Download Brief update of the Global Economic Outlook

EMBARGOED until 10 October 2001, 5PM (US Eastern Standard Time)
11 October 2001
GLOBAL ECONOMIC SLOWDOWN AGGRAVATED BY ATTACKS ON THE
UNITED STATES1
Developing countries increasingly affected
Introduction
The world economy is currently growing at its slowest pace in a decade. A
number of economies are contracting, while several others are on the verge of doing so.
The economic shock resulting from the attacks in the United States on 11 September
exacerbated this already gloomy outlook and is expected to continue to reverberate
through the world economy and global financial markets in the coming months. The
military, political and other reactions to the attacks further amplify the pre-existing
uncertainties for the short-term global economic outlook, and are also likely to have
implications for the global economy over the longer term.
The latest developments in the world economy require the forecasts of economic
growth in 2001 and 2002 contained in the World Economic and Social Survey 20012 to be
revised downward substantially. The earlier hope that some 12 months of deceleration
would be followed by a recovery of the world economy in the second half of 2001 has
1
A brief update of the Global Economic Outlood prepared by staff of United Nations/Department of
Economic and Social Affairs/Development Policy Analysis Division/Economic Assessment and Outlook
Branch. A more comprehensive update of the global economic outlook will be found in World Economic
Situation and Prospects, 2002, forthcoming in January 2002.
2
United Nations publication, Sales No. E.01.II.A..4
1
waned; instead, the expectation now is for a dilatory and tepid recovery in mid-2002. The
growth of world gross product (GWP) is expected to be only 1.4 per cent for 2001, with
only a partial recovery to 2 per cent in 2002 (see table 1). Meanwhile, the volume of
international trade is expected to register virtually no growth in 2001, but to increase by
4-5 per cent in 2002.
---------------------------------insert table 1 here
---------------------------------
Manifesting some of the downside risks identified in the Survey, the world
economy had been deteriorating in a synchronized manner even before the attacks of 11
September. The weakness that originated in only a few major developed economies,
notably the United States, had spread to more and more countries; within countries most
heavily involved in the information and communication technology (ICT) sector, that
sector’s contraction had deepened and spread to other industrial sectors and, most
recently, to the household sector.
As forewarned in the Survey, a vicious circle of downward adjustment had been
intensifying across different economic sectors, most pronouncedly in the United States
but also in many other economies. Lower corporate profits in the ICT sector, due partially
to excessive investment in previous years, had led to cuts in capital spending, the
shedding of labour and a weakening of equity prices. In turn, an increasing number of
companies in other sectors had been reducing spending and lowering projections of future
2
earnings, begetting further declines in equity markets. Manufacturing output in many
developed economies and in several developing economies was lower than one year
previously, as reflected in indices of industrial production. In many economies, the last
possibility for offsetting the decline in capital expenditure was household consumption,
but this began to slow when unemployment and lower equity prices led to an erosion in
consumer confidence. This, in turn, fed back negatively to the corporate sector and
equity markets.
The slowdown in the developed countries increasingly affected developing
countries as 2001 progressed. The size of the negative shock depended on the share of a
country’s trade with the United States, the extent of its involvement in the ICT sector and
the degree of its integration into globalized production processes especially those
centered on the United States. East Asian countries were therefore particularly adversely
affected, with a number of them experiencing a fall in GDP for at least one of the first
two quarters of 2001. Countries in Latin America, particularly those with strong trading
ties to the United States, were also among those most negatively impacted.
New uncertainties and new challenges
Against the backdrop of this weakening global economic situation, the attacks of
11 September inflicted a sizeable adverse “shock” on the world economy and may cause
significant changes in a number of key determinants of the global economic outlook.
Since the nature, size and duration of the responses and their repercussions are unknown,
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it is impossible to assess the full economic implications of the attacks for the prospects of
the global economy, but an assessment of the consequences can be derived by examining
a number of dimensions of the issue.
The most direct economic impact of the incident is the destruction of human and
physical capital, including the losses of intellectual capital and infrastructure. The cost of
lives cannot be measured in money terms, but the cost of the physical destruction in the
United States is estimated to be around $40 billion. If the current military campaign
escalates, destruction will likely increase and more economies will be involved. Such
destruction reduces the supply capacity of the economies concerned, but the direct effect
on the global economy of the physical destruction will be limited.
A second consequence of the events is the disruption of economic activities. The
attacks here already directly disrupted many economic sectors, mostly in the United
States, but also to a lesser degree in many other economies. So far, airlines, insurance
companies, travel agents and financial traders have been those most affected, but the
damage is spilling over to more and more sectors, such as manufacturing, retailing and
technology. Business profits had already been in decline for a year and will now be even
lower: hundreds of companies in the United States have lowered their estimates of
earnings by a further 10 per cent points for both the third and fourth quarters of 2001
because of the consequences of the attack. As a result, larger reductions in capital
spending and layoffs of labour are occurring, leading the economy of the United States
into a downward spiral. The magnitude of the impact from this disruption is greater than
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that from the destruction itself. How soon business activities return to “normal” will
depend on the return of business and consumer confidence, which itself will depend in
part on developments in the new campaign against terrorism.
The downward shift in the confidence of consumers and businesses is the third
aspect of the impact. As mentioned above, even before the attacks, business sentiment in
many economies had long been depressed and consumer confidence was also weakening.
Surveys after the attacks, though available only in the United States and a few other
countries, indicate that the incident has directly caused a significant deterioration in
confidence. The large declines in almost all equity markets in the aftermath of the
incident have indirectly confirmed a broad and sharp decrease in confidence worldwide.
This shift in confidence was caused not only by the one-time psychological shock of the
attacks, but also by a sudden escalation of uncertainties about future actions and
reactions. The direct economic consequence of eroding confidence will be heightened
risk aversion by business investors and a withholding of household spending by
consumers. The nervousness and apprehension of investors and consumers may lead not
only to depressed demand in the short-to medium run, but also to reduced expansion of
supply capacity and lower potential long-term growth. In this sense, the impact on
confidence is more significant than the damage from the destruction and disruption.
Stabilizing and then boosting confidence should therefore be the focus of post-attack
economic policies and should also be taken into account in the military and political
campaign.
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A fourth consequence of the incident has been a noticeable shift in
macroeconomic policies in major economies, with monetary policy becoming more
accommodative and fiscal policy more expansionary. In the week immediately after the
incident, more than a dozen major central banks conducted an unprecedented, concerted
easing of monetary policy, led by a reduction of 50 basis points in interest rates by the
Federal Reserve of the United States (Fed). This was followed by another cut of the same
size some three weeks later. Even before the incident, most central banks had been
easing monetary policy to varying degrees. For example, the Fed had cut interest rates
seven times during the first eight months in 2001 by a total of 300 basis points and
interest rates in Japan had been maintained virtually at zero for a long period. While the
European Central Bank (ECB) had been more conservative in easing, the incident caused
it to immediately reduce its rate by 50 basis points. In order to calm financial markets and
boost confidence by providing an increasing volume of liquidity, further monetary easing
is expected. Implied real short-term interest rates are already near zero in many
economies, but are likely to decline further.
The incident has also already led to more expansionary fiscal policy, most
noticeably in the United States. About $40 billion has been approved for direct
emergency aid and a further $90 billion for discretionary spending and additional tax
reductions. Along with the unfolding military actions, defense spending in the United
States is expected to increase substantially in the coming years. This increased
government spending will boost economic growth, at least in the short run. The $40
billion emergency package alone, for example, if spent in the fourth quarter of 2001,
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could raise GDP by more than one percentage point, even without taking into account the
effect of the increased spending from the private sector that will be induced. If the
economy were running at full capacity and full employment, this additional public
spending could generate inflation and could crowd out some private spending, reducing
the extent of the stimulus on aggregate output. Since the United States economy is on the
verge of, or in, recession, with the lowest rate of capacity utilization for a decade and
rising unemployment, most of the positive “Keynesian multiplier” effects should
materialize.
Fiscal policy in many other economies has also been expansionary, taking the
form of various tax cuts. These have been supportive of household consumption, but less
effective in stimulating business investment spending.
Although both monetary and fiscal policies are becoming more stimulative, there
are some caveats to their present effectiveness. As indicated in the Survey, monetary
policy may be less effective in the current cyclical downturn, partially due to some
special features of the new economic environment; these include the on-going
consolidation in the ICT sector, which may be insensitive to short-run policy changes.
Moreover, when confidence is extremely depressed, monetary easing may not be
sufficient to stimulate increased demand for credit, as has been apparent in Japan in
recent years. The overall effects of expansionary fiscal policy in the longer run are also
questionable, particularly because of the crowding-out effects on private investment and
the consequences for productivity growth, as discussed below.
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Fifthly, in the longer run the military and policy responses to the attacks will have
an impact on the allocation of resources, both within economies directly involved and
worldwide. The increase in military and security expenditure, by both the public and
private sectors, implies a relocation of resources from more productive uses to less, or
non-economically, productive uses. It also implies an increase in the cost of conducting
business worldwide. As a result, the long-run growth rate of the world economy, and for
the United States in particular, will be adversely affected. This can be seen as a reversal
of the gains from the “peace dividend” of the 1990s, when the end of the Cold War led to
reduced military spending in major economies and thus contributed to the rise in the
long-term growth rate, as most apparent in the United States. For the future, increased
uncertainty and risk are also likely to reduce the growth of international trade and capital
flows, particularly if military action escalates and expands, and will thus reduce longerterm growth.
In addition to the consequences of the attacks, other factors addressed in the
Survey will continue to be crucial in determining the path of the global economy over the
short-term. For example, the evolution of the consolidation phase in the global ICT sector
remains important for the recovery of the world economy from the current downturn.
Prior to the attacks, there were some signs that the downturn in the sector was ending, but
it now appears that an upturn will be delayed until at least late 2002.
Changes in the International Economic Environment
8
Along with the downward revision in the forecast for global growth, the outlook
for international trade has become much worse than previously expected. International
trade has been the main channel for transmitting the economic weakness across countries,
although there have also been some international financial repercussions, including
contagion in the deterioration in equity markets. As a result of the reduction in import
demand, a large number of economies in North America, Europe, East Asia and Latin
America experienced a continuous decline in international trade flows for several months
in early 2001. On a year-over-year basis, world trade, measured by the volume of world
merchandise exports, is expected to register zero growth for 2001, with a recovery in
2002 to about 5 per cent. However, World trade in services, particularly tourism and
transportation which have served as important sources of growth in recent years, is likely
to decline because of the attacks.
Private capital flows to developing and transition economies are expected to fall
in the coming year, due to the heightened risk aversion of international investors since the
attacks. Since the 1997 Asian financial crisis, private capital flows had been stagnating at
a level much lower than the pre-crisis peaks, although foreign direct investment (FDI)
had remained relatively stable. Even prior to the attacks, FDI was expected to drop
substantially in 2001; this decline will be exacerbated by the new environment and
accompanied by a decline in other private financial flows. At the same time, the cost of
external financing for developing and transition economies has been pushed higher by the
attacks, as reflected in the rise in the spreads on bond yields for these economies. For
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such countries as Argentina, Brazil, and Turkey, the cost of external financing had
become very high because of their domestic financial predicaments; the further
deterioration will aggravate their problems. For economies that are highly dependent on
private external financing, such as those in Latin America, these developments are likely
to give rise to increased balance-of-payment pressures, requiring them to reduce imports
or seek official financing. The decline in private flows is likely to be offset to some
extent by an increase in official flows, partially in the form of multilateral credit to ease
balance-of-payments difficulties and partially in the form of bilateral flows associated
with the campaign against terrorism.
The outlook for international commodity prices remains close to the prediction in
the Survey, but the attack has complicated the underlying dynamics of supply and
demand. Before the incident, the prices of petroleum had stayed within the OPEC target
range of $22-28 per barrel (pb) for most of 2001, with three cuts in production quotas by
OPEC offsetting the softening global demand. The attack caused prices to rise
immediately to $29 pb, but they declined to the lower $20s in the following week. The
situation has conflicting implications for the prices of oil in the future. In the near term,
lower global growth implies a continued weakening in demand for oil while any
uncertainties about supply could prompt price increases. At present, the near-term
slowdown in demand seems likely to outweigh any upward pressure on prices, but oil
prices are likely to be volatile because the international political and economic
environment has made it more difficult for OPEC to gauge market.
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As previously expected, the prices of most metals and raw materials have been
declining significantly and this trend is likely to continue until global output starts to
recover. In contrast, the prices of a few agricultural products, for example grains, have
continued the recovery from their low levels.
In the foreign exchange markets, the attacks may have triggered a turning point
for the exchange rates between the United States dollar and other major currencies. The
dollar remained strong until the middle of 2001, but then began to decline vis-à-vis the
euro and the yen. Like equity prices in the United States, it dropped substantially after
the attacks, but subsequently partially recovered. Nevertheless, for many international
investors, the attacks may have changed both the image of the United States as a “safehaven” and their underlying optimism about the United States economy; these factors
may cause investors to reduce – or even reverse – foreign capital flows to the United
States (which have been about 4 per cent of GDP annually in recent years). If the dollar
falls precipitously and this is accompanied by an abrupt adjustment in the current account
deficit of the United States, the deflationary impact on the global economy could be
substantial (see World Economic and Social Survey 2001, chap. 1). Elsewhere, the
difficulties created by the slowdown may result in continued downward pressure on the
currencies of a few developing countries.
Regional Highlights
11
The current slowdown is a global phenomenon but countries and regions will be
affected differently.
The worse-than-expected downturn in the United States, exacerbated by the
recent shock, remains the central force behind the global slowdown. Even before the
attacks, many indicators had already pointed to the possibility of a further deceleration in
United States economy in the third quarter of 2001 from the growth of 1.3 per cent and
0.2 per cent in the first two quarters respectively. The impact of the attacks is now
expected to result in an absolute decline in GDP in the third and fourth quarters for the
reasons given above. Growth for the year as a whole is likely to be the lowest for a
decade, with only a mild recovery expected in 2002; a full recovery in some key sectors,
such as ICT, is now not expected until early 2003.
In Japan, GDP is likely to decline by more than 0.5 per cent in 2001. While many
of the weaknesses in Japan are domestic and structural, the downturn in the United States
has exacerbated the cyclical aspect of the situation. Meanwhile, policy actions to address
some of the structural problems, such as the banking crisis and the weaknesses in public
finance, may aggravate the situation in the short run, making even a recovery in 2002
uncertain.
Growth in Western Europe is expected to be about one percentage point lower
than previously forecast, but recession is not anticipated in any of the countries of the
region. The extent of the slowdown suggests that the direct and indirect economic
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linkages between the United States and Western Europe are greater than implied by the
size of their mutual trade flows. Such economies as Germany and Italy have proved
highly susceptible to swings in world demand and have suffered not only the direct
consequences of the slowdown in the United States itself but also the secondary effects of
reduced import demand from slowing developing countries. The setbacks in the larger
economies have subsequently been transmitted to others in the region. In addition,
financial linkages with the United States (such as the cross-ownership of many large
companies and the co-movement of equity prices) and synchronous cycles in the ICT
sector caused the downturn to be larger than expected.
While the main cause of the slowdown in Western Europe was initially the
exogenous shock from the United States, it has gradually become more endogenous to the
region. Germany, the largest economy in Europe, has also been the weakest and this has
contributed to the fact that others in the region are performing worse than expected.
Growth in the region decelerated substantially in the second quarter of 2001, mostly
because of a decline in exports and, to a lesser extent, investment. Industrial production
in many of these economies fell during the first half of the year. Since the second
quarter, consumer confidence has also weakened, partly due to the rise in inflation
(because of higher energy and food prices) and partly due to softening labour markets.
The latter is of particular concern because the sustained improvement in labour markets
had been an important underpinning of the robust consumption demand of recent years.
Since the attacks of 11 September, business sentiment in both the industrial and service
sectors has deteriorated, darkening the outlook further. On the other hand, the recent
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monetary easing by ECB, particularly if continued and accompanied by softening prices
of oil, should provide some support for a recovery of growth in 2002. In addition, there
is some room ceiling in most countries for fiscal stabilizers to provide support without
threatening the eurozone deficit.
For other developed economies, the weaker United States economy is having a
sizeable negative impact on Canada; Australia and New Zealand have also been affected,
but to a lesser extent.
Developing countries are becoming increasingly engulfed in the global economic
slowdown, both in numbers and degree. For the group as a whole, the expectation for
growth in 2001 has fallen from over 4 per cent to some 2½ per cent, implying that, on
average, there will be almost no increase in per capita output. Despite continued
domestic economic reform and the expectation of benefits from earlier reforms, very few
developing countries will improve on, or even maintain, the rate of growth achieved in
the past few years; several of the more advanced developing countries are likely to
experience an absolute decline in per capita income in 2001. Unemployment and poverty
will inevitably and immediately rise in many countries, and the setback will also damage
longer-term development prospects.
The most severely affected developing economies are in East Asia. The
deceleration has been extremely sharp in such economies as Hong Kong SAR, Republic
of Korea, Malaysia, Singapore and Taiwan Province of China, primarily due to the
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decline in their exports to the United States and Japan and the global slump in the ICT
sector. Meanwhile, the prolonged decline in equity markets in the region has been
accompanied by weakening confidence. A few of these economies are already in
recession (defined as a decline in GDP for two successive quarters) and a year-over-year
contraction of GDP is inevitable for some of them. Although some signs of softening
have appeared recently, China has so far been less affected by the global downturn and,
as previously expected, is forecast to grow by 7½ per cent in 2001. On the other hand,
growth in India, another large economy that had achieved solid progress since the mid1990s, is expected to slow to about 4½ per cent in 2001.
Growth prospects for Latin America have also worsened markedly, particularly
for the large economies of Argentina, Brazil and Mexico. The ripple effects of the United
States slowdown have led to a deterioration in the external sector of many countries in
the region, particularly Mexico and others in the north. However, the three-year
recession in Argentina is largely rooted in its own financial problems, while Brazil’s
difficulties stem from its large external imbalances, a domestic energy crisis and its ties
to Argentina, notably through MERCOSUR. The recent IMF replenishment of funds to
these two economies should provide some breathing room, at least in the short run.
The economies of Africa have been less directly affected by the slowdown in
global demand, but the weakening of commodity prices resulting from the slowdown are
having negative consequences for many economies in the region. Economic growth in
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some countries in North and West Africa is likely to be less than expected in 2001, but
this is due mainly to political unrest or other domestic events.
For most of the member countries of the Commonwealth of Independent States
and most economies in transition in east and central Europe (except Poland), economic
prospects for 2001 have not changed significantly, despite the accelerated global
slowdown and the attacks of 11 September. However, as a result of the global campaign
against terrorism, the economic outlook for a few of these economies in central Asia, as
well as other individual countries in south and west Asia, will be altered significantly, but
in varying ways. The subsequent impact of these changes on the global economy will be
limited because most of these economies are relatively small.
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Table 1. Revision of Global Outlook from the Survey, 2001
(annual percentage rates of growth)
Survey
2001
Current Revision
2001
2002
Rates of growth of GDP
World
Developed economies
United States
European Union
Japan
Developing economies
Africa
Latin America
West Asia
S&E Asia (excl. China)
China
Economies in transition
2.4
1.9
1.8
2.7
0.7
4.1
4.3
3.1
2.6
4.1
7.5
3.6
1.4
1.0
1.
1.8
-0.5
2.5
3.0
0.8
1.9
1.7
7.5
3.6
2
1½
2
1¾
½
4¼
3
2
4
4
7
3¾
World Trade
5.5
0.0
5
17