The September 2006 World Economic Outlook (WEO) projects strong global growth of 5.1 percent in 2006, slowing slightly to 4.9 percent in 2007, both numbers up from the WEO’s spring forecast. Growth is becoming more balanced, Raghuram Rajan, Director of the IMF’s Research Department, said when presenting the WEO projections at a press conference on September 14 during the Annual Meetings in Singapore. The U.S. economy is beginning to slow; emerging markets and developing markets, led by China at 10.0 percent and India at 8.3 percent, are delivering impressive growth rates; the euro area has gained momentum; and Japan’s expansion continues. However, after four years of strong growth, risks to the outlook are clearly tilted to the downside.
Rajan, who has announced that he will return to the University of Chicago in early 2007, took the opportunity of his final WEO press conference to talk about the main medium-term risk to growth: not enough is being done to support the worldwide growth in productivity (see chart). The information technology revolution and increased global competition fostered productivity growth in the past, but now political support is fading in the face of popular discontents, strengthened by rising inequality.
“The collapse of the Doha Round, the rising tide of economic nationalism coming in the way of cross-border mergers, and the strengthening of resistance to immigration,” Rajan said, all point in the same direction. “In the name of national advantage—an attitude of me, my, mine,” Rajan cautioned, “politicians are once again ensuring collective disadvantage. The strong world economy we enjoy today is because policies to enhance competition, economic sustainability, and flexibility were implemented in the past. For the good times to continue, today’s leaders should refocus from spending the dividend to reinvesting for the future.”
Asked by a reporter whether a sense of growing income inequality in the United States might also be fueling discontent, Rajan observed that people look at relative incomes rather than absolute, and many feel they are being left behind. U.S. protectionism is due partly to a growing uncertainty in large segments of the workforce about whether they will remain prosperous even though the economy has been growing fairly strongly over the past few years. This has become an important issue in the political arena, and Rajan considered it a useful debate.
Rajan also warned of short-term risks—which are to some degree related—to projected growth of the global economy:
• a sharper-than-projected slowdown in the United States, driven by a cooling of the housing sector, coupled with uncertainty about the extent to which growth in the rest of the world relies on U.S. growth;
• a further increase in global inflationary pressures, stemming from tightening labor and commodities markets, which could induce central banks to tighten more than now envisaged, disrupting currently benign conditions in financial markets; and
• an abrupt unwinding of global imbalances.
Buoyant emerging markets
Overall growth in emerging markets has remained very strong, with good short-term prospects.
Emerging Asia was once again the world’s most dynamic region in the first half of 2006, driven by buoyant China and India (see table). China’s economy continues to rely heavily on fixed asset investment, however, and excess liquidity is exacerbating the problem. China is fast becoming a market economy, and the IMF, Rajan said, has counseled for some time that the best means of managing a market economy is to rely more on market incentives by moving all prices, including the exchange rate and interest rates, progressively to market levels. This may cause short-term pain, he said, but it is ultimately the only way to go, and it is best to take such steps when growth is strong.
The productivity factor
In recent years, productivity growth has been strong in the United States and Japan, but it has lagged in the euro area.
Note: Estimates are for the nonfarm business sector in the United States and for the whole economy in the euro area and Japan.
Data: Haver Analytics; Organization for Economic Cooperation and Development; IMF, World Economic Outlook and staff calculations.
Global economic growth has become more balanced, but developing Asia continues to dazzle.
|(annual percent change)|
|Other advanced economies||3.7||4.1||3.7|
|Central and Eastern Europe||5.4||5.3||5.0|
|Commonwealth of Independent States||6.5||6.8||6.5|
In India, expansion is led more by domestic demand. The authorities should be commended for seeking to spread the benefits of growth, but that job is better done by expanding opportunity through improvements in education, health care, finance, and infrastructure than by offering often-misdirected subsidies, guarantees, and tax sops that a stretched budget can ill afford.
Growth in emerging Europe is still robust. In many countries, growth is fueled by external private sector borrowing and rapid growth of bank credit; many of these countries have wide current account deficits and must take care to limit vulnerabilities to a possible deterioration in global financing conditions.
In Latin America, growth picked up in 2006 but is still modest compared with that in other developing country regions. Macroeconomic management has taken commendable advantage of a supportive global environment to reduce vulnerabilities, but spending pressures must be resisted to ensure resilience if the environment deteriorates.
For oil producers in the Middle East, Africa, and the Commonwealth of Independent States, the challenge is to manage the current high level of export earnings carefully, spending to boost oil-related capacity while improving the economy’s ability to diversify into new areas. Metals producers, including those in sub-Saharan Africa, must be careful about committing to hard-to-reverse long-term public expenditures since prices are unlikely to persist at current levels.
While in the advanced economies …
Overall, the WEO projects 3.4 percent growth for the United States in 2006 and 2.9 percent next year. The housing market is clearly cooling, with house price appreciation close to zero. Rising inventories of unsold houses suggest things will get worse before they get better.
But the slowdown in housing has not yet translated into significantly lower consumption, and robust labor income growth and lower gasoline prices are likely to buffer the effect on consumption. But the usual lags—from interest rates to housing activity and from housing activity to consumption—complicate the interpretation of the picture. The U.S. Federal Reserve has a tough task in deciding whether further interest rate hikes are needed to cool down activity. “The Fed may soon be on the horns of a dilemma,” Rajan commented, “and monetary policy will need to be skillfully managed if the economy is not to be gored.”
In the euro area, the WEO projects growth of 2.4 percent in 2006, slowing modestly to 2 percent in 2007. Investment is now the main driver of the recovery, but consumption will have to pick up, especially if the U.S. economy slows sharply. Over the medium term, Europe needs to improve its growth potential through greater labor market flexibility and increased competition in the services sector, including in finance. Europe’s leaders have to find the will to take on vested interests in both the labor market and the corporate sector simultaneously. “This necessary but difficult domestic battle is constantly postponed till after the next election,” Rajan noted, “but the next election will never come.”
In Japan, the economy looks likely to grow at 2.7 percent this year, despite mixed incoming data, and to moderate to 2 percent next year. Consumption is still lagging, but investment by small firms is picking up. Consumer price inflation has recently turned positive, ending an extended period of deflation, and a modest further increase in inflation is projected.
Japan is facing rapid population aging, and the rest of the world is counting on it to set an example others can follow. Its strategy must include fiscal rectitude, greater workforce participation by women and the elderly, some immigration, and, above all, greater productivity growth. Improving service sector productivity, which has been decreasing—by opening services to foreign and domestic competition—will be essential.
IMF External Relations Department
Copies of the World Economic Outlook, September 2006, are available for $57.00 ($54.00 academic rate) each from IMF Publication Services. See page 292 for ordering details. The full text is also available on the IMF’s website (www.imf.org).