[Viewpoint] The Impact of Middle East Geopolitical Risks on the Global Economy

Geopolitical risks are escalating as the United States and Iran have effectively entered a wartime situation. While the global financial crisis that began in the U.S. in 2008 was a demand-side crisis, the upcoming crisis is more likely to originate from the supply side.

The 2008 U.S. financial crisis stemmed from excesses in the private sector. Private sector debt, which was 241.5% of GDP in 1999, rose to 304.7% by 2017. During the same period, household debt surged from 69% to 99% of GDP. This excessive consumption-driven import increase caused the U.S. current account deficit to widen from 2.0% of GDP in 1997 to 5.4% in 2006. The 2008 financial crisis occurred as part of the process of resolving the U.S.'s internal and external imbalances.

In 2009, the U.S. economy contracted by 2.5% due to a sharp decline in consumption and investment. The impact spread globally, causing the world economy to record a negative growth rate (-0.4%) for the first time since 1970. To overcome the crisis, policymakers in major countries, including the U.S., responded with bold fiscal and monetary policies. According to the Bank for International Settlements (BIS), government debt in advanced economies rose from 76% of GDP in 2008 to 99% by the second quarter of last year. Additionally, central banks around the world cut policy interest rates to nearly 0% and printed large amounts of money through quantitative easing. As a result, government spending, along with consumption and investment, increased, leading to a recovery in the global economy.

The demand-side shock was addressed through demand stimulus. However, during this process, governments in advanced countries like the U.S. became weakened, and corporate debt in emerging markets, including China, surged significantly. Corporate debt to GDP in emerging markets jumped from 56% in 2008 to 101% by the second quarter of last year. In countries such as Korea and Australia, household debt also deteriorated. This suggests that it will be difficult to stimulate the economy with fiscal and monetary policies when the next crisis arrives.

The upcoming crisis may come from the supply side. Global supply chains are being disrupted due to strengthened protectionism, such as the U.S.-China trade war. On top of this, geopolitical tensions originating from the Middle East are intensifying. As the level of reciprocal responses between the U.S. and Iran rises, international oil prices could surge. Rising oil prices shift the supply curve to the left, causing slower economic growth and higher inflation. Analyzing statistics since 2000 shows that when oil prices rise by 10%, U.S. economic growth begins to decline four quarters later, with the largest impact of -0.13 percentage points occurring in the seventh quarter. The effect of oil price increases on consumer prices appears from the very next quarter, with the consumer price inflation rate rising by 0.15 percentage points after one year. Similar effects of oil price increases have been observed in the Korean economy. When international oil prices rise by 10%, GDP growth falls by 0.08 percentage points after one year, consumer price inflation rises by 0.06 percentage points, and the current account balance deteriorates by approximately $1.8 billion.

If productivity improves, the supply curve shifts to the right, offsetting the negative effects of rising oil prices. However, since the 2008 global financial crisis, productivity has actually declined. For example, U.S. productivity growth averaged 1.5% annually from 1980 to 1995, then improved significantly to 2.8% from 1996 to 2007 due to the information and communication revolution. But from 2008 to the third quarter of last year, productivity growth slowed to 1.3%, even lower than in the 1980s.

With global protectionism strengthening and productivity slowing, the rise in international oil prices due to Middle Eastern geopolitical tensions could usher in an era of low growth and high inflation for the world economy. The bigger problem is that it will be difficult to overcome the upcoming crisis with fiscal and monetary policies.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University

This content was produced with the assistance of AI translation services.