Another Rocky Year Ahead for the Big Four

Two thousand seventeen promises to be another eventful year for the global political economy. The world’s four largest economies—the European Union, United States, China, and Japan—all face a troubled mix of economic challenges and political uncertainty. Taking them one by one:

Europe: A spate of elections across the founding members of the European Union could shift European politics sharply to the right. First up is the Netherlands, which holds national elections on March 15, and where the far-right Party for Freedom (PVV) of Geert Wilders currently leads in the polls. Then on April 23, France will hold the first round of its presidential elections. The National Front’s Marine Le Pen is running well in the polls and could come out on top, forcing the French establishment to rally around her opponent in the May 7 runoff, as they did in denying Le Pen’s father the presidency in 2002.

Germany’s federal elections will probably occur in late September of next year. Angela Merkel’s Christian Democratic Union (CDU) holds a double-digit lead over the Social Democratic Party (SPD), and she seems to be on track to win a fourth term as chancellor. But the far-right Alternative für Deutschland (AfD) is polling at nearly 15 percent and driving the political debate, particularly on refugee policy and European integration, and this month’s Berlin bus attack is likely to add fuel to the fire. Merkel has scheduled an early G20 meeting on July 7–8 in Hamburg to boost her credentials as a global leader in German voters’ eyes.

No elections are planned in the United Kingdom in 2017, but Brexit politics will dominate the year. Prime Minister Theresa May has pledged to trigger Article 50 of the Lisbon Treaty by March 31, beginning formal negotiations for withdrawal from the European Union. European leaders have so far signaled a tough stance in negotiations, making a “hard” Brexit, including withdrawal from the EU single market, more likely.

None of this will brighten the outlook for growth in the world’s largest economic area. Britain’s chancellor of the exchequer forecasts his country’s growth to slow significantly over the next five years thanks to Brexit. France’s annual growth has barely topped 1 percent since 2010. And the region’s largest economy, Germany, is expected to grow only 1.4 percent in 2017, as exports fall and the authorities stubbornly resist fiscal stimulus. Meanwhile, financial risks continue to hover over Europe, not least from a fragile banking system in Italy, now run by a weak caretaker government following last month’s defeat of a constitutional referendum.

United States: As Donald Trump’s inauguration on January 20 nears, two threshold questions still cloud the prospects for his administration: what will the new president’s real policy priorities be, and how will he govern?

Trump appears to have backed away from some of his most extreme campaign positions—building a wall along the border with Mexico, abolishing Obamacare, walking away from global climate talks. But some versions of all these items appear to remain on the agenda, and there has been little backing down on issues Trump has held strong views on for many years, notably his skepticism about multilateral trade agreements like the North American Free Trade Agreement (NAFTA) and Trans-Pacific Partnership (TPP).

Glaring inconsistencies in Trump’s policy pronouncements remain to be resolved. For example, his continued berating of China for “currency manipulation” and his desire to eliminate U.S. trade deficits point to a preference for a weaker dollar. Yet in fact the dollar has been soaring on expectations that Trump will put in place massive infrastructure spending, tax cuts, and financial deregulation in an effort to boost growth above its projected rate of 2 percent in 2017–2018. And there are questions as to whether a more fiscally conservative Republican-led Congress will be willing to go along with all of this.

Which leads to the governing style questions. Will Trump be content to act as “king” and let Vice President Mike Pence serve as “prime minister,” overseeing cabinet secretaries with broad autonomy in their respective areas? Or will the White House micromanage policymaking, with Trump himself directing issues he feels strongly about? And what role will presidential tweets play? Will they just be a way for the new president to blow off steam, or will they become a deliberate tool of policymaking, as they have been on China/Taiwan and trade during the transition?

Beyond policy and process, the third of the “three Ps” discussed here last month —personnel—is coming into clearer focus. The economic team is likely to revolve around three wealthy Wall Street executives—Gary Cohn at the National Economic Council, Steve Mnuchin at the Treasury Department, and Wilbur Ross at the Commerce Department—plus one fiscal hawk from Congress, Mick Mulvaney as budget director. How these players interact will be as important to the direction of the Trump administration as the dynamics among the national security team of Mike Flynn at the National Security Council, Rex Tillerson at the State Department, James Mattis at the Defense Department, and Mike Pompeo at the Central Intelligence Agency—assuming of course that all these people survive the vetting process.

China: Politics and personnel will also loom large in China in 2017 and shape the country’s economic prospects. All eyes are on the 19th National Congress of the Chinese Communist Party to be held sometime in the fall. Having been named “core” leader, party chairman and president Xi Jinping will have a chance to further consolidate control of policymaking. Speculation is already rife as to whether Xi will try to extend his term as party chairman beyond its currently scheduled end in 2022.

At its annual Central Economic Work Conference earlier this month, the party made clear that it will put a premium on economic “stability” in 2017 . This suggests that Beijing will leave needed reforms on the back burner and continue to pursue stimulative policies to maintain growth above 6 percent . This could add to China’s already bloated debt, encourage more capital outflows, and put downward pressure on the renminbi, despite Beijing’s heroic efforts to spend down foreign exchange reserves to bolster the currency.

This in turn could add fuel to the fire of a U.S.-China relationship that is already seeing a sharp upswing in tensions before Trump takes office. Most of the hot-button issues in the relationship—trade and investment, the South China Sea, Taiwan, North Korea—are flashing red at the same time, making it difficult to expect smooth relations between the two superpowers in 2017.

Japan: Compared with the other countries surveyed here, Japan is an island of political stability in a sea of uncertainty. Prime Minister Shinzo Abe still enjoys stratospheric approval ratings of over 60 percent and seems at present likely to achieve his ambition of staying in office through the 2020 Olympics in Tokyo.

However, any plans Abe may have had to call a snap election in early 2017 have taken a double hit in recent weeks. First, the election of Donald Trump scotched any remaining hopes of immediate U.S. ratification of TPP, despite Abe’s having spent significant domestic capital to push the trade agreement through Japan’s Diet earlier this month. Then President Vladimir Putin of Russia embarrassed Abe at their meeting in Japan this month by pocketing economic concessions while offering no progress on the two nations’ longstanding territorial dispute in the Kuril Islands.

Meanwhile, the world’s third-largest economy continues to be dogged by sluggish growth—projected at only 0.6 percent in 2017—and the specter of deflation. With TPP on hold, limited progress on structural reform, and decreasing returns to both monetary and fiscal stimulus, Abenomics appears to have stalled. The key test in 2017 will be whether the prime minister can follow through on the long-stated promise of labor-mark reforms, including new action on immigration and women’s participation.

Matthew P. Goodman holds the William E. Simon Chair in Political Economy and is senior adviser for Asian economics at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Daniel Remler is a research assistant with the William E. Simon Chair in Political Economy at CSIS.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2016 by the Center for Strategic and International Studies. All rights reserved.

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Matthew P. Goodman

Matthew P. Goodman

Former Senior Vice President for Economics

Daniel Remler