A closer look at the uncertain prospects for economic growth worldwide this year
Douglas O. Walker
Professor of Economics
Robertson School of Government
Regent University
Virginia-Pilot—January 1, 2006 |
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The economic visibility on the world economic landscape and its prospects, never of more than limited clarity and range, clouded and became more uncertain as the year 2005 closed, and the outlook for 2006 is not only more unfavorable than it was several months ago but points to an extended period of difficult adjustment and changes to policy priorities.
The year 2005 opened with a cyclical recovery in world economic activity reaching its peak as strong forces discouraging a further rise in output gathered strength in many world regions. As the year progressed, the combination of higher oil prices, capacity constraints in many countries, a tighter monetary policy in the United States with its rising interest rates, and wide external imbalances tempered world demand for goods and services, and in response world industrial production and trade began to weaken. In every region, except Africa, the tempo of economic growth slowed significantly during the year, and in Europe it faltered noticeably as domestic demand slackened and unemployment rose. Even in those countries which had maintained some momentum of growth in 2005, such as North America and much of Asia, the expansion seemed to slow somewhat in the more adverse environment.
Taken as a group, the pace of growth in the more economically advanced countries of Europe, Japan and North America, where the volume of aggregate production had climbed 3 per cent in 2004, fell to an average rate of increase of 23 per cent in 2005. The falloff in growth in the economies in transition and the developing countries, regions of the world which had been experiencing an accelerating upsurge in production and trade, was even more noticeable, with a loss of 1 percentage point in their growth momentum. Import demand from these regions dropped sharply in response to the slowdown in their expansion, and acted as a drag on the rest of the world economy, intensifying the negative forces already at work at the global level.
In response to the downturn, the United Nations and other international agencies call for more intense international policy coordination, and forecast a modest recovery in 2006. However, they underestimate the difficulties of implementing expansionary macroeconomic policies and achieving strong and balanced growth in the current environment. Moreover, they misunderstand the policy priorities of governments faced with difficult problems of a structural nature that do not simply limit present growth prospects but test the very viability of their economies.
In the first instance, any response by governments to the current slowdown will be complicated by the recent speed up in the rate of increase in prices and the chronic balance of payments disequilibria which characterize the international economy, both of which worsened towards the end of the year.
Driven by higher oil prices, inflation -- albeit moderate for the moment -- has returned to North America and Western Europe, most noticeably in the form of rising energy prices. Non-energy commodity prices have also been rising on world markets, especially those for agricultural raw materials and metals and minerals, but these influences and the effects from the rapid expansion in the U.S. monetary stock have yet to be fully transmitted across the world. As the dollar weakens on foreign exchange markets in response to the U.S. trade deficit and its past monetary expansion, global inflation measured in dollars is likely to edge up further and fuel expectations regarding future price increases. This will encourage shifts toward tighter monetary and fiscal stances in many countries, in contrast to the more expansive policy orientation hoped for by international agencies.
The most significant constraints on policy are the enormous external imbalances that widened during the course of 2005. As the deficit of the United States grew, the corresponding surpluses of its main trading partners rose in response, particularly in East Asia and among the oil-exporting countries. The negative trade balance of the U.S. appears significantly higher at the end of the year than it was at the start, and will encourage a further tightening of restrictive measures already in place. Confusion about the proximate source of the imbalances, that is, whether they are rooted in trade patterns built on commercial considerations or reflective of differences among countries in saving and investment propensities, inevitably means confusion about how to deal with the imbalances, and with this confusion comes a paralysis in the multilateral policy coordination hoped for by international agencies.
In the second instance, responding to the downturn is not likely to dominate policy discussions at the national level. Governments increasingly realize the very prosperity of their countries -- indeed, the very political stability of their countries -- is at risk because of a host of rigidities, insecurities and negative trends that threaten their economic future.
In the United States, it is concern about the demands of an aging population and the need to deal with huge trade and budget deficits. In Europe, an aging population adds its demands to those of an overburdened welfare state, where high wages, long vacations and generous unemployment benefits create a stifling economic environment. In rapidly growing Asia, it is recognized that the extensive nature of its growth, based on high rates of capital and labor mobilization, must be replaced by growth of a more intensive nature, where efficiencies and productivity advance become central to economic progress. Finally, in other countries, concern centers on problems of development, not problems of a cyclical downturn. The commonality of these problems is that they are long-term in nature and national in focus, and consequently will lessen the need for the policy cooperation hoped for by international agencies.
National governments and the international economic institutions that support the world economy are now at a crossroad. The year 2006 will be the first where fundamental problems of long-term world development could take precedence as policy priorities over immediate concerns about the pace, pattern and stability of world economic growth, important as they are. Turning attention to problems of adjustment to rapid demographic and technological change is essential for the future of all countries, and must now become high on the policy agenda. Success in dealing with these problems could set the stage for a renewal of the strong and balanced growth that now preoccupies policy-makers at the national and international levels.
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