries have also regained their normal rate of activity, but the weak result overall is due to the industries affected by the closure of shops, contact restrictions and temporary slumps in demand. This pattern should go back to normal for many industries in the industrialised countries by the end of the year while it could take another one to two years for the economies of the developing and emerging countries to get back to normal. Tourism, travel, hospitality and the cultural and creative industries have been the hardest hit across the world.

Countries in which these industries account for a high proportion of GDP have therefore suffered the greatest economic loss.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Economic activity in the large economies picks up The global purchasing managers’ index and those of the four large economic powers have been indicating robust economic activity in industry for several months and services are slowly catching up.

Economic sentiment indicators*, OECD

103 101 99 97 95 93 91 Jan 20 Jan Feb Mrz Apr Mai Jun JunJul 20 20 Aug 20 20 20 20 20 20 20 Business Tendency Surveys (Manufacturing)

Sep 20

Okt Nov Dez Jan Jan Feb 21 20 20 20 21 21 Consumer Opinion Surveys

Mrz 21

Apr Mai Jun Jun21 21 21 21 Leading Indicator

*seasonally adjusted (index=100) Source: Macrobond

Purchasing Managers` Index* World 60

50

40

30

20 PMI Manufacturing

PMI Services

PMI Composite

*PMI Source: Market Source: Macrobond

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Purchasing Managers` Indices* 75

Germany

70

65

60

55

50

45

40

35

30

25

20

15 Jan 20

Jun 20

Jan 21

Jun 21

10 Jan 20

Euro area

Jun 20

Jan 21

Manufacturing PMI

Manufacturing PMI

Services PMI

Services PMI

Composite PMI

Composite PMI

75

United States

Jun 21

China

60 55

65 50 55

45 40

45

35 35 30 25 Jan 20

Jun 20

Jan 21

Jun 21

25 Jan 20

Jun 20

Jan 21

Manufacturing PMI

Manufacturing PMI

Services PMI

Services PMI

Composite PMI

Composite PMI

Jun 21

*PMI Source: Market Source: Macrobond

The U.S. engine The United States will be the strongest driver of global economic growth this year. The 1.9 trillion U.S. dollar economic stimulus package of the U.S. government (following on from a package of 900 billion U.S. dollars in December 2020) will push growth up to 6.5 percent (last year: minus 3.5 percent). The rapid pace of vaccination and the foreseeable easing of restrictions are likely to give consumption and investment expenditure a major boost in the second half of the year, although it

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

remains to be seen whether the pandemic really has been contained. More than 50 percent of U.S. citizens had had at least one dose of the vaccine by early June. The rate of new infections is also dropping steadily. Moreover, just under ten percent of the U.S. population has already had a coronavirus infection.

Chinese economy back on track China should grow by a good eight percent, although this is relativised by a considerable statistical carryover effect following the weak growth of 2.25 percent last year. Economic momentum had already dropped substantially in the first quarter this year. Economic growth should pick up and get back to its normal level of between 5.5 and six percent in real terms by 2022. The Communist Party set itself the comfortable target of at least six percent for this year (which would already be achieved if economic activity stagnated from January onwards). The Chinese economy had already rebounded to pre-crisis levels in autumn 2020 and should grow at a higher rate this year than was expected even before the crisis and even without any major stimulus measures.

Broad recovery on the cards in the Euro area Following the steep plunge of minus 6.8 percent last year, the Euro area should grow by at least 4.25 percent over last year as restrictions have been lifted to a large extent in many countries as of mid- May. The negative growth of 0.7 percent recorded in the fourth quarter 2020 and negative 0.3 percent in the first quarter, both quarter on quarter, mean that the Euro area experienced a technical recession (two quarters with negative growth). Growth may even accelerate a little next year.

The figures for the EU are on the same level. The ECB is anticipating a slightly stronger recovery still with a growth in real economic output of 4.6 percent this year.

Regional outlook: diverse pace of recovery The developing and emerging countries have recorded very divergent economic trends (IMF 2021a).

The hardest hit countries last year were primarily the poorest countries and the Latin American continent, while most Asian, African and Middle Eastern and Central Asian countries only suffered moderate economic declines. The least developed countries had the least economic policy space to respond to the impact of the pandemic. Some emerging countries nonetheless managed to implement some mitigating measures.

In Asia-Pacific most countries can expect a good rate of economic growth this year. The five ASEAN countries should grow at almost five percent, more than compensating for the decrease last year.

Australia is set to expand by 4.5 percent, Korea by a good 3.5 percent, Taiwan by 4.75 percent and Singapore with slightly over five percent. India’s economy had a surprisingly strong start to the year, growing at 1.6 percent compared to last year. Real gross value-added rose by almost four percent, investments by ten percent and private consumption turned positive. India’s second COVID wave, which started in February and reached its highpoint in early May with around 390,000 new infections per day has meanwhile been contained. The wide array of lockdown measures imposed has brought new infections down to under 150,000 and this figure is expected to be less than 30,000 by the end of July. If so, the Indian economy should grow by a good ten percent this year. Investment activity could even increase by over 15 percent, compensating for the drop of 14 percent last year. The slow pace of the vaccination campaign (so far twelve percent of the Indian population has received at least one dose) and the precarious state of the healthcare system means that risks remain.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

On the other side of the Pacific in North America, Canada will also grow by five percent, compensating for the slump of a similar scale last year. Mexico is set to grow by about the same rate but will not be able to recover the loss of the previous year completely, which was minus 8.2 percent.

Regional economic outlook*

2021

2022

Europe, advanced and developing economies

4.3

3.8

Middle East, North Africa, Afghanistan, Pakistan

3.7

3.8

Israel

5.0

4.3

Sub-Sahara Africa

3.4

4.0

South America

4.4

2.8

Central America

5.6

4.1

Caribbean

3.3

11.1

Asia-Pacific, advanced economies1

4.1

3.0

Asia-Pacific, developing economies2

8.7

6.0

1 Japan, South Korea, Taiwan, Singapore, Hong Kong, Australia, New Zealand, Macau 2 including China and India *Growth of real GDP over previous year in percent Source: IMF (April 2021)

The large region of the Middle East and Central Asia will grow by 3.75 percent, thus compensating for the just under three percent lost last year. Russia is set to expand by four percent. South and Central America and the Caribbean will grow but not enough to compensate the deep drops seen last year. Following a contraction of seven percent last year, growth should be at a good 4.5 percent.

Brazil is expected to grow by 3.75 percent, compared to negative 4.1 percent last year. Investments are surging and consumption expenditure is also recovering. High budget deficits and a debt level of more than 90 percent of GDP mean that policy space is limited, particularly given the large amount of social spending required due to the high unemployment level of 14 percent and the high percentage of poor households (20 percent). The parliament has however already cut the welfare payments, so a rise in poverty levels is likely. The main problem is still containing the pandemic. The rate of new infections has been between 50,000 and 80,000 since the beginning of the year while the number of infected people is at around 17 million (eight percent of the population) and the vaccination coverage has only just reached over 20 percent. It will take months for the situation to improve. Argentina should grow by almost six percent following the deep plunge of minus ten percent last year. Venezuela, following a deep recession of minus 30 percent last year, is set to tumble a further ten percent. The IMF has highlighted the fact that the countries in this region, apart from a very few exceptions, such as Chile and Costa Rica, have not been able to procure enough vaccine doses and are therefore having to further endure the risk of waves of infections and restrictions. Sub-Saharan Africa will be able to more than compensate for the decrease last year, growing by almost 3.5 percent. This will not be the case for South Africa, which, after shrinking seven percent last year is only likely to grow by just over

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

three percent this year, while Nigeria should grow by at least 2.5 percent following minus 1.8 percent in 2020.

Financial policy still supporting recovery, but on a lesser scale The governments of the major economies propped up economic activity last year and this year through a wide range of programmes. The IMF has calculated the total volume of measures adopted by the end of March at 16 trillion U.S. dollars, of which ten trillion U.S. dollars were spent on additional expenditure or due to decreasing revenue and six trillion on loans, guarantees and equity assistance.

Over half of the measures were earmarked to secure employee income (IMF 2021b). The great majority of support measures were adopted in industrialised countries, which are continuing to support their economies this year. Many developing and emerging countries were only able to take small-scale measures to mitigate the damage and many are already starting to consolidate this year. Without these massive measures, global economic output would probably have dropped by a further six percentage points (IMF 2021a). The dominant factor in financial policy were the rescue elements, while real economic stimulus measures with a policy focus primarily on climate protection, digitalisation, infrastructure and growth are still not very widespread. While the economic packages particularly in Germany, France and Japan contained such elements from an early stage, the United States will only include these approaches in the next two packages of measures planned by the Biden administration.

In the United States the Trump administration had already adopted two packages, which have now been supplemented by the latest Biden package. In 2020, the measures amounted to a volume of 16.7 percent of economic output. The combination of the December package of the Trump administration with a volume of 900 billion US dollars and the Biden package of 1.9 trillion U.S. dollars this year will provide stimulus of a good ten percent of economic output. Biden is planning two further packages of measures. In any case, U.S. financial policy should boost economic growth in Canada and Mexico by up to one percentage point and in Europe and China by between 0.25 percentage points and 0.5 percentage points (OECD 2021); the German Council of Economic Experts has calculated an impact of 0.4 to 0.7 percent (German Council of Economic Experts 2021); we anticipate well over 0.5 percentage points.

China only took moderate measures in 2020 and will slightly consolidate its public finances this year.

Japan used several supplementary budgets amounting to almost 16 percent of economic output to stimulate the economy, while the equivalent figure in the United Kingdom was 13 percent.

In the Euro area alone, support measures amounted to five percent of economic output through direct measures and a further five percent in automatic stabilisers and 19 percent through indirect measures such as loans and guarantees (IMF 2021b). The European Commission is anticipating support measures adopted this year to be on a scale of just under four percent of economic output, slimming down to one percent next year (European Commission 2021). National support programmes have in part been scaled up this year, for example in Italy by 30 billion euros and in Germany by 60 billion euros. In the second half of the year the Recovery and Resilience Plans of Next Generation EU will take effect in many member states. This is set to push up activity by up to one additional percentage point across the Euro area this year and the next, with a higher impact expected in Italy and Spain.

Financial policy in Europe has been and continues to be appropriately expansionary from 2020 to 2022.

Financial policy this year will remain slightly expansionary with some measures expiring next year, but some restrictions will also cease to apply. The general government budget balances in the Euro area will therefore be going from almost balanced budgets in 2019 (deficit of a good half a percent of GDP)

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

to deficits of over seven percent last year (7.2 percent in 2020), rising slightly to eight percent this year before dropping to below four percent next year. Consolidation will then take place gradually; in 2022 however, more than half of the countries are still likely to lie above the Maastricht reference value of net borrowing to GDP ratio of three percent. Structural deficit adjusted for cyclical effects, one-off factors and limited programmes will increase by another 2.5 percent as it did in the previous year but should drop by 2.5 percent next year. In 2021 and 2022, the output gaps in all major Euro area countries will drop considerably. Structural primary deficit, where interest expenditure is also factored out, rose by 3.5 percent on average in 2020, and is only likely to sink to a good percent in Germany.

In France, Spain and Italy it is likely remain at well over four percent even in 2022.

Pandemic is heavy burden on public budgets worldwide Deficit ratios have risen sharply all over the world in the course of the economic slump and efforts to combat the pandemic, increasing to 11.7 percent of GDP in industrialised countries, 9.8 percent in emerging countries and 5.5 percent in low-income developing countries. Debt ratios worldwide increased by 13 percentage points to 97 percent. The economic slump triggered by the pandemic alone accounted for ten percentage points according to IMF calculations. In industrialised countries, additional expenditure on healthcare, support for companies and transfer payments to workers contributed an equal amount to the deficits as the drop in taxes and duties. In developing and emerging countries, the deficit was largely caused by a drop in tax and duty revenue. This year, deficits are expected to decrease slightly, accompanied with a marginal further increase in debt ratios, but will still remain high across the world according to IMF estimates (United States: 15 percent; China: 13.5 percent incl. shadow budgets; United Kingdom: 11.8 percent; Japan: 9.4 percent; Euro area: 6.7 percent; Germany: 5.5 percent). Deficits should drop substantially over the next five years with economic recovery bolstering the income side, one-off expenditure for support measures expiring and economic stimulus boosting activity.

There is consensus that financial policy should gradually shift from broad programmes to more targeted ones, focusing its support on sectors that are still facing restrictions and otherwise reallocating the resources to new areas. However, this is easier said than done. While the take up of loans, guarantees and equity assistance was significantly lower than initially anticipated, uncertainty about a return to normal levels of demand in the hardest hit industries remains high. The extent to which insolvencies in these industries will reduce supply and alternatives will be permanently adopted (such as video conferences replacing business trips) also remains unclear. Financial policy will need to continue with the recovery measures as needed for the next one to two years. Support for reallocation measures on the labour market would be recommendable but is difficult to anticipate in terms of scale.

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Forecast dept ratio 2020/21*

Forecast budget balance 2020/21* 0

300

-2

250

-4 200

-6 -8

150

-10

100

-12 50

-14 -16

0

2021

2022

2021

2022

*in percent of GDP Source: IMF

Central banks flanking recovery The world’s major central banks have so far played a key stabilising role in the pandemic and have succeeded in securing the financing of the real economy and governments through favourable conditions. The main programmes had been established by summer 2020 and are still in place, as described in detail in the last edition of our publication last September. The tasks faced by the central banks in the last six months have not changed much. An expansionary course continues to be appropriate under the circumstances. The central banks primarily used purchase programmes; the ECB has increased its balance sheet size by over three percent of GDP since 2019, the Japanese central bank by more than ten percent, and the central banks of the United States and the United Kingdom by more than 15 percent (OECD 2021). These large central banks have, for the most part, purchased private assets, but also hold significant market shares of government bonds (the United States slightly over 20 percent, large euro countries 20-30 percent). Special measures to inject cash in banks and financial markets and swap agreements have already been largely scaled down in the United States. The ECB, in contrast, stepped up its asset purchase programme last December by 500 billion euros, continues to offer attractive long-term refinancing deals for commercial banks, and has scaled up its security purchases to counteract the increase of long-term yields and the risk surcharges in the south. The ECB is also trying to avoid tightening the commercial financing conditions as bank lending standards have already been raised, bond yields are rising slightly, and the euro is expected to appreciate slightly against the dollar. The tools of the ECB give it enough policy space to make this possible. The Japanese central bank has added a few tools to stimulate lending and inject liquidity.

Only some currencies in a few emerging countries such as Turkey, Brazil and Argentina have been placed under downward pressure, which has forced the central banks there to raise interest rates. Most

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developing and emerging countries have however managed to secure relatively favourable financing conditions and to keep panicked responses and rising risk premiums for their securities at a low level.

By and large, the pandemic policy of the central banks has been rolled out or is in part already being rolled back again with the agenda returning to more conventional issues such as the monetary management of inflation.

Temporary rise in inflation due to one-off factors The monthly inflation rates in the United States and the Euro area, each compared to the previous year, have risen sharply in the last few months, triggering a new global debate on the risks of inflation.

This has caused uncertainty in public opinion and on the financial markets. The main factor causing the increase was oil prices climbing back to pre-crisis levels of around 70 U.S. dollars per barrel following a slump down to just over 30 U.S. dollars last summer. Furthermore, in many countries a number of one-off factors linked to the pandemic are weighing heavily into the equation.

The international economic organisations and major central banks are nonetheless certain that these temporary effects will have little impact on the lower, subdued outlook for inflation over the next few years (ECB 2021, IMF 2021, OECD 2021, Schnabel 2021). The economic recovery still needs to pick up speed. The major economies are still facing higher unemployment and lower labour participation rates than before the crisis. Wage-setting is therefore expected to be moderate. Some bottlenecks in supply (commodities, semiconductors, freight capacities) should be largely smoothed out by 2022. The energy prices over the year are set to fall slightly rather than to increase. The Philipps curves are comparatively flat which means that increases in activity will only gradually put pressure on prices.

Inflation is expected to rise in the short term, but not disproportionately strongly in the medium term; the five-year, five-year forward inflation expectation rate as revealed by the swap prices is still well below two percent in the Euro area and has only increased to just under 2.5 percent for the United States. In other words, the financial markets are anticipating that the U.S. central bank will allow a moderate increase over and above the two-percent mark in the coming decade while it is assumed that despite its monetary policy strategy review, the ECB will not raise the inflation rate significantly over the current target of just below two percent. Not even the pandemic then, has managed to change these assumptions. Central banks still have a high level of credibility and independence. In many developing countries, the institutional and legal parameters for central banks have been improved.

Concerns that so-called fiscal dominance, where excessive government debt leads to politically nonviable debt servicing costs, will stop central banks tightening their monetary policy sufficiently when needed, while widespread in Germany, is not shared on an international level.

More complicated are questions about whether changes in the international division of labour, particularly a possible downturn in globalisation, the aging of Western societies with the corresponding downward pressure on productivity, a decreasing inequality and an increasing focus on key product markets with a corresponding increasing price-setting power of large corporations and larger scale reallocation processes, such as in the wake of climate protection measures, will change the outlook for inflation in the long term. A lively debate is currently taking place on this issue (Goodhart, Pradhan 2020), but no viable conclusions have yet been drawn.

U.S. inflation rate causing uncertainty but will only stay high temporarily Over the next few quarters, the United States in particular will see inflation continue to rise sharply to over two percent and only decreasing in the medium term. In April the Consumer Price Index stood at

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4.2 percent (core inflation: three percent) and the price development of personal consumption expenditure of 3.5 percent (core inflation: 2.3 percent) used by the central bank as a target were already higher than expected.1 In May, the index climbed to five percent over the previous year.

The latest increase was triggered by several one-off factors. First, the inflation rate dropped considerably during the recession in 2020, so we are now seeing a catch-up effect. Secondly, energy prices also rose sharply at the start of the year due to the global recovery and OPEC+ output cuts.

Other commodity, food and transport prices, for example for container shipping on major routes, have also shot up recently. Thirdly, international supply problems for semiconductors, for example, have pushed producer prices up in general and also the prices for specific products such as used vehicles, as the new vehicle production has not been able to meet demand. Fourth, there are statistical collection and estimation problems in areas where consumption is restricted that temporarily drive up inflation rates. Fifth, the pandemic has caused the weighting of individual groups of goods in the baskets to shift which has also driven up prices; this factor will tail off now that consumption patterns are returning to normal.

However, over the next few quarters, too, the boost in demand triggered by financial policy will push up prices. This is because financial policy will have a more expansionary effect than indicated by the output gap, i.e., the gap between (estimated) production potential and current production levels. The two stimulus and spending packages of Trump from December 2020 and Biden from March 2021 have a combined volume of around 13 percent of 2019 GDP. Furthermore, seven percent of GDP is available as extra savings and could also push up demand. In this respect, the current situation has been compared to the years 1951/52, when, during the Korea war demand surged almost to double digit figures for two years with inflation rising to eight percent and unemployment plunging (Gagnon 2021a, b). In 2021 the boost in demand could be on a similar scale while the output gap, generously calculated, is expected to be at four to five percent of economic output; the Congressional Budget Office, for example, puts it at only three percent. As the Biden administration plans to go beyond just closing the output gap, this is intentional. Some economists close to the Democrats believe that the package of the Biden administration is therefore too large and are concerned about the price, recession and stagnation risks as a 1.9 trillion stimulus package unleashed on an estimated output gap of 900 billion U.S. dollars (Summers 2021, Blanchard 2021) will trigger price effects and may raise interest rates which could then lead to a sharp slump in activity.

The monetary policymakers do not view the situation with such concern. The median forecast for the inflation rate (of personal consumption expenditures) of the members of the Federal Open Market Committee of the Federal Bank in mid-June was at 3.4 percent for this year and 2.1 percent for next year. The IMF and the OECD also think the packages will raise inflation temporarily but do not see any real medium-term stagnation risks as a result of restrictive countermeasures by the central bank (OECD 2021, IMF 2021a). IMF Chief Economist, Gita Gopinath, predicts inflation will rise to 2.25 percent in 2022 (Gopinath 2021). The Fed intends to ignore this increase in its monetary policy, but this will not stop markets and the media from getting nervous. Exaggerated market responses in combination with unexpected monetary policy measures, in part also in response to these market developments, could certainly cause volatility and risk impacting the real economy. On the other hand,

1

The indices are collected by various authorities and differ slightly based on the weight of the basket of good, statistical adjustments and the breadth of the prices recorded. The Consumer Price Index is more narrowly defined, it does not contain, e.g., health expenditure and usually has a higher inflation rate than the Consumer Expenditure Index.

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the Fed has a whole range of tools available to influence market expectations and prevent them from becoming unanchored. If necessary, moderate interest rate hikes at the end of 2022 or early 2023 should be sufficient to get inflation back under control.

Inflation in the Euro area on similar path, but lower The Euro area is obviously also affected by some of the same temporary factors (European Commission 2021, ECB 2021, Lane 2021). The inflation rate in May was two percent higher than one year previously (first quarter: 1.4 percent) which is higher than it has been for a long time. The pandemic had a big impact of course, pushing the inflation rate down to 0.3 percent in 2020. Due to the worldwide slump in demand, oil prices plunged from around 70 U.S. dollars per barrel to just over 30 U.S. dollars only to rise back to 70 U.S. dollars per barrel in late autumn. The doubling of the oil price between November and March had a substantial impact on prices. Oil prices are however expected to stabilise at their current level, so there should not be any further pressure on prices from oil in the next few months. In Germany, the introduction of its national emissions trading system additionally pushed up prices. The annual statistical adaption of the basket of goods also drove up prices (by a good 0.1-0.2 percentage points in the first quarter), particularly in Germany, which alone recorded an impact of 0.4 percentage points for the first quarter of the current year. Third, some temporary cuts in value-added tax have expired, also in Germany. Fourth, service prices increased, particularly at the beginning of the year, also, in part, due to base effects from the pandemic-ridden previous year. Fifth, prices for industrial goods also increased by a good 1.5 percent in January as the clearance sale schedule was disrupted in several countries with the clearance sale season being largely cancelled. Consumer goods prices then lost momentum again. In contrast, the higher prices for container shipping, the disturbances at the Suez Canal, the increased input and producer prices only had a marginal impact on inflation. The core rate (excluding energy and food) fluctuated monthly between 0.2 and 1.4 percent last year, if textiles/clothing, shoes and travel goods are excluded then only between 0.6 and 1.0 percent, or if the impact of value-added text is excluded, the fluctuation was only between 0.9 and 1.2 percent (ECB 2021). As can be seen, there is a lot of noise in the figures.

While the inflation rate in the Euro area should be closer to the target level this year (the ECB is expecting inflation of 1.9 percent over last year), due to the low inflationary pressure from the labour market and wages, and an only gradually closing output gap and corresponding low pressure from the goods market, prices are expected to rise less already in 2022 (1.5 percent year on year). The moderate appreciation of the euro is also keeping inflation down. Inflation prospects for the Euro area in the medium term have not changed in an alarming way, the medium-term market expectations and those given by market forecasters in the ECB survey are only slightly below the official estimates, and the market-based indicators for long-term inflation expectations (5-year/5-year forward inflation expectation rate) are still well below the target level of the ECB.

Financial markets undergoing turbulent adjustment Despite the huge economic slump last year, the financial markets have experienced comparatively few turbulences. Although stock markets took a big plunge last spring, they had largely recovered by the end of the year. The bonds markets remained characterised by low yields across the board, with yields only starting to rise again at the start of the year and particularly in the United States. The currency markets did fluctuate mildly but did not see any larger turbulences.

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Stock markets have been on a steep upward trajectory since autumn 2020. The markets in Korea, France, Italy, Germany, and Japan rose the most, expanding by more than 25 percent between November 2020 and the middle of May in each case. The U.S. market was up by slightly over 20 percent, the stock markets in developing and emerging countries by 18 percent overall (MSCI Emerging Markets), and the Chinese market by a good five percent (OECD, own calculations). The valuation on the U.S. stock market, measured in terms of the cyclically adjusted price-to-earnings ratio of the S&P 500 index value, increased from the already high level of 26 in the trough of the pandemic in spring 2020 to a record high of 37 in the middle of May, which is certainly the result of the unusual mix of a very expansionary fiscal policy and high expectations of the markets regarding corporate earnings and economic growth, in conjunction with expansionary monetary policy. European stocks also recovered from a price-to-earnings ratio of 14 in March 2020 to just over 20 (EuroStoxx 600), with particularly high increases in cyclical energy and financial securities. The Japanese stock market, in contrast, after a longer period of higher valuations of between 20 and 25, settled back down to the precrisis P/E ratio of 15.

The hopes of growth, progress in fighting the pandemic, and expectations that inflation will rise, above all in the United States, have also influenced the bond markets. U.S. bonds, in particular, picked up at the beginning of the year with U.S. yields on ten-year government bonds initially rising 80 base points before cooling down somewhat. Japanese bonds remained flat, but all other G7 countries also experienced moderate yield upticks. German bonds were the only ones still stuck in negative territory in the middle of May. The risk premiums for the southern European states even narrowed slightly. The bond markets of most developing and emerging countries did not record any major price fluctuations; Turkey, Brazil and Russia, on the other hand, were forced to take extensive action on the macroeconomic level to bring about yield increases of three, just under two, and a good one percent respectively.

On the currency markets, the biggest changes in the last six months were seen in the currencies of Argentina, Brazil and Turkey, which all depreciated between 15 and 25 percent against the U.S. dollar.

The renminbi, the British pound, the Canadian dollar, and the yen all appreciated. The euro appreciated ten percent against the dollar. In trade-weighted terms, however, the euro has moved sideways since summer 2020 in real and nominal terms, losing slightly against the dollar and the pound but appreciating against the yen, the franc, and the Turkish lira. The U.S. dollar, in contrast, depreciated in trade-weighted, real and nominal terms, losing between five and six percent from April 2020 to January 2021 before appreciating by two percent with the announcement of the financial policy proposals and the swift progress of the vaccination campaign. The currencies of commodity exporters experienced a rollercoaster ride of appreciation and depreciation and should now have reached a new plateau.

Global industrial production drops for the first time in ten years After ten years of continual growth, global industrial production contracted in 2020 by 4.4 percent on account of the COVID pandemic. According to calculations by the Netherlands Bureau for Economic Policy Analysis (CPB), the drop was markedly lower than during the global financial crisis when global production decreased by 7.6 percent. Unlike in 2009, when only the developed economies suffered production losses, this time around both groups of countries were affected.

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World: Industrial production * emerging economies advanced economies Purchasing Managers Index seasonally adjusted (left axis) 60

10

50

5

40 0 30 -5 20 -10

10

0

-15 2020

2021

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis, own calculations

In the emerging countries, industry was still growing at the end of 2019 then stopped abruptly with the outbreak of the pandemic. In the first two quarters of 2020, industrial production dropped by 5.8 percent and then 5.5 percent year on year. It only climbed back over the previous year’s level in the fourth quarter, going up 2.5 percent. For the year overall, production dropped by 2.3 percent. In the first quarter 2021, industrial production surged 13.8 percent compared to the previous year, above all on account of the strong growth in China and in emerging countries in Asia. While production in Latin America managed to rise by 1.4 percent in the same period, production in Central and Eastern Europe dropped by 1.1 percent. The countries of Africa and the Middle East even registered a slump of eight percent. The purchasing managers’ index for industry in emerging countries has lost some ground following an interim high in November 2020 but is still in expansionary territory at 52 index points in May, the latest figure available. The high statistical carryover effect and the strong emerging recovery in Asia should allow industrial production in the emerging countries to grow by ten percent this year.

In the advanced economies, industrial production had already been in decline since the middle of 2019. With the outbreak of the pandemic, the decline accelerated and bottomed out in the second quarter 2020 when activity was 15.4 percent less than one year previously. Despite the robust recovery later in the year, production for 2020 overall was down by 6.4 percent compared to the previous year.

In the first quarter of the current year, industrial production in the advanced economies increased by a very moderate 0.3 percent year on year. While industries in the Euro area and the rest of the advanced economies where back to positive year on year, production in the United States dropped by 2.3 percent and in Japan by one percent. The purchasing managers’ index for industry in this group of countries indicates a robust increase in production for the early summer. Since August last year, the index is back in expansionary territory climbing steadily between December and May this year to a new three-

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year high of 59.8 index points. In view of the clear recovery trend this spring and the high statistical carryover effect, we expect industrial production for the year 2021 overall to increase by five percent.

In the first quarter of the current year, global industrial production increased by 6.9 percent compared to the same period last year. The global purchasing managers’ index for the industrial sector increased to a new three-year high in every month from February to May 2021. The latest figures indicate further expansion. We expect global industrial production to increase by eight percent this year.

Global trade IMF estimates from April put the reduction in global trade, compared to the same month last year, at 8.5 percent. Global trade in goods was significantly impacted by the COVID pandemic but recovered swiftly in the course of the year. In the first quarter of 2021, the volume of global trade was 4.5 percent higher than the previous quarter according to preliminary figures from the Netherlands Bureau for Economic Policy. On the export side, emerging countries benefited most from the robust upturn (China: up 6.8 percent), with European exports also riding the upward tide (up 4.8 percent). The RWI/ISL container throughput index, which forecasts the development of world trade based on the capacity utilisation of key container ports worldwide, has been pointing upward for months. It has now climbed to 127.1, a very high level, following a pause in momentum during the winter. For the year overall, the IMF predicts an increase in global trade of 8.4 percent. In this case, the setback caused by COVID will have been largely overcome.

Foreign direct investment According to UNCTAD, global investment flows plunged dramatically in the course of the global COVID pandemic, going down 42 percent. Investment flows are down particularly in industrialised countries, which recorded a massive decline in investment of 69 percent. The OECD also expects global investment flows in 2020 to have tumbled 38 percent, levels not seen since 2005. Alongside the reluctance of companies to make investments during a crisis, the main factors pushing down investment are the increasing number of new regulatory and legal barriers to foreign investment. The trend towards investment protectionism, which had already emerged before COVID, accelerated during the pandemic. Many countries, including Germany (15th & 17th amendment of the Foreign Trade and Payments Ordinance) and other EU member states, further stepped up the government control over foreign investment despite slumping FDI flows across the world. UNCTAD does not expect the global appetite for investment to recover in 2021.

United States Economic development The U.S. economy took a hard beating from the COVID-19 crisis in 2020 but there are some signs that the economy is starting to recover in 2021. In 2020 overall, U.S. economic output was down by 3.5 percent. The scale of the impact the pandemic has had on the U.S. economy became apparent in the second quarter of 2020 when GDP collapsed by an annualised rate of 31.4 percent. Despite the battering, the U.S. economy gained impressive traction at the start of 2021, with GDP surging by an annualised rate of 6.4 percent in the first quarter (Bureau of Economic Analysis, BEA 2021a). The OECD upwardly adjusted its 2021 growth forecast for the United States in May 2021, bringing it up from 3.2 percent in late 2020 to 6.9 percent (OECD 2021b). The International Monetary Fund and the

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European Commission also expect strong growth, forecasting 6.4 percent and 6.3 percent growth respectively for the current year (IMF 2021d, European Commission 2021).

The unemployment figures in the United States highlight the gravity of the economic situation in the country during the COVID crisis. While in February 2020, unemployment was at 3.5 percent, by April it had shot up to 14.8 percent. Although unemployment is still not down to pre-crisis levels, it had gone down to six percent by March 2021. It has since risen marginally in April 2021 to 6.1 percent. Those most affected by unemployment are the self-employed, low-paid workers and workers employed on a time basis, young people, women, and Hispanics (Bureau of Labor Statistics 2020, 2021). OECD predicts that unemployment levels will be back to pre-crisis levels by 2022 (OECD 2020).

In April 2021, U.S. consumer sentiment climbed to its highest level in 14 months. The U.S. Consumer Confidence Survey climbed to 117.5 points, according to the Institute Conference Board. In May, momentum faltered slightly, dipping down by 0.3 points (The Conference Board 2021). The high consumer sentiment in the United States is also reflected in rising U.S. consumption expenditure. In March 2021, consumption expenditure increased by 4.7 percent compared to the previous month (BEA 2021b). The upward trend continued in April, with consumption expenditure rising a further 0.5 percent.

Household disposable income also increased to 23.6 percent in March, before dropping down to 14.6 percent in April (BEA 2021d, BEA 2021e). The Bureau of Economic Analysis (BEA) attributes the spike in the disposable income of private households to the Biden administration’s stimulus checks during the pandemic. Under the American Rescue Plan Act, 161 million U.S. households received payments of 1,400 U.S. dollars each to cover the economic fallout (White House 2021a).

In April 2021, prices and inflation in the United States reached their highest level since September 2008, rising 4.2 percent month on month. For 2022 and 2023, the Fed is forecasting inflation of more than two percent (Federal Reserve Bank of New York 2021a). Petrol prices rose the most, rocketing up 9.1 percent compared to the previous month. Rising commodity prices and bottlenecks in supply chains had exerted strong inflationary pressure in March 2021 (Federal Reserve Bank of New York 2021b).

Government debt In view of the size and number of fiscal measures taken, it is not surprising that the budget deficit of the United States has increased. In February 2021, the Congressional Budget Office (CBO) published a preliminary estimate of public finances for the fiscal year 2021. According to this report, U.S. debt will exceed the economic output of the country considerably, reaching a debt ratio of 102 percent of GDP at the end of 2021. The budget deficit for this year will amount to around 2.3 trillion U.S. dollars.

The deficit in 2021 standing at 10.3 percent of U.S. GDP will be the second largest since 1945. The COVID stimulus package at the end of last year had pushed the budget deficit for 2020 up to 14.9 percent of U.S. GDP. In CBO’s projections, annual deficits average 1.2 trillion U.S. dollars from 2022 to 2031 per year and exceed their 50-year average of 3.3 percent of GDP in each of those years (CBO 2021).

Foreign trade U.S. foreign trade also suffered badly during the COVID crisis year of 2020. In the first six months of the year, U.S. exports of goods and services recorded a tumble of 20.5 percent in April. U.S. imports also plunged in April 2020, going down by 13.6 percent, compared to the previous month in both cases.

The turnaround occurred in the third quarter 2020, and U.S. exports and imports have been rising

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steadily since. U.S. exports of goods and services amounted to 580 billion U.S. dollars in the first quarter of 2021, which corresponds to a narrow decrease of 3.5 percent in the volume of exports year on year. Trending the other way, U.S. imports of goods and services in the first quarter of 2021 totalled almost 793 billion U.S. dollars, an increase of 8.5 percent compared to the same quarter last year. The OECD expects U.S. exports of goods and services to increase by 6.3 percent in 2021 and U.S. imports of goods and services to increase by 12.8 percent (OECD 2021a).

Fiscal measures under the Biden administration The U.S. Congress and the Trump administration already adopted several emergency packages in 2020 to mitigate the economic impact of the pandemic 2. The Biden administration’s strategy is also to sharply increase state spending. In the first 100 days of his presidency, Joe Biden presented several legislative packages and executive orders unleashing an unprecedented scale of social spending: ▪

Already in effect: The American Rescue Plan: On 11 March 2021, President Biden signed the American Rescue Plan (White House 2021a).

This is the sixth economic package that has been adopted since the beginning of the COVID19 pandemic and has a total volume of around 1.9 trillion U.S. dollars. That is equivalent to just under nine percent of U.S. economic output. Of this amount, U.S. households received 161 million direct payments of 1,400 U.S. dollars each which amounted to a volume of 379 billion U.S. dollars (IRS 2021).

▪

Proposal for an infrastructure plan: The American Jobs Plan (White House 2021d).

At the end of May 2021, Biden presented his budget plan for the expansion of U.S. infrastructure and a social package. These are slated for implementation in the fiscal year 2022 over a period of eight years. The plan covers investment of: - 595.7 billion U.S. dollars for roads, bridges, public transport, ports, and charging infrastructure for electric cars - 308.8 billion U.S. dollars for the expansion of the electricity grids, broadband infrastructure, and water supply - 326 billion U.S. dollars for schools, hospitals, and commercial and private buildings - 400 billion U.S. dollars to expand the health insurance programme Medicaid - 565.5 billion U.S. dollars for research and development in manufacturing and SMEs, and in the expansion of domestic production capacities and supply networks in the field of emerging technologies and critical goods The package also includes the Made in America Tax Plan which provides for tax incentives for the use of renewable energy totalling 307.3 billion U.S. dollars. The additional expenditure is planned to be compensated for in large by a reform of corporate taxation designed to flush an extra two trillion U.S. dollars of tax revenue into state coffers.

2

Details of the first four economic stimulus packages are available in the BDI publication “Global Growth Outlook 09/2020” at https://bdi.eu/media/publikationen/#/publikation/news/globaler-wachstumsausblick-09-2020/ (last accessed on 4 June 2021). In late 2020, the Consolidated Appropriations Act, 2021, was passed providing for further fiscal measures including direct payments to citizens with an annual income of below 75,000 U.S. dollars. For further details, see Associated Press at https://apnews.com/article/health-care-reform-health-legislation-coronavirus-pandemic-762f84e4da11d350d8b5be5680ab01c4 (last accessed 4 June 2021)

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▪

Proposal for a social package – The American Families Plan (White House 2021d). This includes: - 437 billion U.S. dollars for increasing free access to the public education system - Tax credits for families - Increasing tax revenue by strengthening the Internal Revenue Service (IRS), the federal tax authority

Counter-financing through tax hikes Plans are to counter-finance these packages by increasing corporate taxation from 21 to 28 percent (Made in America Tax Plan). The previous administration under Donald Trump had cut the tax rate from 35 percent down to 21 percent. Further financing measures will include raising the income tax on personal income over 452,700 U.S. dollars per year from 37.0 to 39.6 percent (White House 2021b, Axios 2021). Biden plans also include increasing the Global Intangible Low-Taxed Income (GILTI) tax from its current level of between 10.5 percent and 13.125 percent to 21 percent. The Biden administration has also proposed a global minimum tax rate within the OECD of 15 percent.

The plans of the Biden administration also include boosting the capacities of the IRS, the federal tax authority, with a budget of 13.2 billion U.S. dollars for the fiscal year 2022 to reduce tax loopholes (White House 2021b, U.S. Department of the Treasury 2021, Deloitte 2021).

Outlook in the U.S. Congress The proposed fiscal packages can only be adopted with the approval of the U.S. Congress. Opposition to the packages can be expected from the Republicans which will probably result in a long-winded parliamentary process. Implementation may be speeded up by using the Budget Reconciliation 3 process.

U.S. GDP growth, quarterly (annualised) 40

33.4

30 20 10

4.3

6.4

0 -10

-5.0

-20 -30 -31.4

-40 Q1

Q2

Source: Bureau for Economic Analysis

Q3 2020

Q4

Q1 2021

3

Further information on Budget Reconciliation is available from the Center on Budget and Policy Priorities, at https://www.cbpp.org/research/federal-budget/introduction-to-budget-reconciliation (last accessed 4 June 2021).

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Strong start into 2021 in China Overall, the Chinese economy made it through the crisis year of 2020 better than most major economies. By implementing effective COVID-19 containment measures and with considerable fiscal and monetary policy support in the shape of public investment and liquidity assistance, China’s economy gradually managed to pick itself up from a contraction of 6.8 percent in the first quarter 2020 to 6.5 percent growth in the fourth quarter 2020. For the year overall, GDP growth did take a plunge, dropping from well over six percent in 2019 to 2.3 percent in 2020.

Growth is expected to remain strong in 2021, buoyed by the base effects from last year. The latest quarterly growth figures of 18.3 percent for the first three months confirm this interpretation, although the figure is slightly below expert expectations. Overall, growth has almost rebounded to pre-crisis levels and is currently at an average of just over five percent in the last two years.

The latest figures also show foreign trade gearing up fast. Furthermore, the pandemic has now been largely contained. However, the strong figures for overall growth mask the growing imbalances and risks. This is the reason why the Chinese government has only set itself the moderate growth target of ‘more than six percent’ in its current Annual Report. The IMF is more optimistic, forecasting growth of 8.4 percent. We also expect Chinese GDP to grow by eight percent in 2021 and a good five percent in 2022.

Investment and exports rise, while consumption remains weak Looking at the demand side, investment was the biggest driver fuelling GDP growth in 2020.

Investment picked up particularly in manufacturing in the second half of the year. Property investment also recovered and grew by a robust seven percent on account of the strong demand for residential property. Infrastructure investment increased by 0.9 percent, while investment in plant and equipment rose by 2.9 percent. Investment in plant and equipment accelerated rapidly in the first quarter 2021, soaring up 25.6 percent year on year.

Consumption declined in 2020. Although real household income rose, private consumption and retail sales shrank tangibly. In the first quarter 2021, retail sales of consumer goods increased 33.9 percent.

Foreign trade also picked up speed considerably in the second half of 2020. Fuelled by robust exports, China’s trade surplus in the trade of goods expanded. The restrictions on travel narrowed the deficit in the trade of services. The volume of imports of strategically important goods increased. In the first quarter 2021, the Chinese tax authorities reported an increase of 29.2 percent in foreign trade. Exports increased year on year by 38.7 percent, with imports increasing 19.3 percent.

Service sector and industry fortify growth On the supply side, services contributed the most to GDP growth in 2020. Travel, catering, and wholesale and retail sales, in particular, dropped substantially. Especially strong growth in financial services and in information technologies partially compensated for this decline. In the first quarter 2021, the services sector expanded despite the travel restrictions in place during the Chinese New Year. The value added of transport, storage and postal services grew by 32.1 percent year on year, with services in the property sector expanding 21.4 percent.

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In industry, real growth in 2020 dropped down to a moderate rate of 2.6 percent. Manufacturing recovered in the second quarter 2020, particularly the automotive and electrical and electronics industry. High-technology industries, including information technology, computers, and medical instruments, also expanded as did the construction industry, which grew 3.5 percent. In the first quarter 2021, total value added by industrial enterprises (annual sales ≥ 20 million yuan) grew by 24.5 percent year on year, and by two percent compared to the previous quarter. Value added in the production sector grew by 27.3 percent, utilities (energy, gas, water, etc.) by 15.9 percent, mechanical and plant engineering by 39.9 percent and high-tech production by 31.2 percent. The fields of new energy vehicles (electric and hydrogen), industrial robots, excavators and bulldozers, microcomputers and integrated circuits were well ahead of the pack with growth in value added of over 60 percent in each case compared to the same period last year.

More neutral monetary policy, more moderate fiscal support If the upturn continues to strengthen, monetary policy is expected to become more neutral. China has not changed the key interest rate for around one year. The other interest rates also remained stable.

Tightening measures were imposed on the property market to cool down the emerging bubbles. The default on bonds is increasing, with the proportion of corporations owned by the local government defaulting rising sharply. Corporate debt has stabilised but remains very high. Municipal investment corporations, particularly those with a low credit rating will find it relatively difficult to issue corporate bonds.

The support coming from fiscal policy will be less than last year as recovery in most sectors has strengthened. Some support measures currently in place will continue to remain in effect. The debt moratorium will be extended on a case-by-case basis. Corporations affected by the crisis can carry forward their losses for another eight years. The upcoming increase of the retirement age will make more funds available for childcare facilities and lifelong learning.

Outlook for the next six months Investment will remain a key driver of growth this year, with consumption recovering gradually. The robust demand for exports will keep industrial capacity utilisation high. The producer price index (PPI) increased to 6.8 percent in April and could rise further, propelled by globally increasing commodity prices. The consumer price index (CPI) also grew, but moderately, rising 0.9 percent compared to April last year. The high producer prices could push up consumer price inflation.

The prospects for inflation and monetary policy could remain uncertain in 2022. China’s total economic output will probably get back on track to pre-COVID expectations by early 2022. If global demand remains strong, wage growth should then get back to normal or even accelerate.

Geopolitical, trade and technology risks still relevant External risk factors that predate COVID-19 are still relevant. Above all, the tensions between the United States and China concerning trade, intellectual property, and cybersecurity. U.S. import duties, export controls and sanctions amount to, in part, existential risks for Chinese corporations in the technology sector. The risk of general technological decoupling in supply chains or in innovations is considerable.

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The Chinese government plans to address these risks by making the domestic economy more resilient to external influences using its Dual Circulation concept. This concept includes components such as technological autonomy, substituting imports, and focussing on local value added and domestic consumption. It remains to be seen what impact this concept will have on foreign trade and foreign companies’ investments in China.

Target/performance comparison of the economic targets 2020 and the new targets 2021

GDP Consumer prices Money supply M2 Fiscal deficit COVID-19 Bonds Special Purpose Bonds (infrastructure) New urban jobs Urban unemployment

Target 2020

Result 2020

Target 2021

-

2.3%

＞ 6%

~ 3.5%

2.5%

~ 3%

＞ 8.7%

10.1%

Corresponding GDP growth

3.6%

3.7%

3.2%

1 trillion Yuan

1 trillion Yuan

None

3.75 trillion Yuan

3.60 trillion Yuan

3.65 trillion Yuan

9 million

11.86 million

11 million

6%

5.6%

5.5%

Source: SCMP

Euro area and EU A broad-based economic recovery is expected to set in this June. An upward wind is bitterly needed given that the major economies in the region all performed very weakly in the first six months of the year. In the first quarter, economic activity languished across all major countries, either rising marginally or decreasing further quarter on quarter. This trend will have continued into the middle or end of May on account of the high-level restrictions that have remained in place until very recently (European Commission 2021). As restrictions are lifted, the summer season should see activity pick up in the affected industries. In line with the European Commission and the OECD, we expect growth this year in the Euro area and in the EU to come in at 4.25 percent with a similar growth rate next year.

Unemployment is likely to increase further to 8.4 percent this year and then drop down to the 2020 level of 7.8 percent by 2022.

Strong growth in consumption expenditure this year and next Private consumption will be the main driver of economic recovery, first getting back to normal levels and initially boosted, at least to some text, by catch-up consumption activity, with money available from additional savings. The savings rate should also drop down to normal levels. The Commission and the OECD expect growth rates of a good 2.5 percent in 2020 and six percent in 2021.

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Investment should pick up moderately Gross fixed capital formation is being stimulated from the demand side and benefiting from a favourable financing environment, but the consequences of the pandemic on the debt levels of companies will continue to put a damper on the propensity of many to invest. Many companies will first have to consolidate their balance sheet to the extent that they have taken up larger assistance loans.

Construction activity and investment in research and development should also see a positive development. Overall, gross fixed capital formation should grow by a good six percent this year and a good 5.5 percent next year (Commission: 6.7 and 5.3 percent; OECD: 5.7 and 5.6 percent).

Recovery and Resilience Plans bolster public investment Implementation of the measures from the Recovery and Resilience Plans will start in the second half of the year, propping up economic activity in the EU. Over the entire period of the programme, the impetus from grants will amount to a good 1.2 percent of GDP. The Commission expects 40 percent of total funds available to be drawn in 2021 and 2022. That corresponds to 140 billion euros or one percentage point of GDP. Around 30 percent of the funds will flow into public investment, half of the funds used to support private investments and the rest will be spent on other measures. Public investment activity in the EU will rise by a good half a percentage point to reach 3.5 percent of economic output by the end of next year.

GDP growth in the Euro area 8 6 4 2 0 -2 -4 -6 -8 -10 -12

Growth rate 2020

Forecast 2021

Source: European Commission

Net exports to contribute to growth this year Foreign trade and economic activity will benefit primarily from the U.S. economic stimulus package, which should account for around 0.3 percentage points of growth in the EU this year and 0.2 percentage points in 2022 (European Commission 2021). Exports are set to slightly outperform imports, with exports predicted to rise by 8.7 percent compared to a 8.1 percent rise in imports (Euro

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

area: 8.7 percent rise in exports and eight percent rise in imports). Net exports should therefore contribute to growth with a good half a percentage point, before tending towards a balanced result in the following year (European Commission 2021).

Weak start to the year with good prospects for France, Italy and Spain Looking at the major Euro area economies, France managed to move laterally at the start of the year.

Economic output stagnated in the first quarter (down 0.1 percent quarter on quarter) with net exports pulling down growth by almost half a percentage point as companies restocked stores, pushing up imports. Consumption expenditure and gross fixed capital formation were slightly positive. Exports were still a good ten percent and imports seven percent below pre-crisis levels. Activity also looks to have been slightly negative in the second quarter with a hard lockdown in April and May and sales in high-contact services at only half pre-crisis levels. In the second half of the year, a robust recovery is on the cards, fuelled by the French economic stimulus package and very high investment activity, strongly expanding foreign trade and a normalisation in services with consumption expenditure rising.

The French economy should grow by a good five percent this year. Unemployment will remain high initially (around nine percent, following eight percent in 2020). The budget deficit will also peak at nine percent this year before halving next year.

The Italian economy also moved sideways in the first quarter (up 0.1 percent quarter on quarter).

Private consumption expenditure turned down slightly due to the hard lockdown (down 1.2 percent), as did exports (down 0.6 percent), while investment in plant and equipment increased (up 3.7 percent), particularly in buildings and equipment, and inventories and imports (up 2.3 percent) already expanded robustly. With the economy starting into the year with a statistical carryover of 2.6 percent, the government steadily lifting restrictions from May onwards, and the summer season expected to see tourism bloom, growth this year should reach a good five percent (Cordogno 2021; Commission: 4.2 percent, OECD: 4.4 percent). In the course of the year, private consumption expenditure should increase by a good four percent, with investment and exports going up by around ten percent. Foreign trade should be slightly positive. Next year should see similar growth on account of the Italian Recovery and Resilience Plan and upward momentum in consumption and investment that is very likely to continue. The general government budget deficit will increase to just under twelve percent of GDP this year, before dropping to half that in 2022. Italian’s debt ratio will increase to almost 160 percent this year and remain at over 155 percent next year.

Spain’s economy had a slightly weaker start to the year (down 0.5 percent). While consumption expenditure only dropped off a little (down 0.6 percent), gross fixed capital formation, particularly construction investment, decreased tangibly (down 2.2 percent and 5.2 percent respectively).

Investment in machinery, equipment, and research, in contrast, all turned up. Foreign trade remained weak with exports stagnating (down 0.1 percent) and imports drooping somewhat (down 1.3 percent).

With industry already in recovery, various service industries reopening in the second quarter, and good prospects for the summer season, the Spanish economy should still be able to grow by just under six percent this year. Consumption expenditure could even expand slightly more, with growth in investment and exports going into double digits. This still includes a strong catch-up effect given the hard slump in 2020. The Spanish Recovery and Resilience Plan, with a total volume of 70 billion euros within the next six years, should already have a pronounced impact on public and private investment this year.

Unemployment is set to reach a short-term peak of over 15.5 percent this year before going down to 14.5 percent next year. It is not yet clear whether a significant number of insolvencies can be avoided in those service industries particularly affected by the pandemic. If not, this could weigh down the

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

Spanish recovery. The public budget should be past the worst, with public deficit on track to go down from eleven to below eight percent of economic output this year and drop down to around five percent next year.

United Kingdom The UK economy suffered badly during the pandemic and the regulatory measures imposed in 2020 and at the beginning of 2021. Economic output tumbled almost ten percent last year. The relatively early and swift vaccination campaign enabled most restrictions to be lifted in the second quarter of this year. The UK economy started off the year with a further drop of 1.5 percent in the first quarter (quarter on quarter), but recovery appears to have set in steadily since then. For this year, we expect growth of a good seven percent followed by growth of 5.5 percent next year (OECD 2021; the Commission’s estimate is a little more cautious at five percent in each case). The labour market has recovered markedly since the start of the year when unemployment peaked at just over six percent.

Unemployment should be back to pre-crisis levels by the beginning of next year. Consumption spending of private households should rise by just under six percent, capital investment by 6.5 percent.

Net exports could dampen growth slightly as foreign trade overall is hardly picking up momentum, partly on account of the consequences of Brexit. Financial and monetary policy will remain expansionary this year. Financial policy will not initiate steps towards consolidation until 2022. The public deficit of the government of over twelve percent last year will be down to nine percent in 2021 and six percent in 2022.

Japan Japan is also set to continue its recovery this year with growth expected to reach 2.75 percent (following a drop of almost five percent last year). Momentum will remain limited though. Japan also started the year off with economic output losing one percent compared to the previous quarter (down 5.1 percent year on year) despite a positive contribution from inventories of 0.3 percentage points.

Domestic and foreign demand also dropped. Consumers displayed reticence, with a coronavirus state of emergency in Tokyo and other regions between January and March keeping spending on services and durable consumer goods down. Public investment and investment in plant and equipment also dropped, while construction, at least, picked up. Net exports were also negative.

Over the course of the year, however, exports should expand over and above the demand for imports, so that foreign trade will contribute to growth. The latest figures also show industrial production picking up pace considerably. However, another coronavirus state of emergency declared from the end of April in eleven prefectures will have curbed consumption expenditure yet again. The biggest burden remains the extremely slow progress of the vaccination campaign (late approval and low availability of vaccines, shortage of doctors), which is far behind the vaccination pace of Europe and North America, combined with steadily increasing, though still low, numbers of new infections. Whether and at what point the government or the central bank will take further action by implementing further measures remains to be seen. Growth in the course of the year may well be disappointing.

Germany For 2021 overall, we expect exports of goods and services to increase by 8.5 percent in real terms.

This will push up demand for the import of intermediates, with inventories still reduced in the wake of

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

the pandemic. The summer season should also see a sharp rise in foreign travel which will also fuel the import of services. In conjunction with rising consumption expenditure, imports are set to rise by seven percent following price adjustment. In sum, net exports should still contribute 1.2 percentage points to GDP growth.

BDI forecast for 2021: Change in real economic output over the previous year in percent Actual figures

BDI

Federal Government

European Commission

2020

2021

2021

2021

GDP, real

- 4.8

3.5

3.5

3.4

Consumption

- 3.3

2.3

-

-

- Private Consumption

- 6.0

1.0

0.8

0.1

- Public Consumption

3.7

5.2

5.2

3.6

- 2.7

2.9

3.5

3.2

-11.6

7.0

7.5

9.0

2.3

0.5

1.4

-

- Other

- 1.1

2.0

3.3

-

Exports

- 9.4

8.5

9.2

10.4

Imports

- 8.4

7.0

7.8

7.9

Net Exports, Economic Output

- 0.9

1.2

1.1

1.5

Investment - Machinery and Equipment - Construction

Sources: Federal Statistical Office, federal Government (April 2021), European Commission (May 2021), own calculations

The domestic economy should slowly start to gain traction. Employment levels on the labour market are rising while short-time working arrangements are decreasing. With the rate of new infections dropping further, restrictions are likely to be lifted further in retail and hospitality. Private consumption should then also start to pick up. It is very difficult to predict how much of the additional savings households will use for extra consumption. Part of the additional savings may well be used to either pay back loans or make investments. Despite the weak performance of consumption in the first quarter, we expect private consumption expenditure to pick up further and reach one percent in the current year. Prospects for public consumption expenditure have been upwardly revised. The federal government now anticipates public consumption to rise 5.2 percent this year. Overall, consumption expenditure would then increase by 2.3 percent in 2021.

Investment activity should gather momentum in 2021. Following a double-digit plunge in investment in plant and equipment last year, the anticipated increase of seven percent for this year will not wholly

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U.S. engine is propelling global economy | North buoyant, risks prevail in south 06/07/2021

compensate for the slump in 2020. Capacity utilisation in many manufacturing industries was already considerably higher than before the crisis at the start of the second quarter which means that investment will be necessary not only in replacements but also in expansion. We still expect construction investment to rise by 0.5 percent this year. Although construction recorded its highest ever order backlog in March, which would theoretically secure production until November, the growing constraints on supplies in the industry are increasingly putting a lid on growth. Investment in other assets (software, research and development) dipped slightly at the start of 2021 but should recover in the further course of the year. We still expect investment in other assets to increase by two percent following negative growth last year. All in all, gross fixed capital formation should rise 2.9 percent compared to the previous year.

Overall, we expect GDP to increase by 3.5 percent in real terms over the previous year. Our forecasts are based on the assumption that a large proportion of the population will have been vaccinated by autumn and that measures to stop the spread of the pandemic will no longer be impeding economic activity. We should see a return to pre-crisis levels by the fourth quarter of the current year.

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Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu Authors Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu Theresa Halbig Praktikantin Außenwirtschaftspolitik Matthias Krämer T.: +49 30 2028 1562 m.kraemer@bdi.eu Wolfgang Krieger BDI-Vertretung, Peking T: +86 1085 325421 w.krieger@bdi.eu Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu Valerie Ross T.: +49 30 2028 1623 v.ross@bdi.eu Dr. Christoph Sprich T: +49 30 2028 1525 c.sprich@bdi.eu Editorial / Graphics Marta Gancarek T: +49 30 2028 1588 m.gancarek@bdi.eu

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