About two and a half years after the Covid recovery, the global economy faced the prospect of a new recession. On the surface, the global economy faces common headwinds, chief among them inflation, which has been exacerbated by the war’s impact on global energy prices, reducing real incomes and pushing up interest rates.
Even so, the challenges facing the three main economic regions – the US, Europe and Asia – are very different, not least because the aforementioned headwinds are not as global as they seem.
To assess the various risks and their likely timing, we need to remind ourselves of the cyclical factors and structural context of each region. Compared to the US, the Eurozone will face more acute economic difficulties in the near term, but there may be a turning point in 2023 as US challenges are likely to prove more persistent. Meanwhile, the largest Asian economies – Japan and China – are in the most advantageous position in the near term, as recession risks appear relatively low. However, in the long run, both new and old structural problems in Asia are likely to make growth riskier than in the West.
European risks peak this year, US risks next
While both the US and Europe face a high risk of recession – much higher than in Asian economies – the risks differ in degree and type. Yes, the energy shock is global, but it is in Europe that energy prices can cause a recession by themselves. Although the U.S. energy balance is even more dependent on natural gas than Europe’s, spot natural gas prices in Europe have risen more than 15-fold since the start of 2021, making the U.S.’s significant four-fold increase look modest by comparison. .
This diverse energy shock translates into a substantial macroeconomic headwind in the US, but a much more severe shock in Europe, hitting real incomes and purchasing power. It also undermines industrial competitiveness, which has been achieved in part because of unrealistically cheap energy for too long.
But Europe’s much greater exposure to Russia’s geopolitical use of energy resources is only one of the drawbacks — the economies of the Eurozone countries are also less stable than those of the United States.
Like their American counterparts, European consumers today are in a relatively comfortable position to face an economic downturn. On both sides of the Atlantic, household balance sheets are much stronger than before the pandemic because cash has increased, but US households have accelerated even more because of much more stimulus. Both regions similarly enjoy strong labor markets, reflecting factors unlikely to be undermined by an energy shock, but here again US labor markets are particularly tight, with US workers seeing stronger wage growth.
Similarly, American firms demonstrate a greater degree of resilience. Both the US and Europe have seen strong profits, but operating margins in the US are near a three-decade high, while in Europe they are higher than in the last decade, but not as strong as before the 2008 global financial crisis . will contract as input prices – both goods and labor – become harder to pass on as demand declines.
A reversal of fortune next year?
Given Europe’s larger shock and weak resilience, it seems clear that the risks in Europe are greater, but this narrowly focuses on the risk of a recession in the short term. While the US is clearly in a favorable position through the end of 2022, this could change by the end of 2023.
Europe’s energy headwinds can reasonably be expected to peak this winter and then ease as energy demand falls seasonally, and in the medium term Europe will have more time to diversify its energy supply, which will also require investment to build GDP. Of course, this will not be easy, as energy prices are likely to remain high, which will lead to budget constraints and weakening industrial competitiveness.
In the U.S., the labor market continues to show considerable strength – which looks likely to protect the economy from an outright recession in 2022 – but that same strong labor market increases the risk that even if inflation continues to fall in 2023, it will not fall far enough.
In contrast to Europe, where energy inflation is predominant, inflation in the US is more widespread. This broad-based inflation, particularly if it becomes primarily wage-driven, will be difficult to squeeze out of the economy in 2023. This prompted much more aggressive monetary policy in the US with expectations of continued tightening. Unlike Europe, US monetary policy is expected to tighten, deliberately becoming a permanent obstacle to economic growth. This points to very slow growth next year, and while a recession is not inevitable, continued tough policies to combat widespread inflation are a dangerous maneuver that Europe does not need to follow just yet.
Therefore, relative to each other, one can conclude that it is better to be the US at the end of this year, but Europe at the end of the next.
Asian cyclical risks look much better, but no their structural
Compared to the West, the risks facing Asia’s largest economies look slim. To begin with, Japan and China did not experience a European-sized energy shock despite being significant energy importers. And with inflation remaining modest, the need for monetary policy to provide sustained headwinds does not apply.
However, global energy prices pushed Japanese inflation to rise. But energy prices that will push headline inflation just above the 2% target will not end Japan’s two-decade structural struggle to achieve healthy price growth or cause a stunning real income shock. The structure of inflation does not support the idea of maintaining near-target inflation. Services inflation remains deflationary and wage growth is hard to come by. Therefore, the Bank of Japan did not join the course of Western central banks, but maintained its commitment to zero interest rates, despite the sharp weakness of the currency.
So while Japan’s rising recession risk is weak today compared to the West, it remains mired in the same structural problems that have challenged it for years: very low trend growth and a monetary policy burdened by the zero lower bound – a combination that contributed to the weakest real effective exchange rate since the early 1970s.
The structural situation in Japan has turned into regular recessions, and this is likely to remain a reality for the Japanese economy. Since the late 1980s, Japan has spent about a third of its time with output below its peak, a far less common occurrence in the US. With or without cyclical risks to Western economies, the prospect of another Japanese recession is always high.
Similarly, China’s cyclical risks are modest compared to the West. Inflation is below the 3% inflation target and is less driven by energy shortages – partly to the advantage of the buyer of Russian oil, as Ural crude has sold at a deep discount (often over $30 a barrel, recently closer to $20) since the beginning of the war at the end of February. There is no real shock to income from inflation, and no need to raise interest rates to combat inflation.
Instead, China’s cyclical risks continue to focus on its COVID policies. Lockdown, the need for a zero infection strategy for COVID, delivered flat year-over-year growth and negative quarter-on-quarter growth in the second quarter. And while China’s economy is expected to rebound strongly again, the threat of more shutdowns remains. China, which achieved positive growth in 2020, was then the envy of the world, but today other economies are less vulnerable to the virus.
In addition to cyclical risks, a number of structural factors are likely to lead to slower growth than in the past, as China noted by reducing growth target to 5.5% by 2022. Excellent growth rates of 6-8% have been harder to achieve in recent years, both because China’s economy is larger and because recent policies have a number of targets that will make growth more sustainable but also harder to find. These include (but are not limited to) rebalancing economic activity towards domestic consumption, developing greater domestic resilience and developing strategic industries, as well as reducing dependence on debt. real estate development.
Today, Asia’s cyclical risk looks preferable to that of the West, but in the longer term, as structural challenges remain significant, with Japan stuck in a zero interest rate trap and China beginning a transition to slower growth. In contrast, the West’s structural outlook, while facing its own challenges, appears to be better than it has been in recent years. Economies are near potential with tight labor markets likely to persist even during a recession. These tight labor markets can still deliver real and broad-based wage growth, as well as provide spark for better-than-expected performance in the medium term.
Think globally, analyze locally
While recognizing today’s intense global risk recession is a valid starting point, differences between the US, Europe and Asia, as well as differences over time, challenge the idea of homogeneity; the magnitude, nature and timing of these risks vary considerably.
To navigate these complex dynamics, managers and investors must analyze factors and risks at the regional level, as well as consider the interrelationships. The outlook will remain too idiosyncratic to allow for a global recession narrative.
Philip Carlson-Slezak is a managing partner and partner in BCG’s New York office and the company’s chief economist.. Paul Swartz is a director and senior economist at the BCG Henderson Institute in New York.
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