A Global Soft Landing

Economic Projections by the University of Hawaii Economic Research Organization

February, 2001

BY BYRON GANGNES, UHERO RESEARCH ASSOCIATE, AFFILIATED RESEARCHER, UNITED NATIONS PROJECT LINK

The year 2000 has seen the best performance for the global economy in more than a decade. Strength in the United States and rebounding Asian economies has spread to Europe and much of the developing world. The global business cycle has probably now peaked, and we can expect somewhat slower—but still healthy—growth in 2001. World gross domestic product (GDP) is expected to rise 3.4 percent in 2001, following 4.1 percent growth in 2000.

U.S. No Longer Alone at Top The United States has led global growth. In its decade-long expansion, the economy has grown by 40 percent, witnessed a quadrupling of stock prices, and found its way back to low unemployment rates not seen in 30 years. The last several years have been particularly robust, with real (inflation adjusted) GDP expanding more than 4 percent each year since 1997.

Rapid productivity growth, centered in technology industries, has supported rising income without a surge in inflation, an example that has been the envy of the developed world.

While still fundamentally sound, the U.S. economy appears to have begun its descent to a lower growth path. After extraordinary growth above 5 percent in the first half of 2000, real GDP expanded just 2.4 percent in the third quarter. Facing rising inventories, higher borrowing costs and tighter credit, business investment has cooled considerably. Corporate profits remain strong overall, but a string of negative announcements has undermined market confidence in many high tech firms.

Higher oil prices have contributed to the U.S. economy’s slowing. Rising energy costs have acted as an indirect tax on spending and have fueled higher inflation. Inflation fears were behind the Federal Reserve’s decision to raise interest rates six times during the past 18 months. The higher energy costs have now largely been absorbed into prices, and inflation is expected to moderate in 2001.

Although slowing has occurred, a recession is not imminent. The United States economy retains considerable strength. Consumer spending in particular has remained strong, and confidence, though declining somewhat, is still high. Recent pronouncements by Fed. Chairman Alan Greenspan, indicating a possible tilt toward more expansionary policy, have been greeted enthusiastically by financial markets. We expect U.S. growth for 2001 to slow to 3.2 percent from 5.2 percent in 2000.

Asia Stronger but Still Fragile Developing Asia has completed the strong V-shaped recovery that began in 1999. Korea has led the pack, growing more than 10 percent in 1999 and only a bit slower in 2000. Malaysia and Thailand, two other countries at the center of the 1997 crisis, have also grown strongly. Rather weaker performance has been seen in the Philippines and Indonesia. China has continued to perform well, and now India may be joining the club of dynamic Asian economies, with 6 percent growth in both 1999 and 2000.

Growth for the Asian region is expected to decelerate in 2001, as global demand softens. The super-high recovery rates of Korea and Malaysia will cool to the 6 to 7 percent range. Thailand is expected to slow to 5.4 percent growth. Indonesia’s growth should accelerate to nearly 6 percent as recovery strengthens, but the Philippines will continue to lag behnd its neighbors at about 4 percent growth. China’s economy remains buoyant, and will grow more than 8 percent again in 2001.

Lingering weakness in investment spending is a cause for concern in Asia. Recovery was driven first by net exports and more recently by consumer spending. But business investment has remained stagnant, reflecting the slow return of foreign capital and less-than-buoyant expectations. Stock price weakness this year may reflect market pessimism about future prospects. The lack of a strong domestic investment anchor leaves these countries dependent on U.S. and European economies that are expected to weaken over the coming year.

A Japan that Can Grow Slow Japan continues its painfully slow economic progress. After a strong first quarter, real gross domestic product grew less than 1 percent on an annualized basis in the April-September period. For the year as a whole, output is expected to rise 1.6 percent over 1999 levels.

Japanese developments have been a mixed bag of generally upbeat news from businesses and a blasé household sector. Industrial production has grown steadily, profit and investment rates are up, and business sentiment continues to improve. At the same time, personal consumption spending is essentially flat, held back by job market weakness and income uncertainty.

The end of this year may be a bellwether for 2001. If year-end bonuses (which make up a significant share of annual income) recover from last year’s dismal levels, consumer spending may get back on track. Macroeconomic policy continues to frustrate Japanese recovery. Fiscal policy is still supporting aggregate demand, although after years of deficit spending it is at its political limit. The Bank of Japan actually raised interest rates slightly in August, even though most economists believed this to be foolhardy.

We expect labor market improvement and income growth to underpin stronger consumption in 2001, moving Japan toward a sustainable recovery track. But that recovery is unlikely to be robust. Growth in 2001 may reach 2 percent, with perhaps slightly higher growth in 2002. The large government debt burden, lingering banking sector problems, and excess capacity are likely to restrain growth in coming years. On the plus side is Japan’s strength in emerging technologies, such as wireless Internet services, that could create a more dynamic high-tech economy.

May All Your Landings be Soft The problem with reaching a business cycle peak is that the view is down in every direction. Slower growth is in the future for most rich, industrialized economies. That will be felt at home in somewhat higher unemployment rates, slower income growth, and falling profit rates.

Slowing in North America and Europe will be transmitted globally through weaker trade and investment. The focus of discourse has now shifted away from the dangers of too much growth to the perils of a possible hard landing. And there are certain developments that could cause more dramatic slowing than expected: Oil prices could move higher, particularly if conflict intensifies in the Middle East, sparking inflation and a monetary contraction; further weakness in equity markets could prompt a broad fall in confidence and spending; the large U.S. trade deficit could cause a dollar sell-off that would disrupt trade.

These risks must be assessed in context. The global economy begins 2001 in the strongest position that it has seen in many years, providing room for cooling without excessive pain. In fact, the slowdown we are seeing is in part the deliberate result of monetary policy to slow growth from what was perceived to be an unsustainable rate.

A soft landing of global growth closer to long-run potential remains the most likely result for the coming year.

For more information see the UHERO website at www2.Hawaii.edu/~uhero.

 

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