Trump and North Korea: the perils of a pre-emptive strike

As North and South Korean governments meet, US rhetoric about military action on Pyongyang is escalating. Is the president bluffing?

Demetri Sevastopulo in Washington


Days before his inauguration, Donald Trump dismissed the claim from North Korean leader Kim Jong Un that he would soon test an intercontinental ballistic missile. “It won’t happen,” Mr Trump tweeted.

But over the past year Pyongyang has made big advances in being able to strike the US with a nuclear weapon. It has tested three intercontinental ballistic missiles and conducted a sixth nuclear test by detonating what may have been its first hydrogen bomb. The result has been a sharp escalation in talk about a US military response.

Just before Christmas, Jim Mattis, defence secretary, warned that “storm clouds are gathering”. General HR McMaster, the adviser who has been the most bellicose of the Trump national security team, says it would be “intolerable” for North Korea to be able to attack the US with a nuclear weapon. After Pyongyang in November tested a rocket with the range to reach anywhere in the continental US, he said the odds of war were “increasing every day”.

Governments around the world are trying to ascertain if the rhetoric is designed to underpin diplomatic efforts, or if Mr Trump genuinely believes Mr Kim cannot be deterred from using nuclear weapons and, therefore, is serious about preventing him from crossing the finishing line.

US Navy aircraft carriers during a training exercise in the Sea of Japan last June © Reuters

“If he means it, we are going to war,” says Michael Mullen, chairman of the joint chiefs of staff under presidents George W Bush and Barack Obama. “What does nuclear war look like? We haven’t had that debate in this country . . . I still don’t put it past Kim Jong Un to use a nuclear weapon in retaliation against us.”

The Trump administration’s rhetoric is the backdrop for the inter-Korea meeting on Tuesday, where North Korea offered to send athletes to next month’s Winter Olympics in Pyeongchang and South Korea said it would consider temporarily lifting some sanctions on the North. Officials in Seoul acknowledge they have been looking for ways to ease the military tensions, an overture that could create difficulties for Washington’s efforts to impose greater pressure on Pyongyang over its nuclear programme.

As US officials try to determine how close Mr Kim is to crossing the nuclear threshold, the Pentagon is updating its plans. At one end of the spectrum, Mr Mattis has said the US has options that would not necessarily spark retaliation against Seoul — a claim that has been met with much scepticism — while Gen McMaster has talked about the possibility of a “preventive war” aimed at eliminating the North Korean missile and nuclear weapons programmes.

In a private briefing for former national security advisers over the summer, Gen McMaster outlined the options, which led some — but not all — of the participants to conclude that the US was more serious about military action than they had thought, according to two people familiar with the event.

North Korean leader Kim Jong Un, right, celebrates what was said to be the test launch of an intermediate range missile at an undisclosed location in North Korea © AP

Military planners have started using phrases such as “kick in the shin” and “bloody nose” to describe action they believe would send a strong message to Mr Kim, but not one so strong as to spark serious retaliation, according to two people familiar with the internal discussions.

Dennis Wilder, a former top CIA analyst, says there are many options that could be interpreted as a kick in the shin or a bloody nose. They include striking an air base or naval facility not associated with the ICBM programme, destroying one of Mr Kim’s homes, hitting a key part of the missile programme or targeting a missile during a test launch.

“Presumably, such a strike would be a one-off attack that is immediately followed-up by a presidential announcement that this is a warning shot and nothing more,” says Mr Wilder.

Many former officials are sceptical, however, that the US could take such limited military action. James Stavridis, former Nato supreme allied commander and now dean of the Fletcher School at Tufts University, who puts the odds of nuclear war at 10 per cent, sees “no military options which would result in fewer than several hundred thousand casualties and perhaps as many as 2m to 3m”.

Mr Mullen says Mr Trump’s team would be taking a huge gamble if it assumed Mr Kim would not respond to an attack. “Our intelligence is not great, so how do we know that they would not respond?” he says. “If I was Japan or South Korea, I would be asking ‘what are we, chopped liver?’ The US is supposed to be protecting them.”

Dennis Blair, a retired admiral who in his former role as head of the US Pacific Command had experience dealing with war plans for the Korean peninsula, argues that the US has three possible options for military action.

Mr Blair, who also served as director of national intelligence, says the second category entails moving significant military assets to the region to scare Mr Kim into thinking that an attack was imminent. In addition to an uptick in aerial exercises over the peninsula, the US recently conducted joint exercises with three aircraft carriers in the western Pacific Ocean that some interpreted as training for an attack.

In 1994, Mr Blair was commanding the Kitty Hawk carrier battlegroup when he was ordered to sail to the peninsula while the Clinton administration was considering a strike on North Korea. “We steamed around for three months. We were pulling out the war plans, checking our targets every day,” he says. “I always thought that had a strong effect on the North Koreans.”

The third category would be a pre-emptive strike, ranging from targeting a test missile during launch to the kind of major attack outlined by Gen McMaster. Mr Blair says the latter was the riskiest as there was no guarantee the US could find and destroy the whole nuclear programme. “The chances that you’re able to destroy everything in an air campaign of three to five days are low. It would be a brave director of national intelligence who stood in front of the president and said we know where it all is.”

North Korea has made it harder for the US to locate its weapons by storing many of them underground. “North Korea has been the world’s greatest importer of mining equipment,” says Wallace Gregson, a retired general and former top Pentagon Asia official. It is also making progress building mobile missiles that are harder to detect.

William Fallon, another former head of Pacific Command, worries about the loose talk about military action. “Air strikes are essential [to a military operation] . . . the idea that you can do that and nothing else is nonsense — that has been proven again and again,” he says. “If we’re serious that we will not allow North Korea to have a nuclear capability, then you better be prepared to go all the way, and I don’t know how you can do that without sending ground tropos.

Given the risks, some analysts are sceptical that Mr Trump would launch the kind of attack that could spark a big conflict. General Joseph Dunford, chairman of the joint chiefs, said in July that war on the peninsula would lead to “a loss of life unlike any we have experienced in our lifetimes”. But he also said that it was “unimaginable” to let North Korea have the capability to hit the US with a nuclear weapon.

Gen Dunford and Mr Mattis have both warned North Korea about the kind of military response that would follow any attack on the US, but they have also stressed the strong need for diplomacy.

“I can see a lot of bluster . . . but when the North Koreans don’t back off, I can’t imagine Dunford and Mattis in the Situation Room saying the risk of nuclear, chemical and biological weapons is worth it,” says Michael Green, a former Asia adviser to George W Bush.

The critical question for the Trump administration is to assess whether Mr Kim would risk using nuclear weapons in the knowledge that it would trigger the end of his regime and, probably, his life. However, North Korea has long been an incredibly tough place for US spy agencies to glean intelligence.

Jung Pak, a North Korea expert at the Brookings Institution who until recently was a CIA North Korea analyst, says one problem in analysing Mr Kim was that he had shown no interest in talking to foreign leaders. “He hasn’t travelled, as far as we know, in the past six years,” says Ms Pak. “It has been pretty much Fortress Korea.”

In 2014, James Clapper, then director of national intelligence, went to Pyongyang to seek the release of two Americans, but did not meet the North Korean leader. In 2012, the year after Mr Kim assumed power, Michael Morell, then deputy CIA director, made a secret mission to North Korea, three people familiar with the previously undisclosed trip told the Financial Times.

One of the people says Mr Morell wanted to establish an intelligence channel that would provide insight into the new leader, but he was not given a meeting with Mr Kim. The CIA declined to comment.

US officials have also been grappling with the question of what is Mr Kim’s real goal in pursuing nuclear weapons. While some argue that he simply wants a deterrent to prevent a US attack, others argue that he sees the weapons as a tool to unify the Korean peninsula.

Chris Hill, a retired diplomat who was the US negotiator in six-party talks with North Korea during the Bush administration, says the Kim dynasty had been trying to develop nuclear weapons for decades, but the idea that North Korea would launch a nuclear strike was “ridiculous” since it would be suicidal. “This is not about Trump or Bush hurting their feelings. This is a long-term effort to create the capacity to mould the peninsula into what they want.”

Ms Pak says that because Mr Kim’s father and grandfather had pursued nuclear weapons so assiduously, they were “part of his DNA”. But she says he was also conscious of the case of Muammer Gaddafi, the Libyan leader who was killed by opposition rebels several years after he gave up his nuclear weapons programme. “The fact that he is so personally invested means on multiple levels that he can’t give it up,” she says.

Richard Fontaine, president of the Center for a New American Security, says he hoped that the US military talk was simply a rhetorical form of gunboat diplomacy. “If I’m wrong and they mean all these things when they say Kim is not rational or deterrable, then it almost certainly leads to war, because I don’t think the North is willing to give up its entire nuclear weapons programme.”

Tim Keating, another former head of Pacific Command, says Mr Mattis and secretary of state Rex Tillerson were “doing a wonderful job” tamping down the more bellicose rhetoric coming from some officials. “I wouldn’t have said what McMaster said,” Mr Keating says. “I hope that calm heads would prevail and explore any and every diplomatic option short of military activity.”

While some hope Mr Mattis will stave off a catastrophic conflict, he toohas given pause for thought. After warning troops in December about gathering storm clouds, he urged them to read This Kind of War, a book about how the US was unprepared for the 1950 Korean war. But after saying there was still time for diplomacy, he ended on a solemn note: “There is very little reason for optimism.”

View from Seoul: South Koreans worry over ‘erratic’ US leader

Long accustomed to threats from north of the border, South Koreans in 2017 found a new source of concern in an unlikely location: the White House.

The bellicosity of President Donald Trump and his top advisers has unnerved South Koreans, particularly the roughly 25m who inhabit the Seoul metropolitan area — only 50km away from Pyongyang’s amassed artillery and ballistic missile launchers. For them, Mr Trump — not North Korean leader Kim Jong Un — presents the real threat to the Korean peninsula.

“His comments about a military option against the North are troublesome to ordinary South Koreans, who are strongly opposed to any kind of war on the peninsula,” says Kim Yong-hyun, a professor of North Korean studies at Dongguk University.

“South Koreans think Trump is too explicit about placing US interests first without considering South Korea’s position in dealing with North Korea . . . the overall perception is not friendly or positive,” he adds.

Such remarks are likely to cause concern for both US and South Korean officials. South Korea has a history of anti-American sentiment. When Mr Trump visited Seoul in November, protesters turned out in force. The public pressure was undoubtedly a factor on the mind of Moon Jae-in, South Korea’s president, when he sought public assurances from Mr Trump that Seoul would be not be excluded from planning on North Korea.

A rise in anti-US sentiment could complicate the job of General Vincent Brooks, commander of US Forces Korea, which maintains about 30,000 troops in South Korea as a buffer against aggression from the north.

Nam Sung-wook, professor of diplomacy and security at Korea University, says Mr Trump’s tweets have caused South Koreans to doubt his capacity as a leader and that his comments are often viewed as gossip.

“South Koreans see him as an erratic leader, different from most US presidents. Even if he keeps talking about a military option against the North, such comments do not carry a lot of weight as he has lost some credibility here,” he says.

Bryan Harris in Seoul


What’s Blowing Up the Bitcoin Bubble?

Investors and speculators are biting into bitcoin — in a big way. The price of the cryptocurrency surged by nearly 1,900% in 2017, to an average high of $19,499 on December 15 across major bitcoin exchanges, before plunging down to just under $14,000 by year’s end, according to The ascent is striking especially since bitcoin emerged just eight years ago, the creation of a mysterious person or group of people named Satoshi Nakamoto. In 2009, bitcoin was worth zero.

Bitcoin’s popularity persists even though it has no intrinsic value per se. It is not backed by gold or physical assets, nor does it pay interest or dividends. Bitcoin cannot be used as money in most places. That’s why its skyrocketing price is causing concern. Fed Chair Janet Yellen called bitcoin a “highly speculative asset”; JPMorgan Chase CEO Jamie Dimon said it was a “fraud” although he has since softened his stance; billionaire Warren Buffett called it a “mirage,” while Vanguard founder Jack Bogle told investors to “avoid bitcoin like the plague.”

“There has been a lot of hype and excitement, and that clearly has driven the price possibly away from the real utility value of the network and much more into the speculative realm,” said Christian Catalini, a professor of technological innovation, entrepreneurship and strategic management at MIT, on the Knowledge@Wharton show on SiriusXM channel 111. “The floor value of bitcoin is zero. Bitcoin only has value because people believe and agree it has value.”

Much of bitcoin’s stratospheric rise was achieved this year. For years, bitcoin traded in a much lower range due to its novelty, a spate of negative news such as the 2014 hacking of the now-defunct Mt. Gox bitcoin exchange, and early link to criminal activities (Silk Road). Those same concerns are still around — a South Korean digital currency exchange recently closed down after suffering its second cyberattack. However, bitcoin’s adoption by major institutions gives it a sheen of market credibility.

This month, the CME Group (Chicago Mercantile Exchange) and CBOE Global Markets (Chicago Board Options Exchange) began trading bitcoin futures. Nasdaq also plans to launch bitcoin futures in the first half of 2018, according to The Wall Street Journal. The New York Stock Exchange and the Cboe have filed with the Securities and Exchange Commission to list bitcoin ETFs (exchange-traded funds). “What you’ve been seeing recently [in bitcoin’s price increase] is fostered by a lot of momentum around institutional investors getting more into bitcoin,” Catalini said.

Institutional Players

The participation of these major exchanges in bitcoin “suggests a legitimacy of this technology, which I think is a valuable and important thing,” said Kevin Werbach, Wharton professor of legal studies and business ethics. Crytocurrencies represent “potentially a new investment asset class, and the way that it becomes … legitimate and the way investors are protected against fraud and so forth is to have traditional institutional structures and mechanisms like derivatives available.” (Listen to the full podcast of the SiriusXM show featuring Werbach and Catalini using the player above.)

However, even with institutions boosting bitcoin trading, it doesn’t fully explain the size of the price increases. “It’s not clear to anyone why bitcoin and some of these other cryptocurrencies have spiked this year,” Werbach continued. Possibly it could be people’s “fear of missing out, or fraud and manipulation. There’s evidence that there are various kinds of funny business going on at some exchanges that trade bitcoin, especially outside the U.S.”

While the NYSE and Cboe have applied to list bitcoin futures-based ETFs, the SEC has rejected bitcoin ETFs in the past. “Not because the organizations proposing the ETF in the U.S. did not do good enough governance, but because the price was so dependent on things outside their control,” Werbach said. But whether bitcoin prices are up due to good or bad actors, the rate of the ascent should give people reason for concern, he added.

Cryptocurrencies are “highly speculative assets,” Catalini added. “Here you’re investing not only in very early stage projects but also in very early stage technology. Many of these assets may not exist five or 10 years from now, but some may be large successes.… We’re really witnessing the dawn of a new industry.”

Contrarian View

But some believe that bitcoin is not in a bubble. Bitcoin magazine argues that it has “very different fundamentals than early internet stocks and a much more promising growth trajectory.” The October 2017 article cites the following reasons for a bullish view: Bitcoin is gaining acceptance as legal tender, such as in countries like Japan; more merchants are taking it; bitcoin is becoming a way for people to store their wealth in troubled economies such as Venezuela; bitcoin has just gone mainstream with most people likely having heard of it; and bitcoin has a limited supply of only 21 million, which restricts dilution.

However, bubbles are often only recognized in hindsight. “A bubble is only a bubble when it pops,” Werbach said. “Early investors only see it going up. We could see it go down very quickly as well.” As such, the big swings in the price of bitcoin makes it tough to use as money. “If you want to use the currency for payment, you don’t want the price to go up and down a lot.” Imagine holding currency worth $100 that dives to $70 in a day. It would create all sorts of instability.

“It remains to be seen how much of a function bitcoin itself will serve,” Werbach added. “It could be a reserve currency asset or it could be something volatile or it could eventually be tamed by these traditional financial mechanisms, which exist to bring more liquidity into the market.” So is bitcoin a good investment? “I don’t know the answer to that,” he said. But “long term, is this basic technology of cryptocurrencies something real that’s going to be a core part of the financial system? Absolutely.”

Global Standing of Cryptocurrencies

Meanwhile, regulators, central banks and countries are ramping up their scrutiny of cryptocurrencies. France wants the world’s top economies to debate bitcoin regulation at the G20 summit next year, according to Reuters. Countries that have banned cryptocurrencies or initial coin offerings include China, Iceland, Ecuador and Bolivia. Those that have accepted or are regulating them include Canada, Japan, Poland, Ukraine and Australia.

Central banks around the world are testing their own digital currencies. China has completed its trial run while Japan, Sweden and Estonia are developing their own as well, according to CNBC. Japan has J-coin, Sweden has E-krona and Estonia’s is called Estcoin. Also, the U.K., Uruguay and Kazakhstan are interested. Singapore is wrapping up its own digital currency trial in 2018. In the U.S., the president of the Federal Reserve Bank of New York said the Fed is exploring the same idea but it is still “very premature.”

Is there room for multiple digital currencies? “I think so,” said Wharton visiting professor Shimon Kogan, who teaches a course on fintech that includes the blockchain and cryptocurrencies. However, “clear winners haven’t emerged yet.” As for consumer adoption, it all depends on how user-friendly the interface is on top of the technology. “If you’re a customer of Citibank and Citibank now uses this technology to allow you to transfer money to your friend in Europe in real time and a lot cheaper,” he said, “you don’t care how they do that necessarily, right?”

Blockchain over Bitcoin?

Kogan said the cryptocurrency community is divided on whether bitcoin is a “side show or the show.” However, he believes that the “fundamental breakthrough is not necessarily bitcoin but the blockchain technology,” which is the distributed ledger that tracks these transactions. Entries cannot be changed and are transparent to all parties involved. Typically, there is no central authority like a government or a bank controlling it.

“Serious players are investing” in blockchain technology, Kogan said. “It’s hard to point to a serious financial services company or consulting company or technology company that is not already investing quite a bit into this.” Some are doing it through bank consortiums, he added.

One such consortium is R3, Kogan said. It works with more than 100 banks, financial institutions, regulators and other stakeholders worldwide to develop its own distributed ledger called Corda. R3 and other groups are all experimenting with different protocols that are independent of bitcoin, Kogan said.

The blockchain’s biggest impact on financial services is to make back office functions more efficient. “It’s pretty clear that this kind of almost 19th century way that [back office tasks are] being handled is just way too slow and way too expensive,” Kogan said.

Saving America from Trump’s Tax Reform

Laura Tyson , Lenny Mendonca

Pedestrians look at diamonds in a window display along 5th Avenue

BERKELEY – US President Donald Trump and congressional Republicans had an opportunity – and a responsibility – to reform the US tax code to address three major economic challenges: slowing growth, rising inequality, and a looming fiscal crisis. Sadly, they shirked their responsibility by passing a bill that squandered this opportunity.

At a time when US public debt as a share of GDP is already at a post-war high, the legislation will add another $1.5-2.2 trillion to the deficit over the next decade. At a time when income and wealth inequality is soaring, an estimated 80% of the tax cuts will go to the top 1% by 2027. And at a time when the economy has been growing steadily for 33 quarters and is approaching full employment, the legislation will have only a modest effect on growth.

To be sure, a significant cut in the corporate tax rate was long overdue. The legislation will likely stimulate investment and encourage domestic and foreign companies to do business in the United States. But, by an overwhelming majority, economists predict that the increase in the growth rate will fall far short of the annual gain of one percentage point (or more) hyped by Trump and his economic advisers.

Moreover, there is no credible evidence to support the Trump administration’s declaration that the trickle-down benefits of faster growth will “increase average household income in the United States by, very conservatively, $4,000 annually.” A large body of economic research shows that, at most, 20-25% of the benefits of corporate tax cuts will accrue to labor; the rest will go to shareholders, about one-third of whom are foreign. The biggest beneficiaries will be the top 1% of domestic households which own about half of outstanding shares.

Nor is there evidence to support the administration’s claim that the legislation will pay for itself. As many of those who voted for it well know, the expected gains in growth will yield at most about one-third of lost revenues. But they are playing a cynical game. By reducing revenues now, they will be in a position to justify cuts to services benefiting lower- and middle-class Americans down the road – all in the name of “fiscal responsibility” and “entitlement reform.”

Worse yet, the tax legislation is riddled with provisions that will dramatically increase inequality and limit economic and social mobility. By cutting the top income-tax rate, doubling the threshold at which inheritances are taxed, and lowering taxes on pass-through businesses, the legislation amounts to a handout for the wealthy, paid for by the middle class and future generations.

The legislation also prioritizes investment in physical and financial capital over what the US really needs: more investment in human capital and lifelong learning to help workers and communities cope with the disruptive effects of automation and artificial intelligence. Instead of expanding the earned income tax credit to encourage work, the legislation will, for the first time in American history, impose a higher tax rate on employment income than on income earned by proprietors and partnerships.

In addition, the legislation is an unabashedly partisan attack on Democratic-leaning states and cities. For example, the bill imposes an across-the-board limit on mortgage deductions, which will have a disproportionately adverse effect on people living in high-cost Democratic strongholds such as New York and California. Currently, the median price for a home in San Francisco is $1.5 million; in Kansas, a reliably Republican state, it is $187,000.

And if that weren’t bad enough, the bill intentionally penalizes higher-tax states like California and New York, by capping the federal deduction for state and local income and property taxes. Ironically, this provision will hurt growth, by raising the marginal tax rate on millions of workers in the country’s most productive locales and industries. And it will make it harder for state and local governments to finance necessary investments in innovation, infrastructure, and higher education – investments that are largely the states’ responsibility but are pillars of overall US competitiveness.

A majority of Americans already recognize that the tax law is deeply flawed and full of false promises. After failing to repeal the Affordable Care Act (Obamacare), congressional Republicans rammed through a complicated tax package that will please their wealthy donors, but disappoint many of their voters. Given the tax law’s unpopularity, it will be interesting to see what happens in the midterm congressional elections this November.

In the meantime, progressive federalists in forward-looking states and cities must get to work picking up the pieces of the wreckage the federal government is leaving in its wake. Keep an eye out for the many ways states will re-orient their tax regimes away from income taxes, and toward property and sales taxes, including on services, which account for more than 70% of economic activity but have traditionally been taxed lightly at the state and local level.

In some states, there is even talk of reclassifying state taxes so that they qualify as tax-deductible charitable contributions. Similarly, some have proposed replacing state income taxes with payroll taxes that employers can deduct at the federal level. Keep an eye out as well for a sizeable increase in outcome-oriented state and local funding for efforts to reduce homelessness and reform the criminal-justice system.

Owing to its high marginal income tax rates and constraints on residential property taxes, California will likely be at the forefront of fiscal innovation. Already, multiple reform proposals are circulating, including a ballot initiative to amend Proposition 13 that would dramatically ease existing restrictions on commercial-property taxes. And with the Democrats in full control of the state’s government, measures to counteract the federal law are almost certain to be adopted.

California Governor Jerry Brown, for his part, has called the Republicans’ legislation a “tax monstrosity.” He’s right: it’s dreadful policy. Other countries that have reduced taxes on mobile corporate capital have paid for the cuts by increasing value-added taxes and taxes on carbon, dividends, capital gains, and inheritances. Trump and the Republicans, by contrast, chose to cut taxes on both businesses and their owners, while blowing an unsustainable hole in the federal budget, exacerbating inequality, and imposing new burdens on the most productive parts of the country.

Still, necessity is the mother of invention. For progressive federalists in US cities and states – the laboratories of democracy – it is now more necessary than ever to step up and start innovating.

Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, and a senior adviser at the Rock Creek Group.

Lenny Mendonca, Senior Fellow at the Presidio Institute, is Senior Partner Emeritus at McKinsey & Company.

The Global Economy’s Output Gap Has Closed

For the first time in a decade, the global economy appears to be operating at its potential, according to World Bank economists

By Josh Zumbrun

Commuters board a train in Berlin. The euro area saw better-than-forecast growth in 2017, part of a broader international uptick. Photo: Krisztian Bocsi/Bloomberg 

A broad uptick in economic growth around the world in 2017 has led economists at the World Bank to conclude that, for the first time in a decade, the global economy is operating at its potential.

“The year 2018 will likely mark a turning point for the global economy because, for the first time since 2008, the negative global output gap is expected to be closed,” the World Bank said in its flagship report on the global economy, known as the Global Economic Prospects report.

At the root of this observation is a calculation that the world economy performed far worse than its potential in the decade after the global financial crisis that sent most of the world’s economies into severe recession. This difference between the economy’s actual performance and its potential is known as the output gap. When output gaps are large, as they have been the past 10 years, it indicates weak economic demand, spare capacity of businesses and factories, widespread unemployment and a major drag on inflationary pressures.

The output gap, defined as the difference between actual global output and
potential output, has closed for the first time in a decade.


Although the overall global output gap has closed, some countries are still operating below potential, especially commodity exporters. Others, especially the world’s advanced economies, appear to be somewhat “above potential,” meaning that the economy has more demand than is sustainable in the long-run. Excess demand is likely to lead to inflationary pressures, an increase in asset prices and pressure on central banks to raise interest rates.

Closing the output gap could trigger a broad change in economic conditions around the world.

For much of the past decade, inflation around the world has been weak, with many nations fearing they could slip into deflationary spirals. A large global output gap meant that countries faced little price pressure from the rest of the world. Central banks such as the Federal Reserve or European Central Bank have had the luxury to move slowly in reversing years of unprecedented expansionary monetary policy, because inflation pressures were so low. Now, international inflationary pressures could be on the return.

“Slack in the rest of the world forces firms to keep costs at a certain level,” said Ayhan Kose, the director of the World Bank’s Development Economic Prospects Group. “In 2018, that is disappearing.”

With the gap only narrowly closed, and uncertainty around that estimate, Mr. Kose cautions that the inflationary pressures could remain modest in 2018.

Growth around the world has come in higher than forecast.

Percentage change in real gross domedtic product vs estimates for the year made in june

The closing of the gap owes to a broad-based improvement in growth around the world.

In the World Bank’s latest estimates, U.S. and Japanese economic growth in 2017 came in 0.2 percentage points stronger than in the previous round of estimates in June. China’s growth beat June’s estimates by 0.3 percentage points. Growth in the euro area came in 0.7 percentage points stronger.

Overall, the world’s economy grew 3% in 2017, the World Bank said, up from the June estimate of 2.7%, and a considerable strengthening from the 2.4% growth that was logged in 2016. The World Bank forecasts that growth will pick up a bit more in 2018, rising to 3.1%.

Despite a growth surge and closing output gap, however, the report’s authors caution that risks to the economy remain significant, with potential growth slowing in many economies due to aging demographics, slowing productivity growth and less investment than in the past. Adding to those risks are global central banks shifting to tighter monetary policies, and many governments around the world with unsustainable fiscal outlooks.