Economic Outlook of the World
U.S. economy slows, while the rest of the world follows.
The mighty U.S. economy has feet of clay, and those feet are now dragging the world economy to a crawl. Following a year where America led the global economy to its best performance in a decade, now U.S. weakness is limiting growth worldwide. Both the U.S. and world economies will weather the slowdown without a recession, but not without discomfort. The world economy is expected to grow less than 2.5 percent this year, before rebounding to about 3 percent in 2002.
U.S. Will Avoid Recession
The North American economy has slowed markedly since the middle of last year. After expanding at a better than 5 percent rate in the first half of 2000, the U.S. economy grew less than 2 percent in the second half — one percent in the fourth quarter. This represents a dramatic slowing for an economy that had posted four years of 4 percent-plus economic growth.
The U.S. is coming off a once-in-a-generation economic run. Over its decade-long expansion, the economy grew by 40 percent, saw a quadrupling of stock prices and found its way back to low unemployment rates not seen in 30 years. Rapid productivity growth, centered in technology industries, supported strong income gains without a surge in inflation, an example that has been the envy of the developed world.
In a number of respects, the current slowdown is the result of these successes. High equity market valuations have been rapidly unwound, resulting in negative wealth effects for consumers and higher financing costs for firms. Heavy investments in information technology equipment have created a capital base that exceeds near-term demands, so that investment spending has fallen sharply. Rapid borrowing by both firms and households has built up a large stock of debt.Tighter monetary policy last year was imposed to cool an economy whose tight labor markets threatened to re-ignite inflation.
Even high oil prices are in part the result of booming global demand. By September of last year, strong demand and renewed OPEC clout brought oil prices to the $40 per barrel level, the highest prices in nearly a decade. By raising production costs, higher energy costs have acted as an indirect tax on spending and have fueled an increase in the overall inflation rate.
The New Economy is now in a familiar Old Economy downturn, with softening investment—and to a lesser extent consumer — demand leading to reduced production as firms work off excess inventories. Slowing sales and higher capital costs work into lower profits, further depressing stock prices and national wealth. Production cuts result in high-profile job cuts that raise unemployment and batter consumer confidence.
Yet for all the doomsday headlines, the U.S. economy remains in reasonably good shape. So far, most of the weakness has been confined to manufacturing and business investment. While confidence has suffered, consumer spending has held up surprisingly well. Since consumption represents two-thirds of output, this has been a key support for growth. GDP growth for the first quarter came in at 1.3 percent, weaker than the advance estimate, but better than many had feared. The unemployment rate rose to 4.5 percent in April, but remains low by historical standards. The Fed has acted decisively this year, with five half-point rate cuts designed to buoy the economy.
The U.S. economy will have bottomed out by the end of the second quarter, with a pickup in growth in the second half. For the year 2001 as a whole, we expect 1.7 percent real GDP growth, accelerating to 3 percent in 2002.
Europe Alone Provides Momentum
The European continent lagged behind the U.S. during the late-1990s expansion. Now, the tables have turned, and Europe retains somewhat more strength than America. The low value of the euro has supported growth by increasing export price competitiveness, and unemployment rates have continued to fall, further supporting consumer spending.
Nevertheless, American weakness is now a drag on European economies, and a moderation of growth is underway. The recent outbreak of Foot and Mouth Disease has also been very disruptive, particularly in Great Britain where agriculture and tourism sectors have been harmed.
The European Union as a whole will grow by 2.5 percent this year, compared with 3.3 percent in 2000. Britain will slow from 3.0 percent to 2.3 percent this year, and France will expand by about 2.5 percent. In Germany there have been more signs of weakening, and output is expected to expand by no more than 2 percent this year. A policy uncertainty is the European Central Bank’s willingness to cut interest rates to prop up demand. While the ECB did cut rates to 4.5 percent in mid-May, the Bank has been more concerned about inflationary risks than its American counterpart. This may become a problem if European economies slow further in coming months.
The Asian Recovery Cools
Asia will cool from a strong recovery that began in 1999. Following the steep downturn triggered by the 1997 financial crisis, Korea has led an Asian rebound, expanded by nearly 11% in 1999. In 2000, the recovery broadened with Malaysia and Hong Kong expanding by 8.5 percent and 12 percent respectively. Thailand and the Philippines have recovered more moderately, and Indonesia — the country that fell the furthest in 1998 — will take a number of years to climb back to pre-crisis levels.
The slowing U.S. economy, and particularly the tech sector downturn, will take several percentage points off Asian growth this year. The super-high recovery rates of Korea and Malaysia will cool to the 4 to 5 percent range. Thailand and Hong Kong will fall below the 4 percent growth mark. The Philippines will continue to suffer from political uncertainty, slowing near-term growth and threatening foreign investment that is important for long-run economic progress. The economy of China remains buoyant, slowing to 7.5 percent from 8 percent last year, and although Taiwan will be hurt by its dependence on technology exports, the province is still expected to expand by nearly 5 percent.
Dependence on a slumping American technology market represents the greatest short-term problem for developing Asia. But over the long run a bigger concern may be weakness in investment spending. Recovery in South and East Asian economies was driven first by net exports and more recently by consumer spending. Fixed investment has remained weak, reflecting a slow return of foreign capital and less-than-rosy business expectations. The 2000 global technology stock collapse has further raised capital costs. Strong inflows of foreign capital will not return to Asia until countries make more progress addressing systemic banking sector problems.
The year 2000 saw Latin American countries make substantial progress in recovering from the aftermath of the 1998 Brazil crisis. This year will be only slightly weaker. Growth for the region is expected to fall from 3.8 percent to 3.4 percent, primarily because of slowing exports to the American market. This effect will of course be most pronounced in Mexico, Central America and the Caribbean states because of their high dependence on U.S. trade. In the very large Brazilian economy, domestic demand will fuel moderate acceleration this year.
Ready to Rethink Japan?
The change of government in Japan raises hopes that significant policy reform can finally occur. After a decade where growth averaged just 1 percent, barriers to recovery are now widely recognized: a smothering layer of bad debt, inflexible corporate practices, and a burdensome regulatory regime. The size of the reform task is daunting. There remain at least half a trillion dollars of bad debts that must be written off or restructured.
Corporate restructuring would mean more job losses when the unemployment rate is already at near-historical highs. And up until now, the political leadership has lacked the stomach for more than snail’s pace reform.
Along with structural problems, Japan suffered a sharp cyclical downturn following the Asia financial crisis. The corporate sector led a modest recovery beginning in 1999, with steadily rising industrial production, mounting business confidence, and a return to profitability partly as a result of cost cutting measures. Business investment was an important part of the limited growth in the past two years.
Prospects for Japan’s continued recovery have worsened considerably since the beginning of the year. Corporate-sector strength has taken a severe hit, in part from a worsening external environment and extreme stock market weakness. Net exports are now decreasing as the U.S. and Asian markets for electronics have dried up. Industrial production, which rose nearly 5 percent last year, plunged 3 percent in March. While investment still appears to be rising, business sentiment is falling along with corporate profits. Bank and corporate health has been further eroded by the Japanese stock market’ recent decline to a 17-year low.
Supportive macro policy continues to be necessary, but prospects are mixed. After a decade of pump priming, Japan’s government debt now stands at 130 percent of GDP, highest in the developed world. The new administration has made deficit reduction a priority, and there is a risk that early fiscal retrenchment could reprise the catastrophic effects of the 1997 consumption tax increase. The Bank of Japan’s recent move toward stimulus is promising, although so far there is little evidence of a dramatic change. More expansionary monetary policy is needed to bring down the yen, stimulate exports, and offset the deflationary cycle.
The all-important household sector continues to suffer from anemic income growth, high unemployment and job insecurity. Consumer spending remains flat, and sentiment has weakened, suggesting even more trouble for the retail sector in coming months. To be sure, there is no sign that Japan is headed for a sharp downturn, on par with the 1998 recession. But neither is there room for much optimism. We expect the Japanese economy to crawl along at a 0.7 percent rate of growth this year, firming to slightly more than 1 percent in 2002.
It Feels Like a Recession
By conventional measures, the US and global economies will escape an outright recession this year. But a slowdown from 4 percent to 2.4 percent global growth will still hurt. Corporate sectors can expect to see weak domestic and external demand, and flat or falling profits. In many labor markets, economic growth will not be strong enough to prevent a rise in unemployment rates, and job uncertainty will hold back consumer spending. In financial markets, poor profitability may continue to hold down asset prices, at least until clear signs of recovery begin to emerge.
Global business cycles spread and intensify through the trade and financial linkages among countries. The depth of the current downturn will depend in part on these linkages. Over the past year, U.S. weakness led to slower growth abroad, which in turn worsened the export markets for American firms. That process has probably not yet run its course, and there is a risk that the downward spiral could be deeper than expected. But both developed and developing economies began this slowdown in relatively good health, which so far they have largely maintained. The global economy is positioned for a resumption of moderate growth over the coming year.
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