Hamish McRae: The shocks may happen, but still I see encouraging signs for the world in 2006

If the US and China carry on growing swiftly, so will the world economy. It's as simple as that
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The Independent Online

Predictions for the coming year are always dangerous. But as far as the prosperity of the world, and ours, is concerned, there are I believe, reasons for some cheer.

First some perspective. There is a temptation to believe that 2006 will mark dramatic political or economic change - that the world will somehow be different. In politics that does sometimes happen: wars are started, leaders are overthrown. But in economics, sudden changes seem to have become less prevalent. Individual events can cause disruption, such as a sudden rise in the oil price or change of mood in the housing market. But, mercifully, serious recessions have become less frequent. The shocks still happen, but the world seems better able to cope with them than it did a decade or more ago.

But if the world economy is more resilient than it used to be, it is also more interdependent. There are pluses and minuses for an open economy such as our own. If China's demand for oil shoots up, that has an impact on the price of petrol at British pumps, for China is now the world's second-largest oil user. On the other hand, the UK economy has been able to grow without much inflationary pressure, in part because it has been able to increase its labour force by an influx of workers from Eastern Europe.

So while it is hard to foresee any radical economic shift in the coming year, we should recognise that events on the other side of the world may, for better or worse, be the things that have the greatest impact on our own fortunes.

If 2005 has been something of a disappointment in economic terms, 2006 looks like being a little more encouraging. After a year of pretty slow growth, there are reasons to expect that the economy will pick up a little more pace. Expect the housing market to be stable. Expect interest rates to fall a little, with one or two reductions probably in the first half of the year. Expect the pound to remain reasonably stable, whatever the dollar and the euro decide to do - and the dollar does appear vulnerable for all the reasons that have been rehearsed in recent years.

There are, naturally, some serious uncertainties. The Chancellor will have one of the toughest decisions in the forthcoming budget: whether to accept that the Government's deficit is stuck at the present level of about 3 per cent of GDP, or whether to do something about it. The choice is very simple: cut spending, increase taxation, or borrow more. For the past four years, he has broadly chosen the third option. That gives a clue to the outcome next year, too. But every year that borrowing runs above the planned level creates a greater problem for the future.

If public borrowing is a concern, so too is private. Another uncertainty is how we will cope with our borrowings, not just on mortgages but also on credit cards and personal loans. A raft of debt has kept spending going, albeit at a slower pace than before. There has long been a link between house prices and people's willingness to borrow. One of the most interesting issues is whether, irrespective of what happens to the housing market, Britons will be happy to go on increasing their debts in the coming year.

The business community enters 2006 in good heart. Stock markets have had a good year, with shares recovering more of the ground lost since 2000 - though most of the main world market indices have yet to get back to the last peak. The business world has its concerns, of course, but with one important exception, UK retailing, these are different from those of the rest of us. Retailers are directly affected by the domestic consumer slowdown; for most other businesses have to think global.

And so to the big global question: how much longer is the present global expansion likely to last? Business thinks it has a fair way to go - that is why it is cheerful. Is it right?

For the coming year, the short answer is: almost certainly yes. Over the past five years, more than half the incremental growth in the world economy has come from the US and China. So if those two countries carry on growing swiftly, so will the world economy as a whole. It is as simple as that.

It is quite hard to see an early rupture in the relationship between the US and China. The US is China's largest customer and its largest investor. Cheap Chinese goods help to hold down prices in the States, while American companies invest in the factories that produce those goods. This will not continue forever, but for the time being it seems to suit all sides.

But there are strains. Some are political, as evidenced by US pressure last summer for the Chinese to revalue their currency and by the blocking of a Chinese attempt to buy an independent US oil company. Others are economic, the best example being the rise in the oil price as Chinese demand, coupled with American, pushed the price to more than $60 a barrel. Other commodities climbed in price as well, largely in response to Chinese demand. The Chinese economy almost certainly passed the UK in 2005 to become the world's fourth largest. Expect it to pass Germany in the next two or three years to become the third largest after the US and Japan.

Chinese growth will continue to put pressure on the world's resources through 2006, raising further questions about the oil price. Maybe the present level is a plateau, in which case the world is simply getting a useful warning that it should seek to use resources more prudently. But there is a longer-term concern that the world's oil supplies are starting to run out. New reserves are not being discovered quickly enough to meet rising demand, and at some stage in the next few years global oil production will start to decline, just as US (and UK) oil production is falling. Might 2006 see the peak of oil production? Some geologists think so, though the big oil companies see the peak as some years off. We certainly should not rule out another oil price scare in 2006, even if production continues to climb.

One of the good things that might come out of that would be a more thoughtful approach to the use of the planet's resources. Concern about weather patterns will continue, and though in the short-term this will not check economic growth, such worries will not go away. The phrase "sustainable growth" will be heard more frequently, and not before time.

Will 2006 see the fruits of growth spread a little more widely? It would be naive to expect radical change, but there are some grounds for hope. The trade talks in Hong Kong were disappointing, but the fact remains that the world's two largest poorer countries, China and India, are both increasing living standards by 6-8 per cent a year, and will continue to do so. As a result, in 2005 more people were being lifted out of poverty than ever before in human history. More people still will benefit in 2006. For all its imperfections, inequalities and injustices, the world economy is delivering the goods - and we should recognise that success.

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