RECENT GLOBAL MACROECONOMIC TRENDS

Developed countries

Table I.1 summarizes the salient features of the global economy in recent years. Perhaps the most noteworthy aspect has been the tremendous resilience of the United States economy. Its undiluted strength added to the growth rate for the global economy in 1999; it also played a significant role in the rapid turnaround of the crisis economies in Asia. Indeed, contrary to widespread predictions of an imminent slowdown in the American economy, growth in output was sustained at just under 4 per cent per annum in 1999, and for the two preceding years as well. Such expansion, which was noticeably above the recent long-term trend, took place in an environment of remarkable price stability. In addition, from the various indicators now available, actual performance is likely to remain strong so that by April 2000 the current period of economic growth in the United States will have been the longest on record. Furthermore, unemployment at 4.1 per cent in October 1999 had declined to its lowest level since the 1960s.

Some analysts suggest that the United States economy has been reaping the huge benefits from significant investments in information technology and other new or productivity-enhancing technologies.² Such capacity-building has simultaneously raised the long-term rate of growth and kept inflationary pressures muted. Flexible labour and product markets have also played a part in sustaining growth with price stability. Higher productivity gains and subdued cost pressures have been reflected in the strong growth of corporate earnings over the last two to three years, notwithstanding a temporary hiccup in late 1998. This served to underwrite increased levels of business investment and the upward movement of stock market price indices. Such had been the rise in stock market prices in the United States that the price-earnings ratio in early 1999 was close to 30, approximately double its average between 1970 and 1990.³

The substantial capital gains, in turn, supported high levels of household consumption. But as mentioned in Survey 1999,⁴ the wealth effects of rising stock market prices had also contributed to a relatively sharp reduction in the household saving rate. In the middle of 1999, for example, the average household in the United States was spending more than its disposable income.⁵ The fall in private savings was offset only partially by the government's budget surplus, thus contributing to a large deficit in the external current accounts. Moreover, high levels of capital expenditure by the corporate sector and rising consumption outlays by households had together generated a strong demand for credit, leading to a rapid growth in total bank lending and the money stock. Partly as a result, yields on both corporate and government bond rose by around 1.5 percentage points between the third quarter of 1998 and the third quarter of 1999. The financial markets therefore expected inflation to pick up modestly at some point in the near future, given the low level of unemployment.

While the sustained, overall strength of the United States economy bears eloquent testimony to sound policies, a number of other factors also played a supportive part over the last two to three years. The cumulative gains in equity values clearly enabled individuals to maintain consumption expenditure at high levels and corporations to invest in capital equipment beyond what might otherwise have been possible. Low commodity prices and the sustained strength of the dollar contributed to the prevention of inflationary pressures. The latter, in turn, contributed to, as well as benefited from, restrained real wage gains, despite a tight labour market.

A major issue of worldwide interest and concern has been the sustainability of American economic growth over the next few years. Typically, a slowdown occurs when low unemployment and tight labour markets cause wages to escalate faster than productivity; inflation picks up and interest rates have to be increased. Many analysts maintain the view that, despite recent productivity gains in the United States, skill shortages and wage pressures are likely to emerge, especially with the unemployment rate as low as 4.1 per cent. Apart from the possibilities of a wage hike and higher inflation, there are other concerns. These include the large and rising volumes of private dissavings and a high current account deficit, which was estimated at over 3.5 per cent of GDP in 1999. The sustainability of stock market price indices would be another possible area of risk, as already noted.

The strength of the American stock market, however, is not an unmixed blessing. Most categories of stock price indices in the United States have kept on rising over the last few years. A wide range of stocks issued by established or new enterprises, especially those engaged in the development or application of new technologies, can remain buoyant, feed self-sustained optimism and rising stock values, and contribute to the strong growth of the economy. But when high stock values are associated with increasing levels of net dissavings and credit extension to (and indebtedness of) the private sector, then a restoration of household savings to the long-term trend average can trigger reduced consumption and lowering of corporate revenues and earnings, with an adverse impact on growth. Equally, a fall in household dissavings independent of any decline in the stock markets could precipitate a major decline in consumption and corporate sales and earnings, leading to a fall in stock market prices and further adverse effects.

The private sector financial balance in 1999 fell to about -4.7 per cent of GDP in the United States;⁶ such a deficit in the private sector financial balance had never exceeded 1 per cent in the United States over the previous five decades.⁷ Further increases in dissaving are regarded as unsustainable as they would lead to inordinately large private debt levels possibly triggering substantial increases in borrowing costs. At some stage, therefore, private savers could be expected to rebuild their savings and reduce their spending, not least to lower the debt-service burden. Whether consumption and thus GDP growth would decline gently or abruptly in consequence is very difficult to predict.

Thus far, the general mix of domestic policies, and monetary measures in particular, has been highly successful in smoothly steering the American economy through the financial turmoil of the past three years and in maintaining the momentum of growth in output and employment without the penalty of overheated cost pressures and unsustainable debt accumulation. The policy challenge appears to be in ensuring a gentle descent and slowdown in economic growth to a more manageable and sustainable level (of between 2.5 and 3.5 per cent) without provoking a large sell-off in the stock markets. The risk is that monetary gradualism may not be entirely adequate to restrain optimism and consumer spending, and corporate enthusiasm about business investment and rationalization, including through mergers and takeovers.

Turning now to EU, some of the euphoria generated by the introduction of the euro on 1 January 1999 dissipated as the new currency weakened significantly against the dollar. In hindsight, the depreciation proved a blessing in disguise as it reversed, to some extent, the weaknesses in economic performance that had characterized many of the EU economies prior to the introduction of the euro. Growth indeed picked up in the 11 economies of the euro zone in the latter part of 1999, in part due to improved price competitiveness. Unemployment levels also began to decline slowly in the 11 economies of the euro zone. Elsewhere in Europe, too, growth in 1999 was higher than had been forecast at the beginning of the year, partly on account of the economic expansion in the euro zone itself and partly because of other favourable factors, including the supportive strength of the American economy.

Despite this recent improvement, growth performance within EU has been considerably weaker than that of the United States since the early 1990s. Its record was also poorer than that achieved by most EU members themselves in the 1980s. The 11 economies of the euro zone are faced with a range of difficult policy issues in sustaining higher growth trajectories in the short and medium term. On the fiscal side, the Maastricht treaty requires further fiscal consolidation; member countries have to eliminate their structural deficits progressively so as to ensure fiscal positions close to overall balance or to achieve a budget surplus by 2002. This leaves the task of managing the pace of growth almost exclusively to monetary policy, the mandate of the European Central Bank (ECB).

Monetary policy stance in the euro zone is now concerned with all the 11 member countries in monetary union; it cannot therefore be tailored to deal with specific conditions and circumstances in individual countries. Moreover, inflation is to be kept within the target band of 0--2 per cent per annum; ECB has no mandate to pursue higher growth in output and hence employment. The relatively weak performance until recently of the larger economies in the euro zone, especially Germany, Italy and, to a lesser extent, France, contrasted with the rapid economic growth in some of the smaller member countries such as Finland, Ireland, Portugal and Spain. However, ECB raised its refinancing rate by 0.5 percentage points to 3.0 per cent in November 1999. Another supply-side factor that might serve to constrain or impede the achievement of higher growth in EU relates to the extent and pace of restructuring in labour and product markets within the 11 economies of the euro zone despite considerable progress made in these respects.

By and large, unemployment in EU persisted at historical highs with only minor reductions during the recovery in 1997-1998, and in 1999. Longer-term supply factors, such as labour and product market rigidities, remained at the heart of the problem. This was especially true in Germany, where part of the unification costs had been met by levies on wages, thereby raising the cost of labour. The lower productivity of workers in the former German Democratic Republic was another factor in keeping unemployment high. However, several major steps to address these issues, taken recently by the Government of Germany, have boosted business confidence in the country; the pertinent measures included a reduction in pension contributions by employers, early retirement options and an expansion of youth training facilities and programmes. In comparison, the French economy performed better, partly because it did not have to meet the high fiscal costs as in Germany on account of unification. As a result, the extent of fiscal consolidation that had to be made prior to the introduction of the euro in France was smaller as a percentage of GDP. The poorer performance of Italy could also be attributed largely to previous fiscal profligacy; the fiscal consolidation required over the span of two years amounted to some 9 per cent of Italy's GDP. Furthermore, both Germany and Italy had been more heavily exposed financially and otherwise, and were thus more vulnerable to the severe financial and economic crisis in Asia and in the Russian Federation.

Outside the 11 economies of the euro zone, growth picked up in the United Kingdom of Great Britain and Northern Ireland in the second half of 1999. The slowdown in late 1998 and early 1999 was occasioned by the weakening of external demand; in turn, this could be attributed to the strengthening of sterling and the consequent sharp decline in net exports. Interest rates were reduced in April and June 1999 to achieve some economic stimuli; core inflation stayed well below its target rate of 2.5 per cent. Thereafter, economic activities picked up fairly rapidly so that interest rates were raised marginally in September and then in November 1999 to choke off any incipient inflationary pressures. The brevity of the recent economic slowdown in the United Kingdom provided a sharp contrast to previous experiences. This achievement can be attributed primarily to a policy-induced environment of low inflation which, in turn, has allowed interest rates to be adjusted more quickly and often in response to marginal changes in economic activities. Extensive labour and product market reforms carried out in the 1980s have also facilitated speedier outcomes of policy changes.

As a whole, any significant improvement in growth performance in the 15 economies of the European Union in the year 2000 and beyond will depend greatly on the extent and pace of structural reform in the largest economies. First of all, further labour market reforms that would help to reduce structural unemployment could be expected to raise output fairly quickly. Reforms in the product markets, such as in telecommunications, retailing and utilities, and greater flexibility in zoning laws could also achieve similar results. Other than in the United Kingdom, progress in such areas of policy and structural reforms has not been speedy in the larger EU economies.

The slow pace of reform has possibly also impeded or constrained a faster and wider absorption of information technologies and other new technologies in many of these economies. Such technologies greatly improved the performance, as well as the resilience, of the United States economy in the 1990s, as discussed in some detail previously in this chapter. A possible stimulus to economic performance relates to the gradual convergence to higher income levels in the poorer EU economies; the process could promote increased competition and greater efficiency in EU as a whole. But such income convergence and the associated efficiency gains are likely to eventuate in the long run. On balance, it is unlikely that EU as a whole will become an alternative to the United States as a source of significant demand for exports from developing countries over the next few years.

Turning now to the ESCAP region, there is increasing evidence that the Japanese economy has finally bottomed out, with much of the recovery so far gained being a direct result of a series of major fiscal stimuli provided by the government in 1998 and 1999. Output growth was estimated at just under 1 per cent in 1999, compared to a contraction of almost 3 per cent the year before. However, these fiscal packages did not promote higher consumer spending or even higher consumer confidence. Unemployment, at 4.6 per cent in September 1999, remained stubbornly high by Japanese standards, while low levels of capacity utilization and large inventories persisted in the manufacturing sector, especially in activities less exposed to international competition.⁸ In addition, the recent appreciation of the yen has compounded some of the current difficulties.

There was no let-up in the pace of decline in business investment as companies grappled with and sought to reduce overcapacity and large volumes of inventories. Overcapacity was responsible not only for the significant slack in the economy but also for making cost-cutting efforts an indispensable, ongoing feature of Japanese economic life. Such efforts, in turn, tended to add directly to deflationary pressures, aggravate indirectly the bad loan problems in the financial sector, and lower consumer confidence. There was a marked improvement in the performance of the banking sector in 1999 but it is commonly felt that a full resolution of the substantial amount (in absolute terms) of non-performing loans will take considerable time.

On a brighter note, business confidence showed credible signs of improvement and the rate of new bankruptcies slowed down noticeably. Nevertheless, policy makers continued to face a formidable array of challenges in initiating and sustaining the ongoing process of economic rationalization for stronger and more durable growth performance in the near to medium term. The multidimensional reforms will not only involve widespread re-engineering of business corporations and lay-offs of workers for enhanced cost efficiency but also require considerable restructuring and consolidation of the financial sector. In macroeconomic policies, a critical area of concern is the rising fiscal deficit emanating from several large public spending packages to stimulate the economy. On current assumptions, the deficit will be over 9 per cent of GDP in both 1999 and 2000.⁹

A noticeable reduction in such a high level of fiscal deficit will not be a viable proposition until the recovery has taken hold, given the need to support economic turnaround through fiscal means. Monetary policy has been supportive of the expansionary fiscal stance, but limited scope exists for further easing of monetary conditions, especially with overnight rates of interest being close to zero. However, financial market concerns over the expanding volume of public debt have already been reflected in upward pressures on long-term interest rates in Japan. It has been suggested in this connection that part of the fiscal deficit should perhaps be monetized. If the central bank were to purchase and hold more government bonds, yields would not need to rise to provide the needed premium for private investors to hold more public debt. In the process, the money supply and financial system liquidity would expand, and inflationary expectations would rise; these would then serve to counter or weaken some of the recent strength acquired by the yen, sharpening export competitiveness in the process.

These debates have underlined the difficult choices and trade-offs facing policy makers in Japan. Against this backdrop, it is clear that structural reforms would play a critical role in determining the depth and durability of Japan's economic recovery. The problems of the banking sector were discussed at some length in Survey 1999. The recognized need for faster progress with the banking sector's restructuring, recapitalization and consolidation is highlighted by the prospective replacement in March 2001 of the blanket deposit insurance scheme currently in operation with a more limited system. The banking sector plays a greater role in Japan than in any other developed economy. As such, it is of vital importance that the sector regains profitability in its core activities so as to provide the fullest support for Japanese economic revival.

The prospects of successful financial sector consolidation and recapitalization are intimately linked to the resolution of the problems within the corporate sector; the latter depend, in turn, upon the effectiveness and timeliness of both public and private sector measures to reduce excess capacity, large inventories and overmanning in manufacturing. Progress in these areas has not been as speedy as is desirable. Taking all these factors into account, it is unlikely that the Japanese economy will grow appreciably faster than the 0.9 per cent expected for the 1999 fiscal year (ending 31 March 2000).¹⁰ A further major fiscal package equivalent to $172 billion was introduced towards the end of 1999. This should prevent the economy from sliding backwards in 2000. However, it is the structural reforms and the reinvigoration of consumer confidence that would have a more lasting bearing on economic performance in Japan over the medium term.

Australia, one of the three developed countries of the ESCAP region, has performed strongly in recent years. Rising consumer expenditure contributed to another vigorous rate of economic growth of over 3.4 per cent in 1999. On the other hand, the after-effects of the Asian crisis served to widen the current account deficit to over 5 per cent of GDP. Sound macroeconomic fundamentals prevented a further weakening of the Australian dollar, despite relative stability in domestic interest rates. Some degree of economic slippage is possible now that investment expenditure has started to weaken in the face of poorer export prospects. In New Zealand, the economy moved out of the recession of 1998, and output growth was expected at around 2.2 per cent in 1999, with a possible acceleration in 2000 if world economic expansion continues at rates currently projected. The effects of the Asian crisis and the attendant volatility in domestic financial markets were substantially moderated during the latter part of 1999. In fact, the New Zealand economy has been enjoying renewed competitiveness and rising business and consumer confidence. The latter reflects the considerable progress made so far in restructuring corporate and household balance sheets, a process which is inevitable after a recession.

Developing economies

The worst periods of output contraction ended during the first or second quarter of 1999 among the economies hit by the crisis in the ESCAP developing region. The economic consolidation and recovery phase appear to have begun firmly, with the Republic of Korea showing the most dramatic improvement in levels of production, exports and employment. The turnaround process had these common characteristics. First, there was the reversal of the extreme depreciation in the exchange rates which had persisted until the middle of 1998. Second, inflationary pressures were initially contained and then substantially moderated, and this allowed interest rates to fall significantly from the very high levels which had existed up to mid-1998. Third, a rapid turnaround was achieved in the balance of payments, initially based upon a sharp compression of imports but lately reinforced by buoyant export earnings despite the increased outflows resulting from a revival in import spending. Fourth, foreign exchange reserves were built up in the process, to higher levels than before the crisis in some cases. Fifth, domestic and international investor confidence and external perceptions of local credit risks improved significantly. However, the steady recovery in stock prices and a narrowing of international bond yield differentials were also accompanied by considerable instability in the financial markets of the crisis economies in the latter part of 1999. This was partially a reflection of the slow pace of progress with financial and corporate sector restructuring, the continuing overhang of substantial levels of non-performing loans, corporate indebtedness and excess capacity. Such volatility was also due to the ripple effects of other factors, notably the political turmoil in Indonesia, uncertainties as regards the value of the yen and fluctuations in the perceptions of foreign investors not necessarily related to objective conditions.

Economic performance remained encouraging outside the crisis economies of the ESCAP developing region, as has also been the case in the recent past. The rate of output growth in China is estimated at 7.2 per cent for 1999; this is marginally lower than the rate for the previous year but is clearly healthy by regional standards. India achieved a slightly lower GDP growth in 1999 than in 1998. The country benefited considerably from a strong performance in agriculture and exports, particularly of computer software. Inflationary pressures also abated in India during the year. Growth in output and incomes among most other developing countries in the region was not dramatically different from recent trends.

The Asian crisis induced a steep drop in capital flows to many Latin American countries. Monetary policy in most of the larger economies of that region was tightened so as to stem the outflow of capital. The problems created by resultant higher interest rates were made much worse by the sharp decline in commodity prices that had occurred during 1998 and that persisted into 1999. The overall outcome was a fall in export earnings and larger current account deficits in most Latin American economies. Output growth consequently turned negative during 1999 in the five largest economies (namely Argentina, Brazil, Chile, Colombia and Venezuela). Only the Mexican economy had recorded some positive gain in GDP during the 12 months to mid-1999, albeit at a decelerating pace. Even with some recovery in production during the second half of 1999, aggregate GDP for the region is likely to have contracted by one percentage point for the year as a whole. This estimate presumes no further disruptions in Latin American financial markets and assumes that economic growth will continue at its recent pace in the United States. The recent rise in oil prices, the general pickup in commodity prices and some easing of monetary conditions in the region suggest the likelihood of positive growth in 2000.¹¹

African and West Asian economies are primarily commodity-dependent. For these economies, integration with the world economy, other than through trade flows, remains negligible or limited and developments in the external financial markets tend to have a diluted bearing on their economic performance. In 1998, export earnings had declined sharply and, as in Latin America, there was a concomitant widening of the current account deficits in many African and West Asian economies. In Africa, the consequent deficits were funded mainly by official development assistance (ODA); external deficits in West Asia had been funded largely by drawing down foreign exchange reserves.

GDP growth in most of Africa was expected to be about 2--3 per cent in 1999; this was about the same pace as that realized a year earlier, notwithstanding somewhat firmer commodity prices in the latter part of 1999. There was, on the other hand, considerable intraregional variability attributable to economic and other factors; the latter included political and civil unrest. Regarding the former, some improvement in foreign exchange earnings, as well as marginally easier access to external finance, should be the experience of the larger countries of North Africa, and of South Africa, in 1999. These economies are at comparatively higher development stages; they are also more closely integrated with the global economy, including EU, in terms of both trading and financial linkages. Many of the less developed economies in Africa continue to suffer from acute structural problems, including large fiscal deficits, inefficiency in production, market rigidities, inadequate infrastructure and human resources, and debt-service burdens that have long been unsustainable. The recent initiative designed to address the latter problem among highly indebted poor countries should provide them with relief over the medium term, but its benefits and impact are expected to be incremental. In the short run, therefore, economic performance in the African developing region will continue to depend heavily upon commodity prices.

In West Asia, the economic outlook has recently become much better than it has been for some time because of the sharp increase in the price of oil exports. Oil production levels and unit values are the major determinants of economic performance of most West Asian economies. Such windfall gains by no means lessen the pressing need for policy adjustments and economic restructuring in at least three main areas: wide-ranging fiscal reforms; the diversification of output and the promotion of higher value-adding activities; and a sizeable redirection of public spending for human resources development and skill enhancement. These are essential to improve domestic efficiency and flexibility in both factor and product markets. Such reforms and restructuring are also indispensable for ensuring and sustaining higher trajectories of (equitable) output growth and greater diversification in the medium and long term.

On balance, the developing countries as a group could record an appreciable improvement in economic performance in 2000, compared to that of the preceding year. This assessment has to be tempered by the following considerations, some of which were discussed at length earlier in the chapter. On the external front, there are still appreciable uncertainties concerning the economic performance of the United States, EU and Japan in 2000 and the years immediately beyond. On the domestic front, the durability of the growth of the developing countries, and diversification in their output and employment in the near to medium term, will depend on their success in implementing multisectoral policy reforms and restructuring. At the same time, local human resources and institutions will need to be built up and strengthened to handle more satisfactorily the increasingly complex requirements of integration into the emerging knowledge-driven global economy.

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