To listen to the economic forecasters, all is sunny on the global front. The International Monetary Fund, which released its latest projections on Sept. 19, is predicting that the world economy will grow by 4.7% in 2000. That's up substantially from the IMF's last forecast in May and would be the fastest rate in 12 years. The growth acceleration is spread across the entire world, with Europe, in particular, expected to expand at a pace not seen since the 1980s. And the IMF is not alone: Most other forecasters are equally upbeat about growth this year.
MINOR OBSTACLES. Yet beneath the surface, vulnerabilities lurk in every corner of the world economy. In the U.S., the tech sector seems to be losing a bit of its vigor, sending the stock market down and raising uncertainty about growth in the second half. Corporate profits, too, seem to be dampening. Capital investment, retail sales, and industrial production weakened in the largest European economies over the summer. Stock markets are plunging across much of Asia. And all this is happening against a backdrop of soaring oil prices, a plummeting Euro, and a global financial system that is no more stable than it was in 1997 and 1998, when it was wracked by a series of economic shocks.
To be sure, all these events may be nothing more than minor obstacles in the steady march of global prosperity. Indeed, that's what most forecasters believe. Yet over the past decade, economists have systematically underestimated the potential for wide swings in growth, missing both the U.S. boom and several economic crises, including the great Asian bust of 1997. The question now is whether the world economy is exposed to stresses that have the potential to erupt into real problems.
To understand the prospects for global growth, the first place to look is the U.S. Even with the expansion in Europe, the IMF forecasts that the U.S. is expected to account for almost 65% of the growth in the G-7 countries this year. Moreover, the U.S. expansion is still mainly driven by technology spending, with roughly one-third of its growth in the first half coming from the tech sector.
But U.S. tech companies are starting to see signs of a weakening in their extraordinary growth pace. For one, new orders for information technology equipment have flattened out in recent months. In the three months ending in July, info-tech orders rose by only 0.9%, according to figures from the Census Bureau, compared with a 5.5% increase in the previous three months (chart). Meanwhile, investors have pulled back from a broad range of hardware, software, and Internet companies in the last month. Layoffs and closings at dot-coms continue, and the troubles have spread to the telecom sector as well. On Sept. 20, Sprint announced that its third-quarter earnings would fall short of estimates. That came on the heels of an announcement from ICG Communications Inc., a small provider of telephone and Internet services, that lower revenue and profit expectations were forcing it to cut back on expansion plans.
SUMMER BREAK. The tech sector could still bounce back from this lull, just as it has several times before. But the weakness in the Nasdaq has made it much more difficult to raise funds for many new businesses. Other promising technologies, such as broadband and wireless, have not yet proven that they can generate enough revenues and profits to justify the enormous capital expenditures. Meanwhile, the price of information technology equipment, as measured by the Commerce Dept., rose in the first half of 2000, after falling at a 7% annual rate for the previous four years. This trend, if it continues, will substantially reduce the incentives for companies to put money into information technology.
If U.S. tech demand falters, will Europe be able to pick up the slack? Perhaps--though recent events are not encouraging. The New Economy runs on capital spending, but gross investment in the European Union--including both business capital spending and residential construction--was basically flat in the second quarter (chart). That may be one of the factors driving down the euro, since European companies are funneling their funds into the U.S., rather than investing at home.
But it's not just investment that is weak. On several different dimensions, growth seems to have taken a break during the summer in Europe. In France, the gross domestic product growth numbers for the second quarter, released Sept. 7, fell significantly short of expectations. The same was true for Italian growth. Industrial production across the euro zone fell in June, even as the latest downward revisions show that German manufacturing orders were virtually flat in June and July. The German index of business sentiment has dropped for three months in a row, while German retail sales are weak as well. "We definitely don't see signs of a booming retail climate," says Carsten-Patrick Meier, director of German economic research at the Institute of World Economics in Kiel. "Real incomes are growing too slowly."
Indeed, there's a growing sense that European growth, while still around 3.5%, probably topped out in the first half. "The second half won't be as strong, " says Meier. "We've probably seen the high point."
EARNINGS WARNINGS. The flattening of European growth, combined with the weak euro, will filter back to the U.S. in the form of falling exports and weaker profits for multinationals. Already U.S. exports to Europe fell sharply in July, while a parade of U.S. consumer multinationals led by Gillette, and H.J. Heinz have issued warnings that the collapsing euro will drag their profits below Wall Street's expectations. The pain could hit hard at companies such as McDonald's and Coca-Cola, as well as affecting technology providers such as JDS Uniphase, Novell, and Autodesk, which generate 30% or more of their sales from the Continent. "The weakness of the Euro is going to catch up with a lot of companies," says Electronic Data Systems Corp. CEO Richard H. Brown.
On the other side of the globe, Asia can't yet be expected to provide the motor for global growth. True, thanks to its manufacturing prowess, East Asia has been able to ride the wave of high-tech demand from the U.S. and the rest of the world, leading to an unexpectedly rapid recovery from its 1997 economic crisis. The World Bank is projecting that Korea, Malaysia, Hong Kong, and Singapore will all grow in excess of 8% this year.
But one of the lessons from the 1997 financial crisis was that rapid growth does not provide protection against problems in the financial system. In Korea, for example, local banks are still in trouble nearly three years after the country sought an international bailout in December, 1997. The government has spent some $83 billion to buy bad debts and bolster capital in the past two years, but some $100 billion of loans are still regarded as bad. Nearly a quarter of all manufacturing companies don't make enough money to service their debt. What's more, the collapse of the Ford Motor Co. deal to buy debt-ridden Daewoo Motor Co. points out the tremendous amount of work left to do. "Korea is not yet out of its debt crisis, but the government is not moving quickly to resolve the problem," says Park Kyung Suh, finance professor at Korea University in Seoul.
FALLING CHIP PRICES. And the very dependence on high-tech will cause problems if tech demand weakens at all. Already flattening demand for dynamic random access memory (DRAM) chips have caused prices to fall. That's sent shares of Samsung Electronics Co., the world's largest memory-chip maker and a leading tech company in Korea, plunging sharply in the past month. Similarly, the share price of the Taiwan Semiconductor Manufacturing Co., one of the world's leading makers of chips, is down almost 20% in just the last month.
Indeed, the combination of troubled financial systems and the uncertainty of the tech demand has been driving down most of the Asian stock markets. The Korean stock index plunged by 45% this year, while the country's dot-coms have been pounded by the collapse of the tech-laden Kosdaq market, which has fallen 70% from its peak in March. Meanwhile, the Taiwan stock market is down 15% over the last month alone.
All this turmoil is taking place at a time when oil prices have soared higher than anyone could have predicted. The rising price of crude hits especially hard in the Asian countries, which are still recovering from the 1997 crisis. The energy price hike also has the effect of forcing oil-consuming nations to boost energy spending at the expense of investment. The net effect would be a long-term drag on global productivity gains.
Perhaps hardest to judge is the health of the global financial system itself. While there is no obvious immediate problem, it is clear that the system is under tremendous stress. The huge imbalance of money flowing out of Europe and Japan into the U.S. is the prime culprit. Net foreign financial investment in the U.S. ran at a $414 billion annual pace in the first half. Unfortunately, if the tech-driven New Economy slows and the U.S. stock market drops substantially, this flow could reverse. That would open up the possibility of an "abrupt adjustment" in equity markets, as the IMF warns in its just-released economic outlook, that could badly hurt the world economy.
One of the things that the tumultuous events of the 1990s should have taught is humility. It's usually when things look the brightest that it is time to start watching for the storm.