Global Economic Prospects:

A Global Growth Rebound -- How Strong for How Long?

Michael Mussa

After a disappointing first half of 2003, the world economy is poised to rebound in the second half and continue with above-potential growth during 2004.  The United States and emerging economies of Asia will lead the global rebound.  Respectable growth rates will continue in Canada, Australia and in Central and Eastern Europe.  Growth in Latin America should pick up as Argentina continues to bounce back from its 2001-2002 catastrophe, Brazil begins to recover from its recent recession, Mexico benefits from strengthening growth in the U.S. and Venezuela halts its headlong decline toward economic oblivion.  As the world economy recovers, Japan will also be pulled along in the upswing

In contrast, near-term growth prospects for Western Europe remain somewhat of a mystery: the hard data points to continued stagnation, reinforced by the effects of an extremely hot summer.  Several key sentiment indicators (including rising equity markets), however, point to a significant strengthening of growth before the year’s end.  Despite a remarkably stubborn European Central Bank (ECB), I am with the optimists and expect that real GDP growth will strengthen to 2 percent during 2004.

For the world economy (on a WEO-weighted basis), global economic growth should rise from barely a 2 percent annual rate during the first half of 2003 to about a 4 percent annual rate during the second half and continue at that pace during 2004.

Indeed, a strengthening of growth is already apparent in the U.S. economy, where second quarter performance surprised on the upside and where the third quarter real GDP now appears likely to record better than a 4 percent annual rate of advance. With respect to the necessary correction of the U.S. current account deficit, acceleration of growth in the rest of the world and the depreciation of the U.S. dollar since 2001 should help to bring an end to further increases in the U.S. imbalance.  However, the factors necessary to bring about a substantial reduction in the U.S. current account deficit—especially the factors necessary to accomplish this in a manner consistent with growth—are not yet in place.

Asia’s emerging economies will also show a sharp strengthening of growth as several countries snap back from SARS-related slowdowns and other temporary problems that retarded economic activity last winter and spring. On the WEO weighting basis, China is the largest economy in Asia and the second largest economy in the world.  For the first quarter of 2003, China reported real GDP growth of 9.9 percent versus the same quarter a year earlier.  For the second quarter, reported real GDP growth dropped to 6.7 percent versus a year earlier.  This suggests that quarter on quarter real GDP was virtually flat, or even declined lightly, in the second quarter. 

Because the economic effects of SARS in China were concentrated in the major commercial centers, especially Beijing, a modest negative impact for China as a whole is moderate in comparison with the sharp second-quarter declines of real GDP in Singapore and Hong Kong, where the effects of SARS were more heavily concentrated.  For these economies, like China, there is increasing evidence of rapid rebounds of activity now that the SARS crisis has past.  This suggests that the net effect of SARS on real GDP growth for 2003 will be moderately negative, with Singapore and Hong Kong showing larger net effects, while the effects for China, Malaysia, Taiwan, and Thailand are more moderate.  

For all of these economies, 2004 looks to be a better year for Asia—provided that SARS does not return this coming winter.

As always, it should be noted that there are risks to this forecast—both on the upside and on the downside.  On the upside, the key risk is that once an expansion begins to gain forward momentum in different regions of the world, the expansion tends to be mutually reinforcing to an extent that often exceeds expectations.  [This is the reverse of what happened during the global economic slowdown of the past two and one-half years, when the general and mutually reinforcing factors tending to depress global economic growth were significantly and consistently underestimated.] 

On the downside, two potentially important global risks should be noted.  First, global equity markets and business and consumer sentiment have recovered substantially from their lows of mid March.  These are important positive factors tending to induce—as well as forecast—stronger global economic growth.  But these important improvements in sentiment are at risk if they are not soon validated by actual improvement in economic performance.  Second, world oil prices remain at high levels (just above $30 per barrel) and the situation in world energy markets remains tight.  Futures markets predict that world oil prices will decline over coming quarters as world supply constraints ease, and, if this happens, it will provide a further boost to global growth.  However, a disturbance that produces a further upward spike in global energy prices would undermine global economic growth.

Beyond the next few quarters, two further questions cloud the medium-term outlook:  (1) Will the inherent strength of the cyclical recovery in private demand be sufficient to compensate for the erosion of the near-term stimulus presently provided by expansionary macroeconomic policies in the United States and Asia?  Will the U.S. economy and the global economy successfully adjust to the challenge of a declining U.S. current account deficit and to the necessity of a further substantial depreciation of the U.S. dollar against the currencies of all of its major trading partners? 

The answers to these questions, which will be critical to global economic performance beyond 2004, are not yet clear.  A resurgence of private investment demand does appear to be beginning in the United States, and there are more tentative signs of a pick up in business investment in Japan and Europe.  With the waning effects of tax cuts and mortgage re-financing, continued strong growth of private consumption in the U.S. is contingent on an upturn in employment growth—which should materialize if output growth remains near 4 percent.  At this stage, the basis for a resurgence of private consumption in Europe and Japan seems less secure—although stronger economic growth (and its likely positive effects on consumer confidence) should help.  For emerging market economies, both business and consumer spending should pick up with the upturn in global growth, although prospects for some countries are still limited by the relatively low level (and high cost) of foreign financing.

Michael Mussa is a Senior Fellow at the Institute for International Economics (http://www.iie.com)  This essay is based on a presentation given at the Institute on September 9, 2003.  A fuller version can be accessed at http://www.iie.com/publications/papers/mussa0903.pdf.