Washington, D.C., 2 October 2004

  Global Economic Prospects

The United Nations Department of Economic and Social Affairs currently forecasts that gross world product (measured at market exchange rates) will grow by 3.7 per cent in 2004 and by about 3 to 3 1/4 per cent in 2005. 

The major developed economies, particularly the United States and Japan, experienced a relapse in their recovery in the third quarter, primarily because consumer spending lost buoyancy as a result of the increase in oil prices and the sluggish improvement in employment. Recovery in most Western European economies remains slow and highly dependent on external demand.  Nevertheless, and despite some risks of a further deterioration, the present world economy embodies several elements of resilience that seem likely to sustain reasonable growth in the short term. Business investment continues to strengthen in a large number of economies; global inflation remains benign; macroeconomic policies worldwide, despite tightening in some cases, remain accommodative; international trade has returned to a more solid rate of growth; external financing conditions remain favourable for most developing countries; and exchange rates among major currencies seem to have stabilized, although some developing economies remain subject to revaluation pressures.

Among developing countries, many African economies have benefited from increased domestic demand and increased commodity prices. Encouragingly, most countries in Sub-Saharan Africa are achieving growth rates in the range of 3 to 7 per cent. Asia is expected to achieve a solid overall economic growth but performance has become more diversified across economies. The outlook for West Asia remains mixed: higher oil prices, together with increased oil production, have brought an unexpected windfall of oil revenue to the region, but the deteriorating security situation in Iraq and the ongoing conflict between Israel and Palestine continue to have adverse effects on the region. The Latin American and Caribbean region has been performing better than expected, but the strength remains mostly cyclical and, in many countries, uncertainty over the sustainability of the recovery has prevented increases in employment levels. Meanwhile, most economies in transition are expected to register another year of strong growth.

The positive short-term outlook for the world economy is tempered by several downside risks. One of the unusual features of the present situation is the number and diversity of the downside risks and the fact that, although largely independent, they might interact, with compounded effects. The least tangible of these risks are the geopolitical uncertainties and broader apprehensions about terrorism:  although less intense than previously, these anxieties have become perennial, curbing consumer and business confidence.

Against this backdrop, the most immediate uncertainty is that oil prices will remain at their recent high nominal levels for some time or become even higher. The surge in oil prices has been driven mainly by stronger-than-expected global oil demand, compounded by the geopolitical tensions in the Middle East and herd behaviour in the oil futures market in response to such events. To date, there has been no major long-term disruption to supply and the major oil producers have some capacity to increase output.  Oil prices therefore seem unlikely to maintain their end-September levels over the medium term and the world economy should avoid an oil-induced economic reversal. In the meantime, higher oil prices have brought sizable income gains to oil-exporting countries, but the burden on the oil-importing developing countries is growing. Higher prices for their exports are alleviating the situation in many cases, but are insufficient to offset the increased price of oil that has prevailed in the past few weeks.

The major potentially destabilizing factor for the world economy remains the large twin deficits of the United States. The increase in fiscal expenditure in the United States served as a stimulus during the recent economic recovery but it is disconcerting that the fiscal deficit is not expected to dissipate faster during the present period of economic recovery, particularly in the light of the strength of that recovery in the United States. The anticipated magnitude of the deficit will reduce the flexibility that the United States has to respond if any of the other downside risks materialize.  It will also, through various channels, have negative effects for growth in the United States over the medium term. Of broader concern, the likely effect of the deficit on global financial markets will also have adverse repercussions for developing countries that rely on private capital inflows to augment their domestic savings.

Policy priorities

The challenge for policymakers worldwide is to sustain the current economic expansion in the light of these risks. To this end, developed countries should continue to maintain accommodative macroeconomic policies, focusing on a gradual reduction of their imbalances, particularly the fiscal deficit of the United States. Many other countries should also take advantage of the current period of improved growth to build capacity to weather future setbacks and to initiate actions to strengthen longer-term growth. During the recent downturn, many developing countries were constrained in their ability to implement countercyclical policies, mainly, either directly or indirectly, because of excessive fiscal deficits. Improved growth provides both the economic and political space to initiate some consolidation of fiscal imbalances and to address longer-term structural challenges. 

In the fiscal area, efforts should concentrate primarily on increasing revenue. Most developing countries face severe deficiencies in institutional and physical infrastructure, health and education. These needs largely have to be financed from public revenues so that efforts should focus on increasing such revenues, first and foremost by improving tax collection and broadening the tax base. Countries that are currently benefiting from increased world prices for their exports should focus on ensuring that their windfall revenues are used effectively, including through higher savings, so that they will not face difficulties when prices retreat. In many cases, it would be timely to emulate the example of those countries that have introduced measures to mitigate the volatility in the future prices of their exports.

Official Development Assistance (ODA)

The international community at large and donor countries in particular have made tangible progress in the implementation of their commitment in the Monterrey Consensus to support developing countries in their development, but progress has varied significantly across the various dimensions of this partnership. The turnaround in the downward trend in official development assistance (ODA), not only in quantitative terms but also in terms of "aid effort", was a critically important step forward.  Moreover, several donors have made commitments to increase ODA further over coming years, with a number having pledged further specific additions to their ODA flows up to 2006 and a number having committed themselves to a date for reaching the United Nations target for ODA of 0.7 per cent of gross national income. Nevertheless, even delivery of all ODA commitments made until now will fall far short of what is widely considered to be needed to achieve the Millennium Development Goals.  The international community must give urgent attention both to scaling up ODA flows in the short-term, say until 2010, and to possibilities for securing additional finance over the longer term. In addition to the quantitative dimension, donors need to live up to their commitment to improve the qualitative dimension of aid flows both by improving the harmonization of their own procedures and by giving tangible  meaning to the concept of 'country ownership'.

Innovative Sources of Development Finance

In addition to a further immediate scaling-up of ODA, donors countries need to begin examining the prospects for official financial flows over the medium to longer -term. Even if the MDGs are met by 2015, the task of eradicating poverty, as well as achieving the vast array of other global development objectives, will be far from complete. Recognizing the difficulties in providing the required amount of ODA from conventional sources over the longer term, there have been a number of initiatives to explore alternative means of mobilizing additional resources. There is now a “menu” of proposals for consideration, including international taxes, such innovative arrangements as the International Financing Facility proposed by the Government of the United Kingdom and the use of Special Drawing Rights (SDRs) for development purposes, a global lottery, and mobilizing additional resources from the private sector. It will take some time to reach the necessary political consensus and arrange for implementation of those proposals that the international community considers appropriate. It is therefore not premature to begin a process of consultations on them. On the basis of a study commissioned by the Secretary-General to UNU/WIDER, and of the report prepared at the initiative of the Governments of Brazil, Chile, France and Spain, the General Assembly is addressing this matter at its current session.

Debt sustainability

Despite the progress to date, the HIPC Initiative has not yet realized the goals that were set when it was established and when its completion date of end-2004 was decided. The external debt burden continues to be one of the elements that impedes the efforts of many of the poorest countries to extricate themselves from their “poverty trap”. This problem has become even more serious with the increase in oil prices because many of the poorest countries are also oil-importing countries and are, therefore, facing increasing pressure on their balance of payments. To remove this underlying impediment to growth and development, the HIPC Initiative should be continued until it fully meets its original objective. This involves first, ensuring that all eligible countries are able to benefit from the Initiative and, second, ensuring that all receive the relief necessary to reduce their debt burden to sustainable levels. The first will require extending the duration of the Initiative while the second will require more “topping up” at the “completion point”. Both types of actions will, in turn, require additional financing. Previously, the lack of financing was overcome through off-market sales of some of the Fund's gold holdings. A similar solution should be given consideration if financing difficulties are an impediment to the necessary action on this occasion.

The Design of Appropriate Fiscal Targets

It is now clear that one of the reasons for the lack of infrastructure investment in developing countries has been the restrictions that have been placed on overall levels of government expenditure in the pursuit of sound macroeconomic fundamentals. But this represents borrowing future real growth to meet short-run financial stability and, as recent research, including major studies by the World Bank, has shown, this is self-defeating in the long run. It is thus imperative that means be found to make policies that produce sound macroeconomic fundamentals compatible with the substantial increases in investment in human capital and social and economic overhead capital.

The design of appropriate fiscal rules has received in this regard a great deal of attention in recent years. On the basis of ongoing debates, it is important to stress three basic principles. First, any fiscal rule should facilitate the countercyclical role that public sector finances must play in any economy. To do so, all rules should be set on the basis of the structural stance of fiscal policy. It is also essential that multilateral financing be made available to support such countercyclical spending in developing countries subject to sudden stops in private external financing. Second, rules should clearly differentiate between current and investment spending. In this regard, setting the deficit targets on the basis of the primary structural balance or surplus, in some variant of the “golden rule” of public sector finances, seems superior to the overall fiscal targets that have been widely used in the recent past, and that have led to widespread reductions in public sector investment during crises. Third, adequate attention should be given to avoiding the fiscal risks associated with both weakly managed public sector firms and with public-private partnerships. However, this requires rules that do not discriminate against public sector investment vis-à-vis private sector investment in infrastructure. Thus, rules that place stringent conditions on what type of public sector firms are excluded from the fiscal targets and, on the contrary, do not fully incorporate the risks that public-private partnerships may imply for public sector financing, are inappropriate. The best rule could thus be one in which some current structural deficit target is adopted together with some form of debt target that takes into account the present value of the contingent liabilities that the public administration has incurred vis-à-vis both public sector firms and public-private partnerships.

Such changes are important not only because of their impact on the domestic economic environment, but because they also provide a response to the calls by many developing governments that are subject to support from the IMF for additional short-term policy space to respond more actively to internal and external shocks that cause unacceptable reductions in growth and employment.