EconSouth - Fourth Quarter 2007

Despite Increased Risks, Global Growth to Remain Solid in 2008

The developing world continues to set the pace for worldwide economic growth, a trend that should continue in 2008. While mature economies should also grow, significant risks persist.

Chart 1
Global GDP Growth Forecast
Chart Global GDP Growth Forecast
Note: Developing Asia excludes China and India.
Source: International Monetary Fund and the Economist Intelligence Unit

The global economic expansion that marked 2006 and 2007 is likely to slow in 2008, in part reflecting weaker growth in the United States. Still, according to most forecasters, the world economy will continue to enjoy one of the better performances in recent decades. Not only has the current global expansion been the strongest since the early 1970s, but recent economic gains have been distributed broadly, with most regions and countries doing well by historical standards.

In 2008, developing countries, especially those in Asia, should continue to lead worldwide growth while most developed countries outside the United States are likely to expand at a solid but slower rate (see chart 1).

China alone should account for one-fifth of global growth in 2008, almost as much as all Western European countries combined. The rest of developing Asia—which the International Monetary Fund defines as all Asian countries except Australia, Japan, and New Zealand—should contribute an additional 15 percent to world gross domestic product (GDP) growth, which is expected to equal the U.S. contribution to global growth in 2008 (see chart 2).

Strong exports boost developing economies
Exports continue to be the dominant force driving Asian economies, supported by strong intraregional trade and large shipments of goods to developed countries. Importantly, many Asian countries' own consumption and business investments are increasingly contributing to their economic growth. In China and India, still the region's growth leaders, investment and the ensuing productivity gains continue to be the biggest drivers of economic expansion.

Related Links
On the Web:
International Monetary Fund Survey magazine
World Bank
Data on international residential property markets

Overall, Asia's growth is likely to moderate only slightly in 2008 in response to monetary policy tightening among governments there, less robust export growth, and slightly slower growth in China, which accounts for 40 percent of Asia's GDP. Recently, the Chinese government has tried to slow the country's economy to prevent it from overheating. Assuming the government's efforts are successful, growth in China is likely to decelerate in 2008 but is still expected to remain at almost 10 percent.

Among other developing economies, Brazil and Russia are becoming increasingly important global players. They represent the second- and third-largest economies in the developing world, behind China and slightly ahead of India. Both Russia and Brazil are large commodity exporters. In Russia, oil and gas account for more than two-thirds of exports and almost a quarter of the country's economy, so high energy prices should continue to support its economic growth in 2008. Brazil's key exports include soybeans and metal products, both of which have seen a sharp price increase and are likely to remain a major source of the country's income next year.

Many other Latin American countries are also major exporters of raw materials and will continue to reap benefits from the global commodity boom. For example, Chile is the world's leading copper exporter, Venezuela and Ecuador are large petroleum producers, and one-third of Argentina's exports are agricultural products.

Photo depicting global growth
Developing economies should grow fastest in 2008, forecasters say, as growth may moderate in developed countries. India's investment-fueled economy will be among the biggest gainers in the coming year.

Growth moderates for developed economies
In Western Europe, growth may slow next year, but the economy still is likely to expand close to its estimated potential rate of 2 percent. Several years of economic reforms, such as labor market reforms, will continue to foster growth in the 13 countries of the euro area.

Germany, the world's largest goods exporter in dollar terms, has been enjoying strong growth for the past few years and is on track to continue that performance in the near future. Germany's economy is heavily export oriented, and strong demand from developing countries for its machinery and equipment will continue to boost its economy.

Japan's economy has grown robustly for the past four years and should expand at a solid rate in 2008. But the pace of growth is likely to decelerate in 2008 as business investment, which has been booming for the past several years, moderates.

Risks to growth loom in 2008
Financial markets. Financial market turmoil, which hit the world economy with full force in August 2007, poses perhaps the most significant risk to global growth in 2008. The turmoil originated in the U.S. subprime mortgage market and quickly spread worldwide, demonstrating just how interconnected financial markets have become.

European financial institutions and investors hold a significant portion of U.S. subprime mortgages, so Europe also felt the United States' financial stress. Although Japan and China are the two top holders of U.S. financial securities, their exposure to subprime mortgages is comparatively small.

Inflation. Rising prices also threaten global expansion in 2008. After several years of strong economic growth, productive resources have become stretched in many countries. Unemployment rates have fallen to record lows, and capacity utilization has risen high, putting pressure on prices. These price pressures have raised concerns about inflation.

Worldwide, food prices also have risen considerably. An extremely hot, dry summer caused grain crops to suffer in Europe, the United States, and Australia. As a result, the price of a bushel of wheat has more than doubled in the past year. Meat, milk, and dairy prices have surged as well, in part because of the increased cost of feed and higher demand from Asia. Also, expansion of biofuel production, which diverts products from food production, has boosted prices of feedstocks such as corn, soybeans, and oils used in food.

Developing countries will feel the pinch of rising food prices most acutely because food accounts for 35 to 40 percent of their consumer expenditures. Food represents more than 60 percent of expenditures in sub-Saharan Africa and 30 percent in China, but only 10 percent in the United States.

Developing countries will feel the pinch of rising food prices most acutely because food accounts for 35 to 40 percent of their consumer expenditures. Food represents more than 60 percent of expenditures in sub-Saharan Africa and 30 percent in China, but only 10 percent in the United States, according to the International Monetary Fund (IMF).

Meanwhile, petroleum prices will continue to be elevated, boosted by lagging supply growth and ever-growing demand from China, India, and the United States.

On a positive note, central banks in many developing economies have recently tightened their monetary policy to keep inflation under control. In addition, expected slowing in major developed economies should dampen inflationary pressures in the industrialized world. Consumer prices in 2008 should grow 2 percent in the developed economies and a little more than 5 percent in developing countries, according to the IMF.

Chart 2
Contribution to World GDP Growth in 2008
Chart of Contribution to World GDP Growth in 2008
Source: Economist Intelligence Unit

Housing prices. The past decade has seen a housing boom across much of the developed and developing world, but this so-called global housing bubble also poses risks to global growth. In past years, Australia, Ireland, France, Spain, and the United Kingdom have witnessed even larger increases in house prices than the United States has seen. While prices in the United States rose 124 percent between 1997 and 2006, house prices grew 194 percent in the United Kingdom, 180 percent in Spain, and a whopping 253 percent in Ireland in the same period.

Several factors should mitigate severe housing corrections in many countries. Although strong immigration and planning restrictions (including lot size, land availability, and development limitations) in several countries have contributed to much of the growth in house prices, these same factors should forestall dramatic corrections. In addition, most countries have generally avoided U.S.-style subprime mortgage originations and have maintained mortgage lending standards that should help make any housing corrections less painful. Even more importantly, in Japan and Germany, the world's second- and third-largest economies, housing prices have declined over the past several years.

Despite potential potholes, worldwide prospects positive
Deteriorating financial markets, rising inflation, a potential housing correction in major developed economies, and possibly weaker U.S. demand for foreign goods represent risks to the world's growth in the coming year. Despite these problems, the global economic outlook for 2008 is positive. Overall, sustained economic expansion abroad will continue to provide support for U.S. export growth.

This article was written by Galina Alexeenko of the regional section of the Atlanta Fed's research department. The international estimates and forecasts represent a consensus of private-sector or multilateral outlooks and are not those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.