Among the Group of Seven leading industrial nations only Japan, battered by the crisis among its Asian neighbours, is currently seen as lagging well behind the forecasts. But even with this shortfall, the consensus among G7 finance ministers is that the global economy will expand by 2.5 per cent in 1998, only a quarter point worse than in 1997; trade in manufactured goods will climb by a further 9 per cent; and inflation will remain remarkably subdued. In fact a 'Goldilocks' economy can be expected for the whole world.
But like all fairy tales, this one too has some possible nasty endings, which are being deliberately skirted by international policymakers. The fear appears to be that the more the risks are talked about, the greater the impact on confidence, investment prospects, and eventually growth, will be.
In the US the prospects look superfically good. Even after the astonishing 3.7 per cent growth seen in 1997, leading forecasters like the International Monetary Fund still believe the US is capable of a further 2.6 per cent growth next year. With inflation running at 2.2 per cent - its lowest level in 30 years - there appears to be no immediate reason to fear the advent of a downturn.
The risks are, however, ever present. The first is an outbreak of wage inflation, as the labour market tightens, provoking the Federal Reserve into a series of interest rate rises which will stifle growth. The second potential risk is from Wall Street: the same over-inflated values in the technology and financial sectors which provoked a near market meltdown last November are still in place and could bring business confidence to a juddering halt.
Thirdly, the US is the biggest trading partner of Asia-Pacific. The more pessimistic forecasts suggest that Asia's peril could cost the US up to 1 per cent of gross domestic product, which would reduce growth to below 2 per cent. There could be other negative trade and financial effects such as a flood of Asian imports, the return of the protectionist spectre, and some repatriation of Japanese bonds which could unsettle the financial markets. It is thus relatively easy to pull the American part of the global growth equation apart.
In Europe, the theory runs like this: the current upturn among the G7 has not been synchronised. As the US slows down modestly, the forecasts expect the expanding European economies to take up the slack. In Germany, where growth recovered to 2.3 per cent last year, the pace of ouput is expected to reach 2.8 per cent in 1998. With France and Italy moving increasingly in tandem with their main European trading partners, forecasters expect output to expand to 2.8 per cent and 2.1 per cent respectively. Across the Continent inflation should remain subdued, ranging from 1.3 per cent in France to 2.3 per cent in Germany.
But is this a realistic outlook? Europe has been considered to be well insulated from the Asian upsets. However the London Business School suggests Europe's exports to non-Japan Asia (including China) are 18.5 per cent of the total, not far short of the 19.8 per cent directed at the same region by the US. If the Asia-Pacific crisis is bad for America, it is equally bad for Europe.
Moreover, Europe has its own potential risks in 1998, not least the locking of exchange rate values in April/May 1998 ahead of European Monetary Union on 1 January, 1999. Among the fears about this exercise is that some currencies could be locked at rates which are too high, pricing Europe's goods out of global export markets and exerting downward pressure on their economies. Furthermore, the squeeze on public spending will have to be maintained to keep within the 'stability pact' and the launch of the new currency could be greeted by huge turbulence in the foreign exchange markets.
If these seem like big unknowns for the global economic outlook, they are nothing compared to Japan's. After what appeared to be a good recovery in 1996 - with growth in the order of 3.5 per cent stimulated by governments spending - the economy was back in the mire late in 1997, growing by just 1.1 per cent. Most major forecasters have predicted a pickup in 1998 to 2.1 per cent growth.
This is now looking wildly optimistic. Tokyo is at the core of the Asia-Pacific problem. An astonishing 43.7 per cent of its exports go to the rest of the region and the collapse in demand, from the smaller tiger economies to South Korea (the 11th largest economy in the world), is an enormous blow to its economic prospects.
But that is not all. An already weak Japanese banking and financial system, exemplified by the November collapse of the Yamaichi investment house, is going through a rapid readjustment. It will have to cope not only with its own bad loans, resulting from years of neglect and sometimes fraud, but with those by Tokyo to its Asian neighbours. While this financial implosion may prove invigorating over the longer term, it seems highly unlikely to encourage economic expansion in 1998 - unless, that is, the domestic authorities are willing to pump up domestic demand by lowering income and consumer taxes to fill the gap created by lost Asian exports and diminished financial confidence.
The reality for the world economy in 1998 is that there are more than the usual number of banana skins, not least further problems in emerging markets from Latin America to Russia. The biggest risks, however, come from the G7 economies. Policymakers will need to be alert to the risk of recession and adjust accordingly.
Alex Brummer
Source: Airline Business
