Forecasters fall foul of passing fashions

One of the most useful things the BIS report does is to explain why things are not what they might have been

ANYONE TRYING to forecast what will happen to the world economy is going to get things wrong.

The great thing about the Bank for International Settlements' annual report - more a commentary on the world of finance than a regular bank report - is that it acknowledges and defines the areas of uncertainty. Unlike the research departments of the commercial financial institutions, which feel they have to give a firm view of future developments, the BIS can stand back and think. This may not be quite so useful for people wanting to be told whether to buy or sell, but for anyone trying to understand what is happening it is a breath of fresh air.

In its analysis of the world economic situation, the BIS focuses on the way things turned out differently last year from previous expectations: the United States and UK did not slow down as expected, and the Japanese recovery failed to sustain itself. In the rest of Europe, small countries tended to grow swiftly while the larger ones underperformed. Yet inflation in the small countries was actually lower than in the big.

To understand the future you have first to understand the present, and one of the most useful things the BIS report does is to explain why things are not what they might have been. In particular it hints at the unsustainable nature of the US and UK expansions, where inflationary pressures have only been held down by rises in the dollar and the pound, and where the current accounts have accordingly deteriorated.

However, the BIS also points out an aspect of the US expansion which I had not fully grasped: the extent to which investment in information technology might have increased the potential for growth. The chart on the left is derived from some statistics the BIS dug out on IT investment, which last year took 20 per cent of total investment in the States. The information industry now accounts for 4 per cent of US output, against only 0.8 per cent in 1992. If you exclude the information industry, real GDP would have only grown at an average of 2.2 per cent over that period. As it was, real output rose by 2.9 per cent a year. In addition, the growth of the information industry helped hold down inflation: strip out information and inflation would have averaged 3 per cent over the period. In fact, inflation was only 2.4 per cent. If one wants a single example of American exceptionalism, this is perhaps the best.

To some extent it must also apply to the UK, where the information industry is also expanding very fast, but it would be nice to see some figures to confirm this. Worryingly, the BIS does note that continental European investment in general has been rather low, and accordingly the spare capacity there is less than might be expected. This is bad news for the continent's unemployed, for it suggests that there might be high residual unemployment, even when the economies are at full capacity.

An even bigger surprise than the divergent performance of the main developed countries last year was of course the abysmal performance of what had been the fastest-growing region, East Asia. It would not have been a complete surprise to anyone who read the previous year's BIS report, which did warn of the excessive investment that was taking place, and the price bubbles that were a-brewing in the property markets. The region was clearly vulnerable to any sharp fall-off in demand, but what everyone had failed to spot was the way in which the decline in demand would interact with a fragile financial system and companies heavily burdened with debt.

What no-one really saw was the way in which the short-term response to the financial crisis, sharp devaluations, would hit growth prospects and thereby put even more pressure on the region's banks and companies. The right-hand graph shows how estimates for the 1998 growth of the crisis- hit four (Indonesia, South Korea, Malaysia and Thailand) were cut during the second half of 1997, as their currencies simultaneously collapsed.

Normally you might expect a devaluation to boost growth by encouraging exports and leading to import substitution. In this case, because one country's exports were another country in the region's imports, the devaluations had the effect of depressing the whole region.

What happens next? The BIS believes that asset prices have not been inflated by the global fund management industry to any substantial extent, but there is an implicit warning here that the present high asset prices are not sustainable. The BIS is not predicting a stockmarket crash later this year; but if there is one, it would be able to say that such an outcome was consistent with what it wrote.

The most interesting part of the report is, as usual, the final few pages of commentary at the end. It starts by pointing out the dangers of fashion. It is fashionable at the moment to take a generally positive view of the future, despite the trauma of Asia. It suggests that there is a danger of over-optimism at the moment. Just as the Asian economies were admired for their high savings and high investment, no-one focused on the fact that a lot of this investment was going into unprofitable projects. With that warning, it looks at the potential weak spots in the world economy now.

One is the imbalances among developed countries and, in particular, the rising current account deficit of the US. It sketches a scenario (not, it notes, a forecast) where US growth slows, confidence ebbs and foreign funds are suddenly withdrawn from the dollar.

Two, banking systems throughout East Asia and Japan need to be rebuilt. The weakest banks will have to be closed and the rest recapitalised.

Third, there are imbalances within the rest of the developed world. The new European Central Bank will find it difficult to set a single interest rate for the entire region, given the different cyclical position of the large and small economies; and the US and UK will have to tackle tightening labour markets, worsening trade balances and rising inflation.

Finally, the BIS asks: can we learn to cope with crises better? It concludes that crises will undoubtedly continue - we cannot hope to prevent them - so we will just have to learn to manage them as well as possible, but "it is simply not prudent to assume that everything will turn out for the best".

Start your day with The Independent, sign up for daily news emails
ebooksA celebration of British elections
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Trainee Consultant - Surrey/ South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Ashdown Group: Trainee Consultant - Surrey / South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Recruitment Genius: Claims Administrator

£16000 - £18500 per annum: Recruitment Genius: This is an excellent opportunit...

Recruitment Genius: Senior SEO Executive

£24000 - £28000 per annum: Recruitment Genius: A Senior SEO Executive is requi...

Day In a Page

Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever
Robert Fisk in Abu Dhabi: The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers

Robert Fisk in Abu Dhabi

The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers
Vince Cable interview: Charging fees for employment tribunals was 'a very bad move'

Vince Cable exclusive interview

Charging fees for employment tribunals was 'a very bad move'
Iwan Rheon interview: Game of Thrones star returns to his Welsh roots to record debut album

Iwan Rheon is returning to his Welsh roots

Rheon is best known for his role as the Bastard of Bolton. It's gruelling playing a sadistic torturer, he tells Craig McLean, but it hasn't stopped him recording an album of Welsh psychedelia
Morne Hardenberg interview: Cameraman for BBC's upcoming show Shark on filming the ocean's most dangerous predator

It's time for my close-up

Meet the man who films great whites for a living
Increasing numbers of homeless people in America keep their mobile phones on the streets

Homeless people keep mobile phones

A homeless person with a smartphone is a common sight in the US. And that's creating a network where the 'hobo' community can share information - and fight stigma - like never before