EconSouth (Fourth Quarter 2002)


INTERNATIONAL FOCUS


The 2003 Global Outlook: Recovery to Continue

Modest growth should continue in the world’s major economies in 2003, but weak performances are anticipated in a few South American economies and in Japan. While downside risks to the outlook remain plentiful, current trends — especially low inflation — seem ready to support global economic expansion.

International Focus

The global economic recovery that began in 2002 looks set to continue in 2003. Unfortunately, forecasters do not expect the rebound to be very impressive, and many downside risks to the outlook remain. Looking back at 2002, the recovery trend has been generally disappointing. After slowing in late 2001, most of the world’s economies recovered in early 2002 at a pace that impressed many economists. The better-than-expected turnaround lost some steam midyear, however, and most major economies experienced slower growth in the second half of the year.

As a result of the moderation in global economic growth in late 2002, forecasts for 2003 were revised downward. In September 2002, the International Monetary Fund (IMF) projected a 3.7 percent expansion in global real gross domestic product (GDP) in 2003, down slightly from its April 2002 forecast of 4 percent. Such a result would be near the average global growth rate in the late 1990s and up from 2001 and 2002 growth estimates of 2.2 and 2.8 percent, respectively (see chart 1).

Forecasters expect the economies of the developed world to post economic growth of 2.5 percent in 2003, up from the 2002 estimate of a 1.7 percent expansion and much better than the 0.8 percent result posted in 2001. Developing economies should grow 5.2 percent in 2003, up from 2002’s estimated 4.2 percent growth rate and better than the 2001 result of 3.9 percent.

Within the two broad groupings of developed and developing economies, there are significant differences. Among developed countries, for example, Canada’s 2003 real GDP forecast is 3.4 percent while the outlook for German economic growth is 2 percent and Japan’s forecast stands at just over 1 percent.

For developing economies, the differences are even more striking. Asia’s emerging economies are expected to grow an average of 6.3 percent in 2003; Latin America’s developing economies are seen expanding by 3 percent, according to the IMF. Importantly, many private forecasters expect growth to be much lower than the IMF’s forecast. Even within Latin America, expected growth rates diverge quite a bit among individual economies. But before investigating specific regional outlooks, a look back at the world economy over the course of 2002 can help provide perspective.

CHART 1
Global Economic Growth
Chart 1
Sources: International Monetary Fund, World Economic Outlook, September 2002

The first half of 2002: Recovery
The rapid shift from negative to positive economic growth — or from recession to expansion — in the global economy during the first quarter of 2002 took most economists and policymakers by surprise. One of the main reasons for the reversal was the resilience of consumer demand and a widespread turnaround in manufacturing activity.

Consumers from the developed economies, especially those in the United States, were much more active than anticipated — especially in light of the global recession of the second half of 2001 and the terrorist attacks on Sept. 11 of that year. In many economies the housing and real estate markets proved to be quite resilient as well, adding to positive momentum heading into 2002. Furthermore, a global rebound in manufacturing took hold in late 2001 and continued in early 2002.

Another important component to the 2002 recovery was low inflation. The fact that inflation in 2001 in nearly all major economies remained very low meant that central bankers were able to ease monetary conditions as economic growth slowed. For example, the average global short-term interest rate for the major developed economies in December 2000 was over 4 percent. That average rate fell to near 2 percent by the end of 2001. The positive impact low interest rates had on consumption was significant.

The second half of 2002: Stall
The positive start to 2002 was not sustained, however. By midyear, even though consumers continued to spend and robust housing markets remained a source of strength in many economies, businesses around the world clearly were not enthusiastic about their prospects. Firms remained cautious about investment and spending on new equipment. In addition, few businesses added to payrolls although new job losses in the major economies were curtailed overall. Competitive forces worked to prevent businesses from adding to profits through higher prices, and poor equity market performances around the world limited firms’ abilities to generate cash for investment. In addition, questions about corporate governance in the United States and rising interest rates on corporate debt in several economies limited business investment globally. As a result, overall economic growth did not improve much from the first quarter. In fact, recent economic data point to a deceleration in economic activity in 2002’s fourth quarter.

The 2003 outlook
Looking ahead to 2003, forecasters believe that businesses around the world will remain cautious, and the positive contributions of strong consumer spending and real estate will likely moderate somewhat in the major economies. Notably, however, corporate profits are beginning to turn around, and businesses have responded by ending reductions in investment. The outlook, therefore, moving into 2003 is for overall global economic growth to remain positive based on a slow but steady rebound in business spending and investment, which should lead to job creation. Consumption and real estate will continue to make positive contributions — although somewhat off the torrid pace of recent years.

Underpinning the entire outlook are forecasters’ expectations for continued low inflation, which should allow the world’s central banks to maintain low interest rates. As with any forecast, there are risks, and in 2003 most of those risks are concentrated on the downside.

Risks to the forecast
Developments that may lead to weaker economic output in 2003 include the possibility of armed conflict in Iraq, instability in the Mideast and South Asia, and the financial situations of Japan, Brazil and Argentina.

The economic cost of a possible war in Iraq notwithstanding, the short-term impact is likely to be negative because of the uncertainty such situations generate, not just in the United States but throughout the world. The likely impact that a war would have on oil prices is clearly negative in the short-term, if only because of concerns about supplies. The ongoing conflict in the Mideast, should it spread beyond its current borders, is also negative in this respect. In addition, although India and Pakistan are not oil exporters, the potential for a conflict between two nuclear states has clear downsides for the global economy. North Korea’s admission that it has a nuclear weapons program could also have negative implications for the economic outlook should a crisis develop there.

Japan’s ongoing struggle to right its financial system has taken on new life. Efforts are under way there to address the problem of nonperforming loans and bring the banking system back to health. If successful, these efforts hold long-term positive advantages for the Japanese economy in particular and for the global economy in general. The downside risk is that there will likely be some short-term pain that must be endured. Cleaning up Japan’s financial system could result in an increase in corporate bankruptcies and additional unemployment.

Brazil also faces a severe test in 2003. The country’s new president, Luiz Inacio “Lula” da Silva, must address a deteriorating debt situation, which, if unresolved, poses a serious threat to that country’s already poor economic outlook. Because Brazil is among the world’s largest emerging markets, a negative credit event there would likely be felt by other developing economies that depend on foreign investment as part of their growth strategy. Investors may choose to shy further away from emerging markets if Brazil’s situation degenerates into a crisis.

Regional developments
As noted earlier, economic performance was not uniform in 2002. Some areas enjoyed significant recoveries, like many economies in Asia, while other regions barely rebounded at all or remained in recession, as was the case in several South American countries.

NAFTA countries. The economic performances and outlooks of the United States’ partners in the North American Free Trade Agreement (NAFTA) depend largely on conditions in the United States. Nearly one-quarter of Mexico’s overall GDP and one-third of Canada’s overall GDP are related to exports to the U.S. market. In 2002, Mexico’s economy remained in recession until the second quarter while the Canadian economy rebounded strongly early in the year. Since then, Mexico’s economic performance has improved while Canada’s has moderated a bit. Forecasters expect both economies to grow in 2003 — Mexico at 4 percent and Canada at 3.4 percent.

South America. South America’s economies did not perform well in 2002. They suffered from the effects of the 2001 global economic recession, weak investment inflows, political instability in several areas and general uncertainty with regard to future economic policy in a number of countries. Overall, South America remained in recession in 2002. Positive, but modest, growth is expected by analysts in 2003. Much depends on Brazil, as noted earlier. But conditions in Argentina, which saw its economy contract an estimated 16 percent in real terms in 2002, and Venezuela, whose economy shrank an estimated 6.2 percent in 2002, will have to improve as well if the region is to regain its footing in 2003 (see chart 2).

Poor economic performance in South America has been matched by a resurgence in political criticism of the open-market approach to economic policy undertaken in many countries there. Some analysts see this development as an indication that the region is sliding back toward more antimarket economic policies that have in the past resulted in devastating economic consequences. This interpretation is not necessarily accurate, however.

The latest Latinobarometro survey suggests that Latin Americans continue to support both democracy and free markets despite high levels of dissatisfaction with both sets of institutions. While most citizens expressed a desire for change within their governments, the difference between today and decades past is that there is now more of an expectation that such change should take place through democratic institutions.

CHART 2
Latin American Economic Growth
Chart 2
Sources: International Monetary Fund, World Economic Outlook, September 2002

Significantly, a majority (57 percent) of those polled believed that the market economy is most suitable to their country despite the fact that only 24 percent stated that they were satisfied with the market economy system. In South America, only 17 percent of those surveyed expressed satisfaction, but 53 percent believed that a market economy was most suitable.

The low levels of satisfaction with market economies help to explain the popularity of candidates who openly question the market-oriented reforms of the 1990s. Since there are no popular movements to turn back the clock on the reform process, it may be that the frustrated populations of South America are demanding more efficient macroeconomic management and governments that can better deliver on reforms rather than dismantling the reform process. Indeed, half of those polled blamed government economic policies for their country’s economic problems (compared to only 16 percent who blamed globalization and 14 percent who blamed the IMF).

In the end, whether termed “reform fatigue” or frustration, the issue comes down to the need for better governance and deeper societal reforms that will allow the positive aspects of economic reform already undertaken to reach more people in South America.

Europe. The economic performance of the 12 countries participating in the European Monetary Union (the Euro Area) was disappointing in 2002. The IMF estimates that economic growth in the Euro Area was 0.9 percent for the year. The output performance of Germany was particularly weak, managing only an estimated 0.5 percent growth in 2002. Weak domestic demand was the main reason for slow Euro Area growth. In addition, the fiscal and monetary policy responses were more modest in Europe than elsewhere. In 2003, these drags on demand will probably fade, and the IMF has forecast economic growth to be 2.3 percent for the year in the Euro Area.

Elsewhere in Europe, the United Kingdom enjoyed a comparatively positive 2002 and should see its economic performance improve further in 2003. The IMF estimates that the U.K. economy grew 1.7 percent in 2002 and expects that economy to grow 2.4 percent in 2003. Forecasters expect the developing economies of East and Central Europe to improve from their estimated 2.7 percent rate of growth in 2002 to 3.8 percent in 2003; the fact that many of these countries may soon join the European Union could lead to increased investment flows into the region, resulting in stronger rates of economic growth.

Asia. Japan’s financial sector problems were noted earlier, and the negative effect of the ongoing crisis continues to take its toll on the country’s overall economic performance. The Japanese economy contracted an estimated 0.5 percent in 2002 and was forecast by the IMF to improve modestly to a positive 1.1 percent rate of growth in 2003. Weak economic data from late in the third and early in the fourth quarters of 2002, coupled with the negative short-term implications of a major financial reform effort, may lead to downward forecast revisions for 2003, however.

The developing economies of Asia remain a bright spot in the global outlook. After expanding an estimated 6.1 percent in 2002, developing Asia is expected by the IMF to post a slightly stronger growth rate in 2003 of 6.3 percent. Importantly, however, slower-than-expected economic growth in the United States — a major destination for exports from the region — would likely lead to a downward revision in these growth forecasts.

Inflation outlook
Consumer prices in the developed economies rose an estimated 1.4 percent in 2002 and are expected by analysts to remain low in 2003 as well; the September 2002 IMF forecast calls for an average annual increase of just 1.7 percent. Consumer prices will rise if oil prices increase significantly, a potential downside risk to the global economic outlook. The modest inflation outlook will support the forecast for improved economic growth in 2003.

Modest growth on the horizon
The global economic recovery that began in 2002 looks set to continue in 2003 at a modest pace. Forecasters expect growth in all major economies, but weak performances are anticipated in a few South American economies and in Japan. Downside risks to the outlook are abundant, but current trends, especially that of low inflation, appear set to support global economic expansion in 2003.

This article was researched and written by Mike Chriszt of the Atlanta Fed’s Latin America Research Group.

Southeast Should See Slow Improvement in International Trade

International trade’s performance in 2003 depends largely on the overall international economic growth outlook. A more positive result for global economic growth, especially for growth in the United States, is expected by forecasters to lead to an improvement in international trade flows in 2003. In overall volume, global trade in goods and services increased an estimated 2.1 percent in 2002 after falling 0.1 percent in 2001. In 2003, global trade volume should increase 6.1 percent, according to the International Monetary Fund.

Imports lead exports
Although both import and export growth improved in 2002 in the United States, imports rose faster than exports, leading to a deteriorating trade balance. The trade deficit was running close to $500 billion by the third quarter of 2002, and the current account deficit was just over 5 percent of GDP. How the imbalance is addressed in 2003 will be a component of the overall trade outlook.

Southeastern exports mixed
The trade performance of the Southeastern states mirrored the U.S. performance in 2002 in some respects but differed in others. For example, the region’s trade activity improved from 2001, like the country’s as a whole. But according to recent data, import growth in 2002 was flat while exports weakened sharply.

Exports to the region’s leading markets — Canada, Mexico, Japan, Brazil and the United Kingdom — weakened in 2002. Exports to Mexico were soft until later in the year; several ports noted that shipments to Mexico posted a turnaround in 2002’s second half. The most dramatic declines in regional exports occurred in shipments to Brazil, Argentina and Venezuela, reflecting poor economic performance in those countries. Exports to Japan, the Southeast’s third-largest market, have been declining for the last few years — again reflecting continued disappointing economic performance in that country. On a more positive note, recoveries were observed in regional exports to the United Kingdom, Germany and China, markets that in recent years have ranked as the Southeast’s fastest-growing markets.

Outlook for 2003
Looking ahead to 2003, Southeastern trade is likely to improve modestly along with the forecast improvement in the global economy. Since a significant portion of regional trade is with South America’s struggling economies, however, overall export improvement may not be as strong as in the nation as a whole.

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