Rather than pulling up strongly together as many expected six months ago, the leading economies have all been heading downwards, following a sharp slowdown in the United States. With emerging markets still vulnerable to economic shocks, the downside risks facing the world economy are mounting. Bolder policies from, and cooperation among, all the major economies will be needed to stop the global situation deteriorating further. These are some of the key messages from UNCTAD’s Trade and Development Report 2001(1) released today.
Will conventional policy remedies steady the new economy?
The only thing that looked like upsetting the world economic prospects in 2000 was rising oil prices, which reached some US$35 a barrel in September. But with every region enjoying faster growth and the world economy posting its strongest performance (4% growth) since the Asian crisis, such concerns seemed oddly out of place. Doubts about the health of the world economy have come back with a rush in 2001, and UNCTAD economists worry that without determined policy responses everywhere, the downside risks are considerable.
In the end, it has been the unwinding of the high-tech boom in the United States, forewarned in TDR 2000, which has knocked the world economy off kilter. Hopes of a rapid rebound are beginning to fade, and the question now is just how long and how deep the downturn could be and whether the swift response by the Federal Reserve will bring about an orderly recovery.
The Report worries that “if households and the business sector were to simultaneously limit their spending to current earnings there could be a significant decline in GDP”.
Given the high level of private indebtedness, the extent of unviable investments in the information and communications technology sector sustained by the venture capital boom and stock market bubble over the past few years, along with the uncertainties surrounding the dollar, there should be no underestimating the magnitude of the policy challenge.
Can Europe take the lead?
Whatever the immediate future holds in store for the United States, longer-term global economic prospects cannot, the Report argues, hinge on policies and events in a single country. The hope now is that Europe, where growth in 2000 broke the 3% barrier for the first time in over a decade, will grasp the baton from the US.
However, Europe’s limited trade ties with the US do not mean the continent is immune to the slowdown across the ocean. European corporations with sizeable US operations could see their profits suffer from the economic downturn. According to the Report, European growth peaked about the same time as in the US, and some of the big European economies have been relying heavily on exports for their growth stimulus. The Report concludes that “without a determined change in economic policy, growth in the European Union is unlikely to reach 3% in the current year, and it may be much lower”. But recent pronouncements from the European Central Bank on inflationary worries suggest there is little enthusiasm about using monetary policy to test the limits of Europe’s potential growth, just as the United States did in the second half of the 1990s. Not only would annual growth edging over 4% give a timely boost to global demand, it would also help tackle the European unemployment problem.
Hopes that the Japanese economy was beginning to build a head of steam rose through the first half of 2000 as rising net exports helped spur investment. However, growth was stagnant in the second half of the year and unemployment began to edge back towards 5% at the year’s end. Growth for 2000, expected at 1.3%, will not exceed the average for the past decade, and with prices still dropping, the signs in early 2001 continue to disappoint.
A weaker yen could provide some impetus. But with slower US growth, exports are unlikely to take the lead this year. Strong domestic sources of growth will, according to the Report, be needed if the economy is to get back on track. With firms and households in a cautious mood, stimulating spending will require government action. However, a sizeable fiscal stimulus package looks increasingly less likely to turn things around, with the public debt at over 100% of GDP. Interest rate cuts signalled a concern about immediate economic prospects, although by themselves, they are unlikely to produce a swift upturn. More aggressive measures designed to reverse persistent price deflation may be needed.
Channels of contagion to developing countries
All the developing regions picked up in 2000, posting an overall growth rate of 5.5%.
Only Africa failed to register a significant increase in per capita income; its modest acceleration in growth to 3.5% is still insufficient to tackle rising poverty and declining health.
Among the fastest-growing economies were those, such as Republic of Korea, Malaysia and Brazil, that had been struck earlier by financial crisis (see table below). Many of these had particularly credible performances, given that they took a sizeable hit from oil price hikes, ranging from 0.5% of GDP in Brazil to over 3% in Singapore.
There seems little likelihood that these performances will be repeated in 2001. While crises in emerging markets yielded some benefits to the industrial economies in recent years, no such easy symmetry can be expected to accompany the US slowdown. According to the Report, prospects in emerging markets very much depend on how countries are plugged into the global economy. But all are vulnerable to a sharp global slowdown.
The most direct impact of slower growth in the US will come through trade flows. Economies in Central America look particularly vulnerable. Mexico has been bathing in the glow of the US boom, with an unprecedented 7% growth last year. But with more than four-fifths of Mexico’s exports going across its northern border, industrial output and employment there have already showed signs of slowing.
Many Asian economies are also vulnerable on this front. Recoveries there have relied heavily on exports to the United States, which amount to anywhere from 7% (Republic of Korea) to 20% (Malaysia) of GDP. A combination of declining sales in the US and falling semi-conductor prices has already resulted in terms-of-trade losses and reduced export earnings. The Report worries that intraregional trade could amplify the negative impact of these shocks. And uncertainty in Japan could have serious knock-on effects for the region.
The transition economies, which posted a record 5.6% growth in 2000, also benefited from strong export growth to the European Union and high prices for some of their commodities. A European slowdown will show whether domestic growth impulses have taken hold in these economies.
Some economies are expecting to benefit from lower interest rates and a weaker dollar, both of which are likely to accompany the slowdown in the United States. These include Asian and Latin American countries with currencies tied to the dollar. While a weaker dollar would mean increased competitiveness vis-à-vis third parties, lower interest rates should reduce borrowing costs and debt servicing, easing the pressure on payments and budgets. These could help Argentina to emerge from the stagnationary spiral of the last two years. Brazil, whose growth hit 4% in 2000, should also benefit. Still, neither of these economies appears ready to seriously test the limits of its growth potential in a way which would lift the overall performance of the region much above the 3.7% achieved in 2000.
More fundamentally, there are downside risks linked to excessive indebtedness and dependence on capital inflows, especially if a further round of uncertainty produces a reassessment of risks, rising spreads and a flight to the dollar.
The Turkish crisis which hit in February this year serves as a reminder of just how precarious the situation still is for many emerging markets. The Report explains the crisis not only in terms of the familiar vulnerabilities associated with soft currency pegs, but also of shortcomings in the design of the stabilization programme.
Trade and financial flows
International trade was buoyant in 2000. Oil and the US economy were key forces behind double-digit growth in imports and exports, and these same forces helped to move the terms of trade for many developing countries in a favourable direction. Still, the prices of a number of agricultural commodities stagnated or dropped. The combination of falling export and rising import prices hurt some of the world’s poorest countries. Even with oil prices looking more stable this year and perhaps dipping below US$20, prospects for many commodity-exporting developing countries, particularly in Africa, remain bleak.
Capital flows to the developing world in 2000 were little improved over the 1999 figure. Most forms of such flows dropped off last year, with only bank lending keeping steady, after sharp falls in 1998 and 1999. Only Latin America was able to attract larger amounts, mainly in the form of international bond issues. But if uncertainties persist, the lid will likely be kept on financial flows to emerging markets this year.
For the world economy to regain its momentum this year, the big economies will have to be firing on all engines and at the same time. So far, policy makers in the US have shown their willingness to respond to worrying economic signals, but Europe has remained reluctant to follow suit, and Japan’s limited room for expansionary policy holds out at best the hope of gradual improvement. Stimulating growth needs to be the uncompromising policy message everywhere, including in developing countries. The Report also argues that better policy coordination will be required among the G3, paying attention to the impact on weaker economies if the latter are to enjoy the promised fruits of globalization.