I am pleased to present to you the World Economic Situation and Prospects (WESP) 2006. The WESP is a joint product of the Department of Economic and Social Affairs (DESA), the United Nations Conference on Trade and Development (UNCTAD), and the five United Nations regional commissions.
The report provides the UN’s short-term economic outlook for the world economy. It also summarizes the views of the UN Secretariat on key current issues in international macroeconomic policy making, trends in world trade and multilateral trade policies, and trends in international finance and development assistance.
As such, the WESP aims in great part to serve as a point of reference for deliberations on economic, social and related issues taking place in various UN entities throughout the year—and not least, here, in the Economic and Social Council.
You all have the report before you. I would now like to take you briefly through its highlights.
World economic growth slowed noticeably in 2005 from the strong expansion in 2004. According to our projections, during 2006, the world economy is expected to continue to grow at this more moderate pace of about 3 per cent. This rate is about average considering the world economic expansion over the past decade.
A weakness in the state of the world economy—and one common to most countries—is the unsatisfactory level of employment growth. In a majority of countries, job creation has been sluggish; consequently, unemployment rates are still notably higher than the levels prior to the global downturn of 2000-2001. Many developing countries continue to face high levels of structural unemployment and underemployment, which both limit the positive impact of growth on poverty reduction.
Another point of concern is that inflation rates have edged up worldwide in 2005. This higher inflation has been driven mainly by higher oil prices. When we exclude volatile components, such as the prices of energy and food, we get what we call “core inflation”. And core inflation rates have remained rather stable. This indicates only a limited pass-through of higher oil prices to overall inflation. In our view, therefore, fears about a strong acceleration of inflation are unwarranted.
Across major groups of the economies, growth in most parts of the developing world and in economies in transition is well above that in the developed countries. Particularly in the least developed countries (LDCs), growth continues to be strong. On average, the LDCs are expected to grow at 6.6 per cent in 2006, their fastest average rate of growth in decades. In fact, they have shown strong growth since 2001. This good economic performance has been supported by higher prices of oil and other commodities in many LDCs, but also by improved political stability and economic governance in a number of others.
Not all LDCs, however, are experiencing strong growth. Net importers of oil and food producers have suffered negative terms-of-trade shocks. Some African exporters of textiles were hit by the end of the Agreement on Textiles and Clothing. And continued political conflict and civil strife have hampered growth performance in still other LDCs.
In all, 18 LDCs will see more than 3 per cent per capita income growth in 2006. As a crude rule of thumb, this is the level considered high enough to reach the poverty reduction target in the Millennium Development Goals, if it can be sustained for a prolonged period. Other LDCs continue to fall short of that target level. This casts a shadow on the bright outlook for developing country growth. Moreover, non-oil commodity prices have apparently reached a plateau in general and could even be on the decline in some cases, putting in doubt the sustainability of LDC growth in the near future.
Among the major economies, the US economy remains one of the main engines of global economic growth. Its growth, however, is expected to moderate further, to 3.1 per cent in 2006. This is due in part to a few structural problems in the US economy still awaiting adjustment, including the large external deficit and the extremely low household saving rate. Lacklustre economic performance will continue to prevail in Europe, with growth reaching no more than about 2 per cent in 2006. The recovery of the Japanese economy is expected to continue, albeit at a modest pace of 2 per cent.
The dynamic growth of China, India and a few other large developing economies is becoming increasingly important for the growth of the world economy. China and India are expected to maintain a strong pace at 8.3 and 6.8 per cent, respectively. At the same time, the rest of East and South Asia is expected to grow at a healthy rate of more than 5 per cent. Latin America is lagging somewhat behind, with growth of around 3.9 per cent. But African economic growth is expected to remain solidly above 5 per cent. And growth in West Asia should maintain a strong pace at around 5 per cent, as oil prices are expected to remain high.
These prospects for the world economy are surrounded by uncertainty. The WESP identifies several major risks to the downside.
These risks are associated with an increasing danger of four possible developments: a disorderly adjustment of global imbalances; the persistence of high oil prices; a reversal of the substantial appreciation of house prices in a number of large economies; and the outbreak of a pandemic of avian influenza.
A disorderly adjustment of the global macroeconomic imbalances poses the most acute risk. During 2005, global imbalances widened further. The current account deficit of the United States surpassed $800 billion. This was matched by increased surpluses elsewhere, particularly in Europe, East Asia and oil-exporting countries.
Despite low interest rates worldwide and ample liquidity in global financial markets, there are strong reasons for concern about the sustainability of the global imbalances. As a result of the chronic and widening current account deficit of the United States, the accumulated increase in its net foreign liability position could eventually erode foreign investors’ confidence in dollar-denominated assets. This could lead to: a precipitous fall in the value of the US dollar; an abrupt and disorderly adjustment of the global imbalances; and thus a disruption in global trade, finance and growth.
The WESP elaborates extensively on this risk, and I will come back to this point later when I discuss the report’s policy implications.
The second risk is associated with oil prices. Oil prices rose by about 40 per cent on average in 2005. Higher oil prices have no doubt benefited oil-exporting economies, including a number of developing countries. Even for these countries, however, the windfall gains from oil revenues are creating inflationary pressures and an appreciation of the real exchange rate.
Meanwhile, a growing number of oil-importing countries have started to feel the adverse impact of higher oil prices. Many countries initially adopted measures to protect domestic consumers by introducing or strengthening energy price controls and subsidies. These measures are becoming more and more difficult to finance as high oil prices persist. Consequently, the measures are being dismantled and more of the oil price increases is being passed to consumers.
Strong global oil demand has been the key factor behind the rise in oil prices. On the supply side, tight conditions prevail. We expect limited oil supplies to remain a key constraint in the medium term, given under-investment over the past two decades, low spare production capacity and mismatches in global refining capacity. The upshot is that oil prices are expected to stay at around $60 per barrel in 2006. There is a risk, however, that supply shocks will cause further oil price increases, hitting world economic growth more severely than the high prices have thus far. This would be the case whether the shocks arise from the existing supply constraints or from heightened geopolitical tensions, terrorist attacks or natural disasters.
The third risk lies in the booming housing sector, which has been a major driver of GDP growth in a number of economies, with household consumption boosted by significant wealth effects coming from housing appreciation. Yet various housing indicators in these countries are at historical highs, and there are discernible signs of continuing speculative activity. A cooling off in house prices would therefore lead to the moderation of overall economic growth, as already shown in the economies of Australia, the United Kingdom and several other European countries. Moreover, declining house prices would heighten the risk of default on mortgages and could trigger bank crises. A number of these economies are also running large external deficits and have low household savings. This means that a sharp fall in house prices in one of the major economies—especially the United States—could precipitate an abrupt and destabilizing adjustment of global imbalances.
A fourth risk, of a pandemic outbreak of avian influenza, must also be taken seriously into account. The recent outbreak of the avian flu in some countries has already caused significant economic losses and claimed 70 lives. The world is not yet adequately prepared for an outbreak of pandemic proportions, which could have, in addition to its human toll, enormous macroeconomic costs.
Given these prospects for 2006, the report details an array of policy implications. It puts its main emphasis on how to address the problem of the global imbalances. Economists tend to disagree on this question. In the WESP, we take issue with one influential view which considers the financing of the fiscal and external deficits of the US economy not to be a major problem, for the world could be witnessing a so-called “global savings glut”, which is keeping world interest rates low and providing sufficient finance. In fact, as evidenced in our report, the global savings rate, and with it the global investment rate, is at an all-time low, and it has been on a downtrend for several decades. Our analysis suggests that savings surpluses in various parts of the world are caused by a pervasive weakness in non-residential business investment. So we are seeing not a “savings glut”, but, rather, “global investment anaemia”. This means that policy makers should give priority attention to strengthening investment demand, particularly in the surplus countries, in order to sustain global economic growth and reduce the macroeconomic imbalances.
The report questions, at the same time, the effectiveness of a major realignment of exchange rates as a means to adjust the global imbalances. It also examines the policy challenges for the many developing countries facing pressure on their currencies, given their large holdings of foreign-exchange reserves.
On the exchange rate front, let me indicate first that, during 2005, the US dollar rebounded notably vis-à-vis the euro and Japanese yen. This appreciation was not the type of adjustment that might be expected, given the large and increasing external deficit of the United States. Nonetheless, we argue in the report that a massive depreciation of the dollar and further major realignment of the exchange rates among major currencies would not be the best means to achieve an orderly adjustment of the global imbalances.
Because of the sizable US current account deficit, a very large depreciation of the US dollar would be needed to have a visible effect on the trade deficit. But an orderly adjustment of the global imbalances should aim to avoid such a free fall of the dollar. A strong depreciation would erode confidence in the international reserve currency and imply large wealth losses for those holding dollar assets. These wealth effects may well offset the “expenditure switching” effects of dollar depreciation, nullifying the initial impact on the trade balance and thereby seriously endangering the stability of the world economy. Therefore, a sudden and major realignment of exchange rates should not be the centrepiece of the policy response to the risk of a disorderly unwinding of the global imbalances.
At the same time, over the past year, the US dollar has depreciated against the currencies in a number of developing countries. As one result of this, part of the cost of the adjustment of the global imbalances has shifted from developed countries to these developing countries. A number of them have found it difficult to respond to the appreciating pressures on their exchange rates and to the massive increases in their foreign reserve positions. Many have opted for intervening in foreign-exchange markets and sterilizing the excess liquidity, in order to avoid inflationary pressures. But this has often come at the expense of competitiveness, through appreciated real exchange rates.
All this suggests that, in order to mitigate the risk of a disorderly adjustment in the global imbalances, the major economies should coordinate their macroeconomic policies over the medium run, with a major focus on stimulating investment in the surplus countries, while stimulating savings in the deficit countries.
The United States should stimulate household savings and increase public savings by reducing the fiscal deficit. Europe should keep interest rates down to stimulate private demand, as room for fiscal expansion seems limited in most European countries. And more efforts should be made to revitalize investment, which the structural reform policies of recent years have failed to do. In Japan, financial sector reform should continue, and fiscal incentives to stimulate private investment demand should be strengthened further. Most Asian surplus countries should boost public and private investment rates, while China should boost broad-based consumption demand. Oil-exporting countries could increase both social spending and investment in their oil production capacity, while also diversifying their economies.
The effectiveness of this approach will depend on action in these suggested policy directions being taken in a coordinated fashion, among the governments of the major economies. The report suggests that the International Monetary Fund, given its original design, would provide a natural forum for international macroeconomic policy coordination. Of course, for this to work, the governments of the major economies must be willing to support this major departure from present practice. We hope, however, that they will do just that, given the evident danger of disruption in the world economy in the absence of concerted efforts to deal with the imbalances in an orderly way.
Finally, the report also discusses, at some length, recent developments in international trade, finance and development assistance relevant to developing countries.
The results of the Sixth World Trade Organization (WTO) Ministerial Conference at Hong Kong could be qualified as very modest and marginal, yet still positive. The Hong Kong agreement advances the Doha Development Agenda by a few small steps. Completing the Agenda fully and successfully in 2006—and, particularly, materializing the expectations of major enhancement in the development dimensions of the global trade regime—will require from all the participants considerable political will to take the crucial, but tough decisions that remain.
The external financing conditions for developing countries and economies in transition have improved notably during 2005. For emerging economies, the costs of external financing have reached historical lows. But this news should be met with some caution. Exceptionally low risk premiums for external borrowing by these countries may encompass some degree of exuberance, causing excessive capital inflows to some of them and seeding the risk for a sharp reversal in the future.
In practice, total private capital inflows to emerging market economies declined in 2005, even as some components remained strong, such as FDI flows and bond issuance. Overall, when looking at the total flows received by developing countries less the interest payments they make, we find that developing countries, in the aggregate, transfer more resources to developed countries than they receive. This pattern of negative transfers has lasted for about ten years now. In recent years, it reflects the growing trade surpluses of developing countries and is also closely associated with the global imbalances.
Official development assistance (ODA) has recently increased in nominal terms. But—excluding resource flows for emergency assistance, debt relief and reconstruction—the amount of aid received by the LDCs in recent years was only marginally higher last year than a decade ago. We all welcome the commitments by major donors to deliver increased and more effective aid. Nonetheless, even if these commitments are fully met, the share of ODA in the gross national income of DAC countries would reach only 0.36 per cent, still far short of the 0.7 per cent target reaffirmed in the 2005 World Summit Outcome.
In short, while the recent improvement in the economic growth of many poor countries is encouraging, it is still not strong enough for them to achieve the Millennium Development Goals. The WESP calls for galvanizing efforts in all three areas—trade, aid and finance—to support the achievement of the MDGs. At the World Summit, the world’s leaders reiterated their political commitments made at previous high-level international meetings on development issues, particularly the commitments in the Millennium Declaration and the Monterrey Consensus. The challenge now for all countries is to meet these commitments, on time and in full.