Brace Yourself For A Global Slowdown

On the eve of the G-8 talks, the world economy is roaring along. But a year from now, watch out

When the leaders of the seven richest industrial countries--plus Russia--get together in Tokyo on July 21, expect a lot of talk about economic growth. Most of it congratulatory, if a recent meeting of the Group of Seven finance ministers is any indication. At that gathering on July 9, one minister after another remarked upon the happy state of the world economy. "I think we're really on to a period of sustainable growth," said Canadian Finance Minister Paul Martin. Added Germany's Hans Eichel: "If the U.S. economy slows, I see a chance for the European Union to take over as the locomotive of world growth." Even Japan's Kiichi Miyazawa, cheered by surprisingly favorable economic data released recently, looked confident.

They may not be as pleased with themselves a year from now, though. A global slowdown is likely to be in motion by then. Judging by the latest employment statistics, that's already happening in the U.S., where the days of blistering growth of 6% are over and rates of 3.5% to 4% are more likely from now on. And the odds are that Europe's economy will be less vibrant than Eichel expects: It will grow by at least 3.75% this year, but probably only by 3.5% the next. That's not enough to take up the slack from the U.S.--especially if the Federal Reserve Board continues to push up rates and dampens growth more quickly than expected. Meanwhile, it will be years before Japan is strong enough to pull the rest of Asia, let alone the rest of the world, along with it. So, while the global economy may grow by at least 4.5% in 2000, its fastest clip in more than a decade, chances are that it will fall back to 3.5% in 2001.

One reason for the slowdown is the 170% rise in the price of oil since January, 1999. That will almost certainly dampen growth and boost inflation, especially in Europe, where the euro's weakness makes oil imports, mainly priced in U.S. dollars, even more expensive. And analysts don't expect that Saudi Arabia's plans to increase output will help much, at least in the short term. They calculate that businesses relying on oil, such as British Airways and Dutch freight company TNT Post Group, could see their profit margins narrow by some 15%.

NEW ECONOMY? As a result of costlier energy, Europe's inflation could reach a 2.2% annual clip this month--well above the 2% rate the European Central Bank says is the limit for price stability. Europe Inc. fears that would push the ECB to raise rates to levels that curb the Continent's 15-month-old recovery. "Further rate rises are the last thing we need," says the deputy chief executive of one of Germany's largest retailers. "Although domestic consumption is reasonably strong, it could be undermined if the cost of borrowing goes up much more."

Trouble is, the ECB doesn't believe that a U.S.-style New Economy--in which technology-driven productivity increases allow faster growth without inflation--exists in Europe. "It is difficult as yet to find evidence of a New Economy in the euro area," said ECB President Wim Duisenberg on July 5. "And an inappropriately lax monetary policy would not create better conditions for the emergence of a New Economy." As a result, the ECB fears that inflation could be fanned if growth is faster than 2.5% for long.

That's not to say European labor productivity isn't improving. Indeed, economists predict it should increase by more than 2.5% this year. Italian ceramics manufacturer Gruppo Ceramiche Ricchetti, for example, says it raised productivity 10% this year with a reorganization. MeritaNordbanken, the Finnish-Swedish bank, foresees an equally big increase thanks to the growth of its online business.

Still, some argue that this surge owes more to the economic upswing than more efficient working practices. "That's exactly what you'd expect at this stage in the cycle, when output has been growing strongly," says Jurgen von Hagen, professor of economics at the University of Bonn. "It doesn't mean that the rate at which growth becomes inflationary in Europe has changed."

The ECB has already pushed up its key refinancing rate to 4.25% and will likely raise it an additional 0.5% this year. That wouldn't be such a problem if the economy really were going to speed along. But it isn't. Giampaolo Galli, director of Economic Research at Confindustria, the Italian employers' federation, says Europe's fast growth is due mostly to exceptional circumstances that have boosted exports: America's spectacular performance, Asia's strong recovery from financial crisis, and the euro's weakness. Without those, the recovery looks more fragile. "The ECB has been over-tightening," says Janet Henry, a global economist at HSBC Group in London. "It is reacting to data as they are released rather than thinking a year ahead. The economy is going to be squeezed in [late 2000] as a result."

There are other impediments to growth in Europe, as well--namely, politicians. The Continent's leaders haven't put in place many of the labor and fiscal reforms needed to generate high, sustainable growth without inflation.

And if Europe isn't in a position to lead global growth, Japan certainly won't be anytime soon. It's true that most private-sector economists have upgraded their growth forecasts for Japan from around 1.2% to 1.8% this year, and to 2% or more in 2001. But that's hardly powerful enough to have much impact globally. Besides, even that modest figure could be optimistic.

And if it's not, Japan's growth will still come at a cost. The newly reelected government says it will stimulate the economy with a spending package of up to $30 billion this fall. This even though it already is saddled with a huge level of public debt--equivalent to 10% of gross domestic product--and faces serious public hostility to the idea.

PERFECT WORLD. But deflation is still the order of the day in Japan. Core consumer prices in Tokyo slid by 1% year-over-year in June, for example. Banks are lending less money this summer than last. Consumer spending fell by 0.4% in May from the previous month. That may not prevent the Bank of Japan from abandoning its zero-interest-rate policy, though, possibly at its next meeting on July 17. Such a move shouldn't kill the nascent recovery, say executives. But it could limit growth. Consumer-electronics companies such as Toshiba Corp. and Sony Corp., for example, would be vulnerable to a further downturn in retail demand. Heavy industrial companies, such as Kawasaki Steel and Sumitomo Metal Industries, would be affected by the expected slowdown in corporate investment.

In a perfect world, say business executives, the U.S. economy would slow just as the euro zone is moving into top gear. Then, Japan would get up to speed a year or so later, when Europe begins to slow. Unfortunately, that isn't going to happen--no matter what G-7 finance ministers say.

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