US holds the key as experts hedge their bets over world's growth outlook for year 2000
NEWS ANALYSIS So many got it wrong in 1999 that economists are being doubly cautious in predicting the future of the world's biggest economy
Monday 20 December 1999
With the hangover from the Asian financial crisis expected to slow growth markedly compared with 1998, most forecasts were for a slowdown this year. In fact, the US powered ahead, Europe started to recover, Japan edged away from deflationary recession and Asia rebounded.
Some of the most dramatic forecasting errors concerned the US economy, which is so important in the world economy that if you get that wrong, predictions for other countries will go awry too.
John Llewellyn, the chief economist at Lehman Brothers, bravely admits to having predicted real GDP growth of just 1.7 per cent in the US this year. The actual figure will be closer to 4 per cent.
He was not alone. Last spring, questioned about the IMF's forecasts which showed US growth slowing from 3.9 per cent in 1998 to 3.3 per cent this year, chief economist Michael Mussa joked: "We forecast the US economy would slow down last year and the year before, and we'll carry on predicting a slowdown until the US economy gets it right."
Once again, economists have pencilled in a US slowdown, to varying degrees. Goldman Sachs reckons there will be a very slight deceleration in growth to 3.8 per cent, combined with rising interest rates through 2000. Lehman's paints the same picture.
A new report from ING Barings recognises both the vast uncertainties and the innate caution of economic forecasters. "The most striking characteristic of long term economic forecasts is how conservative they are," says chief economist Mark Cliffe.
He therefore looks at three scenarios. One is a conservative based case which has a gentle US slowdown - a soft-landing followed by gradual take- off. The second is a technology-driven long boom, a genuine New Era for the world's biggest economy. The third is a boom turning into bust mid- way through 2000 as inflationary pressures finally force the Federal Reserve to push interest rates higher.
The base case has US growth slowing to 3 per cent in 2000, recovering to 3.5 per cent in 2001, and settling around 3 per cent in the longer term. Inflation stays close to or below 2 per cent.
In the optimistic alternative, real GDP growth slows to 3.5 per cent in 2000 but then stays above 3 per cent, while inflation slows further from around 2 per cent to just 1 per cent in the longer run.
In the pessimistic alternative, there is little slowdown in 2000 but inflation picks up to 2.6 per cent. To bring inflation back towards 2 per cent, growth has to be slowed to below 3 per cent in 2001 and 1 per cent in 2002, and never climbs back above 3 per cent before the end of the first decade of the 21st century.
What is interesting about looking at different scenarios is that they spell out the kind of things that need to be true for each forecast to be fulfilled. What must New Economy enthusiasts be assuming if high growth and low inflation are to continue? The assumptions are actually highly controversial, even though the pace of technical change is undeniably impressive.
For one thing, it assumes continuing liberalisation of markets within countries and between them so that the economic benefits of technological improvements can be captured. As the chart shows, technological trade has outpaced trade in other goods and services, which in turn has exceeded GDP growth.
Hi-tech trade therefore can drive growth but it has to be allowed to happen. Governments have to create the right institutional framework. What's more, events like the Asian crisis and the demonstrations in Seattle over the WTO and trade liberalisation suggest that there might be setbacks on the path towards ever-freer free markets. As Mr Cliffe puts it, "There are substantial social and political barriers to this outcome."
To list just a few of the obstacles, there is the strong voter demand in many countries for measures to tackle poverty and inequality, there are consumer concerns about some new technologies, there is the ageing population in the OECD (outside the US and one or two small countries) which will compel unpopular pension reforms. If growth faltered at all, governments' ability to compensate losers from the ongoing process of globalisation and liberalisation would vanish.
Nevertheless, looking at the extraordinary forces that have been unleashed in the US economy, most forecasters can not believe that it will be business as usual in 2000 even if the numbers on their computer printouts predict the usual modest slowdown in US economic growth in 2000.
"What is at work is faster and almost certainly bigger than the industrial revolution," said Mr Llewellyn. The big question, he said, is how far it spills over from the US to the rest of the world. "It will put structural reform in Europe even more firmly in the spotlight." He predicts a bounce in EU growth to 3.5 per cent in 2000. Others are more pessimistic about Continental appetites for reform; Goldmans predicts just 2.8 per cent growth, up from 2.1 per cent this year.
As for Japan, the other big economy in the OECD area, nobody can get very enthusiastic about its prospects, although most forecasts think it will continue to emerge from recession. Economic recovery is simply posing too many difficult social and political problems for the fruits of any long boom to bless the Japanese economy quickly.
The highest forecast, in the ING Barings base case is for 2.6 per cent real GDP growth, more than twice 1999's pace. Lehmans actually forsees the economy's pace of expansion slowing a little from just over 1 per cent to 0.8 per cent in 2000. If there is a New Economy, it is going to take even longer to cross the Pacific than the Atlantic.
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