EconSouth (Second Quarter 2001)


U.S. Sneezes, World Catches Cold

The U.S. economy has slowed considerably over the last few quarters; after peaking in the fourth quarter of 1999 at 8.3 percent, growth rates slumped to 1.0 percent in the fourth quarter of 2000 and 1.3 percent in the first quarter of this year (see chart 1).

The U.S. economic slowdown is being felt around the world. As the world’s largest economy, the United States is the leading export market for many foreign economies. For much of the ’90s the United States was the engine for world growth, helping pull the international economy through several negative episodes. Strong U.S. gains meant that countries suffering the effects of the Asian crisis, for example, could boost their economies by selling goods to the United States.

U.S. investors also played an important role in boosting the global economy. Flush with profits from the strong performance of the stock market, investors expanded their portfolios to include areas of the world with even higher growth potential, emerging markets in particular. But as the U.S. economy weakened, the demand for imports moderated, and investors’ ability to send funds overseas declined.

As a consequence, countries that depend heavily on selling goods to the United States and on U.S. capital have seen their economic growth slump. In turn, weaker growth in foreign economies has resulted in weaker demand for U.S. goods abroad. The decline in both U.S. imports and exports has been pronounced (see chart 2).

Another factor weighing on the U.S. export outlook is the strength of the dollar. The dollar’s value is at its highest level versus foreign currencies since the mid-1980s (see chart 3). The strong dollar makes U.S. exports more expensive overseas and makes imports to the United States cheaper. The result is a widening trade deficit.

The outlook for the global economy has softened in 2001, and slowing growth in the United States is a contributing factor. But a subdued U.S. economy is not the only reason global growth has slowed. Many countries face domestic problems, such as political situations in some Latin American countries, that continue to constrain growth. In addition, higher energy costs worldwide have dented both personal spending and business investment in most economies as consumers and firms are forced to pay more for power and fuel.

U.S. Real GDP Growth
Chart 1
Source: Bureau of Economic Analysis

Checking the vital signs
Until recently, industrial weakness was concentrated in the United States, but frailty is now emerging overseas as well. Recent indicators of industrial activity and business confidence have been disappointing for a wide range of countries outside the United States. Surveys suggest that unwanted inventories are now building in countries that use the euro and in Japan. As domestic demand weakens, production may fall in both these economies through the third quarter of 2001. In addition, the weakness in U.S. capital spending reflected in first quarter gross domestic product (GDP) data and the still-declining trend in activity in emerging Asian economies suggest that the global slowdown in high-technology spending is not over.

U.S. Trade: Export and Import Growth
Chart 2
Source: Bureau of Census
Federal Reserve Bank of Atlanta Classic Dollar Index
Chart 3
Source: Federal Reserve Bank of Atlanta

Asia. Japan has so far been unable to emerge from a decade of stagnation; implementing economic reform there remains difficult. Recent economic data from Japan point to continued weakness. Consumer confidence slumped in the first quarter, factory and machinery orders continue on a downtrend, and the leading economic indicators point to further near-term contraction. Real GDP growth contracted in the first quarter, and forecasts point to contractions in the second and third quarters as consumer spending retrenches and industry continues to struggle. On a positive note, Japan’s new Prime Minister, Junichiro Koizumi, is expected to accelerate the economic reform process. Japan’s central bank has altered its monetary policy that has driven its nominal overnight interest rate to near zero. The uncertain outlook has resulted in weak demand for loans, however, and limited the potentially positive effect of lower interest rates in Japan.

Elsewhere in Asia, domestic financial systems in the emerging economies remain weak in the aftermath of the financial crisis of 1997–98. In addition, recent data show slowing industrial production and weak export demand for these economies — not surprising given the region’s dependence on high-tech exports to the United States. Unemployment remains well above rates prevailing before the financial crises, and consumption is weak as well. China was the only Asian economy to post solid first-quarter growth, fueled by exports and government spending.

Europe. Industrial production in Europe continues to post healthy gains, with year-over-year growth at 3.8 percent in March. However, recent surveys found that business confidence continued to slump in major economies, indicating that Europe’s economy may slow soon. The European Central Bank lowered its benchmark interest rate 25 basis points to 4.25 percent on May 10 despite an upward trend in inflation data. In March, the headline consumer price index rose 2.6 percent year-over-year, and the core rate hit a four-year high with a year-over-year growth rate of 1.8 percent. Inflationary pressures are expected to ease later in the year as the effects of high energy and food prices wane.

North America. Canada’s economy is showing signs of deceleration. Industrial production has slipped, contracting nearly 1 percent from late 2000 levels. Decelerating inflation rates and weak growth led Canada’s central bank to lower its benchmark interest rate 125 basis points this year to date.

The Mexican economy contracted on a seasonally adjusted basis in the fourth quarter of 2000 and the first quarter of this year. Industrial activity, in particular, has softened. Reflecting this weakness, the number of workers in manufacturing declined for the fourth consecutive month in February on a year-ago basis. On the consumption side, retail sales are growing at their lowest rate in nearly a year.

Latin America. For Latin America as a whole, regional growth is now expected to be roughly 2 percent, compared to the 3.7 percent forecast in December 2000. The downward adjustment to the outlook reflects the effects of the global economic slowdown as well as domestic situations such as the ongoing financial struggles in Argentina and expected power shortages in Brazil.

Downward revisions were made for all major economies except Ecuador, but that country’s forecast is also uncertain given the current struggle to implement tax reforms there. Of the larger economies, the outlooks for Mexico, Argentina, Chile and Peru all fell by at least 1 percentage point. Brazil’s forecast has been downgraded in response to a series of negative developments, including problems in Argentina and Brazil’s power shortage.

In Argentina, recent events reflect ongoing market uncertainty over the fate of the country’s economy. Argentina is struggling to implement policies that move to end nearly three years of recession while protecting against inflation. The appointment of Domingo Cavallo as finance minister has brought instant credibility to Argentine economic policy. Cavallo was the father of the Convertibility Plan that ended years of hyperinflation in the early 1990s and returned the country to economic stability.

Prognosis: Delayed recovery
At the beginning of 2001, forecasters predicted a turnaround in real economic growth in most regions of the world by midyear. But greater-than-expected industrial contractions early this year and ongoing downgrades in consumer and business confidence have pushed their timetable for recovery to later in the year. This turnaround should be fueled by lower worldwide interest rates, reduced energy prices and a rundown in excess inventories.

The current forecast for 2001 global economic growth is the lowest in a decade. The April Consensus Forecast for world real GDP growth in 2001 is 2.3 percent compared to 2000’s estimated rate of 3.9 percent (see the table). Most analysts expect slower annual growth rates in all major economies and areas. Forecasters expect the most pronounced year-over-year slowdown in North America, followed by the developing countries of Asia. Japan’s economy is predicted to remain stagnant while Latin American growth should also decelerate until later this year. Europe’s economy is forecast to slow as well.

Global Real GDP Outlook
  Percent Change From Previous Year
  2000 2001 2002
   Japan 1.7 0.9 1.6
   Emerging Asia* 7.6 4.0 5.1
   China 8.0 7.7 8.0
   Euro Area 3.3 2.6 2.8
   United Kingdom 3.0 2.4 2.7
   Canada 4.7 2.4 3.3
   Mexico 6.9 3.1 4.5
   South America 3.0 3.0 3.7
   World 3.9 2.3 3.1
*Not including China
Sources: April 2001 Consensus Forecasts; Federal Reserve Bank of Atlanta

Protectionism: Not the cure
Weak growth abroad and the strong dollar mean that the United States can expect little help from exports in its bid to return to stronger economic growth. In the face of these pressures, calls for efforts to shield the U.S. economy through protectionist measures may emerge. Both economic theory and experience show that protectionism is not the answer, however. Instead, maintaining close economic ties to the rest of the world is in the best interests of the United States in both the long and short term.

The United States remains a world leader in supporting free trade and open capital markets. The U.S. economy has been and will continue to be a major beneficiary of the open global system. More international goods and capital than ever before flow into the United States, giving consumers more choices at lower prices than possible under a closed economic system. The flow of capital has helped lower borrowing costs for individuals and businesses, and the competition fostered by an open trading system has helped make the U.S. economy among the most productive in the world.

Although the recent U.S. economic sneeze has helped the world catch cold, both the United States and other economies should be moving toward faster growth by late 2001. Maintaining and expanding ties with foreign economies through international trade and investment will help the global economy return to better health.

This article was written by Michael Chriszt, a senior international analyst and the director of the Atlanta Fed’s Latin America Research Group.

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