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Upbeat projections laced with uncertainty

by Chakravarthi Raghavan

Geneva, 5 Dec 2000 -- Two reports made public Tuesday, one from the World Bank and the other from the UN Economic Commission for Europe, projected an upbeat view of the world economy and that of developing countries, but with both hedging bets with caution over the uncertainties and downside risks.

Among the downside risks that both have mentioned are questions about whether the US economy would have a ‘hard’ or ‘soft’ landing, the developments in the oil markets (and how importing countries may respond).

The World Bank’s report, “Global Economic Prospects and the Developing Countries 2001”, said the economic growth in developing countries could register 5.3% this year, five percent next year and ease to 4.8% by 2002, but cautions that developments in the oil market and the durability of the non-inflationary US expansion remain major uncertainties.

The ECE (which does not undertake its own projections, but rather looks at and makes a judgement on the basis of the national and other projections, and assumptions behind them) says that current forecasts are for continuation of the cyclical recovery in western Europe (with real GDP expected to grow by about 3% in 2001, down from the 3.4% of this year), for the US growth slowing down from a 5% to a 3-1/4% in line with a ‘soft landing’.

Both reports see growth in the developing world providing a boost to the continued growth in the industrial world, and both have question marks about the effects of the oil-price rises.

But contrary to the normal advice from the Bretton Woods institutions for ‘adjustment’ to global markets and prices, the Bank suggests that since “the oil shock is expected to be temporary, there is a good economic case for oil-importing countries to meet higher bills for oil and gas imports through temporary balance-of-payments deficits and external financing rather than through adjustments.”

However, adds the Bank, there is a “great deal of uncertainty” about how high prices will go and for how long, and even a temporary shock could make international lenders jittery about the sustainability of external debt of countries, and this uncertainty increases the risk of a sudden withdrawal of external finance.

“It is thus likely that the risk averse policy-makers in oil-importing countries will undertake some degree of prudent adjustments.”

The short-term (optimistic) outlook for the western market economies and the world however remain subject to important downside risks which have not diminished in the recent months, the ECE says. It points to the risks from the considerable imbalances built up in the US economy, and hence the possibility of a hard landing (involving sharp fall in share prices and the dollar) not being discarded and leading to spillovers in the rest of the world economy. Another downside risk is from the unexpectedly large increases from oil prices, which could lead to stronger than expected dampening of economic growth and demands for wage increases and more restrictive monetary policy.

The World Bank too for its base line scenario assumes a soft-landing for the US economy, smooth private sector adjustment, and prudent policy reactions to the oil-price shock, but hedges its bets with warning of a “less favourable resolution of tensions now affecting the global economy.”

The Bank envisages favourable prospects for a soft landing in the US economy - though it is not clear whether the Washington-based Bank economists, like others, believe that the Federal Reserve Chairman Mr.  Alan Greenspan will continue to be able to pull rabbits out of a hat, and through monetary policy and signals enable continued US growth at a slower pace.

It notes however the consensus view of financial analysts is that the Federal Reserve is likely to raise interest rates further in 2001 against the background of still rapid domestic demand growth, high oil prices and continued wage pressures. But with a expected slackening of economic pace over 2001, policy as well as long-term interest rates should ease moderately in 2002.

“The underlying risk of a harder landing remains, however, since domestic savings are not expected to recover and the current account deficit is likely to register $450 to 475 billion or 4.5% of US GDP over 2000-02.

And the possibility of tax cuts following the November elections suggests a reduction of the public sector surplus which would tend to increase the current account deficit yet further. Current financial tensions in the high-yield sectors may be a first sign that financing of large US private debt is becoming increasingly difficult.

[If, as seems more likely George Bush makes it into White House, those who have financed his campaign and got him elected, will ensure that big tax cuts are put through, ala the Reagan era of the 80s.]

Economists and their models though cannot factor in the occupants of the White House next year, and the policies and failures that might ensue, but perhaps can fall back in defense on the ‘uncertainty’ principle. And if scientists engaged in ecosystems analysis, to illustrate the uncertainty principle (of quantum physics and science) by talking of giant butterflies fluttering wings over the amazon rain forests of Brazil setting off storms over the Korean peninsula, the economists can fall back on the US ‘butterfly’ - the ‘Palm beach butterfly ballot” and the uncertainties brought by it into the elections and US politics over the next four years.]

The Bank also expects strong productivity growth in the US, with the rapid growth in Information Technology (IT) investment to continue at higher rates on a secular basis. However, achieving the potential growth, it says, would present policy challenges - as correction of the persistent external deficit will require extended periods of low import demand, a fall in the value of the dollar or both.

Elsewhere though, while still talking of the New Economy and productivity growth due to computers and other technological developments, the Bank report does notice some analysis challenging this talk of the New Economy and productivity growth - particularly since most of the effects have been seen in the computer industry and some manufacturing, but not much in the services or other sectors.

The bank report also notes recovery in Japan - with rising public investment, sharp recovery in profits, rising house-hold demand, all providing the necessary boost to consumer confidence. However, the Bank report notes the fragile financial under-pinnings of the economy and the critical challenges facing this sector.

It also sees growth solidifying in the Euro area, but with a weak euro underpinning inflationary pressures.

However, the ECE economists note that while the ‘headline’ inflation in the euro-zone is well above the ceiling of the European Central Bank, core inflation remains at about 1-1/2%. The consensus forecast is for consumer price index will fall back close to 2% and hence ECE sees no need for any further tightening of monetary policy as it poses unnecessary risk to economic growth.

The bank report expects world trade to remain on a long-term high growth path and continuing to grow strongly, although somewhat below the current record pace. It stresses the enormous impetus to world trade provided by the GATT and now the WTO, but also notes the increasingly important role played by regional agreements.

The bank clearly favours regional arrangements involving the industrial and developing countries, but not the latter alone, arguing that these “lack the economic diversity required to meet the bulk of their trade needs.”

But the literature examined and the trade theories of comparative advantage used, appear to ignore the fact that in the post-war era the boost to growth in manufacturing trade in Europe and across the Atlantic came from intra-industry trade, and not the old Ricardian view.

In the longer-term (2003-10), the Bank projects world trade to grow by 6.8% a year, 2.1 times the projected growth rate for world GDP -lower than in the 1990s, but higher than in the 1980s.

On capital flows, the World Bank reports that according to preliminary data, there was a contraction in FDI flows to developing countries in 2000 -- from the $180 billion figure recorded in 1999.

The downturn came due to reduced commitments for new projects, combined with a slow down in mergers and acquisitions and completion of major privatization projects. China, the largest recipient of FDI, experienced a substantial reduction in value of new commitments over the past few years—from a $111 billion in 1993 to $52 billion in 1998 and $41 billion in 1999.

However, the bank expects FDI flows to developing countries to rise over the longer term - fuelled by cross-border mergers and acquisitions among corporations in industrial countries and growth rates in developing countries exceeding those of the industrial world.  “However,” adds the bank, “the growth of FDI is unlikely to be as spectacular as it was in the 1990s.”

While the baseline scenarios of solid growth in all regions is realistic and achievable, says the Bank report, it is difficult to anticipate cyclical downturns or crisis induced by commodity or financial shocks.

The Bank has projected a low-case scenario - combining a short-run downturn in global economy and long-run lower potential growth - with high oil prices contributing to inflationary pressures and increased uncertainty, cuts in demand and restrictive monetary policies, the high US current account deficit resulting in investor concerns and rapid reversal of foreign funds, and a global recession.

In such a scenario, the Latin American countries with relatively high levels of debt and dependence on exports to the US, are hit hardest.  East Asia too will be hit by fall in US demand, depreciation of the dollar, and mounting financial difficulties.

Central and eastern Europe, the Middle East and North Africa and sub-Saharan Africa - all with a stronger focus on Europe - experience a more moderate downturn in the short-run.

In South Asia, as in earlier crises, India exhibits some resilience to less favourable external developments,  but Pakistan will face severe consequences due to worsening of international financial conditions.

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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