For professional investors only. 

Last week saw the publication of the IMF’s bi-annual World Economic Outlook, which includes both the IMF’s forecast for the world economy and also a variety of topics that the Fund’s staff have researched. The main conclusions have been extensively covered in the media (‘IMF Cuts Global Growth Outlook for 2019’ - Bloomberg), but we wanted to pass on some other insights that we gleaned from reading it.

1.    Corporate power is rising at a rate that troubles the IMF, but not in emerging markets

The fascinating (no, really) second chapter of the report (‘The Rise of Corporate Market Power and its Macroeconomic Effects’) investigates rising corporate market power and its relationship with slowing growth and rising inequality. The study has looked at a dataset of over a million firms across 27 countries, focusing on price markups (the ratio of a good’s price to the marginal cost of producing it).

The Fund’s broad overall conclusion:

‘There has been a moderate rise in corporate market power across advanced economies. Economy-wide markups increased by close to 8 percent, on average, across firms during the 2000–15 sample period, alongside rising profits and market concentration. By contrast, markups remained broadly stable in emerging markets, possibly reflecting limited country coverage and the fact that market competition was weaker than in advanced economies to start with.’ 

Whilst noting the limited emerging market coverage, this does suggest that capitalism may be in better fundamental health in emerging markets than in advanced economies.

The report then goes on to identify some of the negative effects of rising corporate market power, such as reduced private fixed investment and a falling share of national income paid to labour. It doesn’t go on to make the link with the explosion of populist politics (I mean, it’s the IMF we’re reading here), but this is an intriguing report and worthy of both additional consideration and extension studies into emerging economies not covered by this report. Our instinct is that the two emerging markets at opposite ends of the competitiveness spectrum are Mexico and China, neither of which are covered here, and they would show some interesting results in this kind of study.

2.    Looking at trade on a value-added basis is more meaningful than on a gross value basis, and shows up some unusual effects

Popular and political debate around trade balances focuses on the gross values of exports and imports. This is despite economic theory being very clear that it is the value added by the export country to the goods that it has itself imported that should be considered.

The report uses the example of trade among China, Korea, and the US in electrical goods, such as smartphones: 

‘The United States exports some inputs (such as design) to Korea, which adds new inputs (semiconductors and processors) to the production stage and exports the resulting new intermediates to China, which in turn completes production by assembling the inputs and ships the final goods back to the United States. In the example of these goods, the United States accumulates a gross bilateral surplus with Korea and a deficit with China. These values, however, do not reflect the true origin and destination of the value of production generated—and consumed—in each country.’

Thus, the trade deficit that the US reports with China includes the import of value added in China and countries like Korea to the US’s own exports, and the politicisation of trade with China threatens not only the Chinese economy, but also the US export sector. Equity investors have very much focused on the risks to emerging markets from a trade war and perhaps not enough on the risks to some major US sectors.

Additionally, elsewhere in the report, the IMF details the results of a modelling exercise which concludes that, if US-China trade is permanently impaired, the main beneficiaries would be Mexico, Korea and some South-East Asian nations. For us, the conclusion is to not be overly pessimistic on the prospects for EM ex-China in the event that trade relations between the US and China do not recover.
 

3.    Outlook for India remains very strong

Looking at the IMF’s medium-term economic forecasts, one clear pattern is the superiority of the growth opportunity in India to that of growth, well, everywhere else. 

With China expected to see a ‘gradual slowdown [in growth] to 5.5 percent by 2024 as internal rebalancing toward a private-consumption and services-based economy continues and regulatory tightening slows the accumulation of debt and associated vulnerabilities’, India is left as the fastest growing of the major economies and regions. 

The report notes that ‘growth in India is expected to stabilize at just under 7¾ percent over the medium term, based on continued implementation of structural reforms and easing of infrastructure bottlenecks.’ It also recognises that ‘important steps have been taken to strengthen financial sector balance sheets, including through accelerated resolution of nonperforming assets under a simplified bankruptcy framework.’ We would agree wholeheartedly.