The World Economy: Mostly Cruising
By Michael Englund
Despite the sharp uptrend in energy prices -- and the continuing interest rate hikes undertaken by many central banks -- the world economy continues to be characterized by high growth, low inflation, and low "real" (adjusted for inflation) yields.
But the major global players aren't faring equally. Which nations, and regions, are enjoying solid growth -- and which are lagging? We at Action Economics decided to look at the trends at work in the world economy in the context of the most recent global projections from the International Monetary Fund.
First of all, world gross domestic product is poised for a robust 4.4% gain in 2005, in our view. This is just short of the 5% rise in 2004 that marks the high reading in our set of data extending back to 1984. The IMF forecast of 4.3% 2005 growth in its biannual projections released in September is only slightly lower. We expect 4.5% growth in 2006, vs. the 4.4% IMF estimate. The bulk of the discrepancy is due to differences in forecasts for U.S. GDP.
Though the financial press has mostly described global growth this year and last year as mixed, the results for the aggregate "advanced" and "emerging" economies have been anything but. Growth slowed modestly in 2005, but in most countries it remains quite high.
Rapid expansions in China and India, and solid growth in the larger U.S. economy, are driving world GDP, while growth rates in Europe and Japan remain anemic. As shown below, the share of global GDP held by these five largest countries/regions is rapidly shifting. As would be expected, the Chinese economy's share is exploding, largely at the expense of Europe and Japan. India's is rising more slowly, only because the high growth rates in the subcontinent -- up until now -- are from a lower base.
The U.S. is actually losing global share only slowly, because it has a large current size and still a reasonably high growth rate.
The interplay between "high growth" and "large size" is evident when looking at the contribution of these big countries/regions to aggregate global growth. The result is counterintuitive to many U.S. pundits who fear the increasing size of China: The U.S. has added to its economy over the last two years at close to the same rate that China has added to its economy, despite the much higher Chinese growth rate.
In total, the U.S. is "adding a new Australia" each year, and China is doing a bit more than that. Rather than converging, these two economies have been pulling far ahead of other countries in terms of size since the 1980s, though India has been dancing around an impressive third-place growth clip, and will eventually start to gain ground on the U.S.
In the future, the unusually high percentage growth rates of China and India are expected to moderate. And the paths for these large countries, and the U.S., are now being restrained less by domestic productivity and labor-force growth than by the global "supply constraint" appearing in energy markets, where soaring prices are functioning as a throttle to global growth. This drag is being shared globally among high-growth and low-growth countries alike.
Alongside the world economy's apparently still-solid trajectory, inflation appears to be well under control, despite a modest global uptrend led by rising energy prices. In the advanced economies, prices are rising above the rates seen in much of the 1990s, but below those of the decades before that.
This encouraging global-inflation outlook is even more impressive if we include the historically high-inflation countries of the emerging-economy category. The graph below shows global CPI growth, with the IMF's "advanced" and "emerging" dichotomy. And here it's clear that the emerging economies have worked hard to bring inflation under control, just as the advanced economies have recently loosened up on the monetary restraints to price gains. The world consumer price index should rise 4% in 2005, with a mix of a 2.4% gain in the advanced economies and a 5.9% gain in the emerging economies.
As for interest rates, we see Federal Reserve Chairman Alan Greenspan's infamous "conundrum" -- that policy tightenings were failing to boost long-term rates -- in the context of this global moderation in inflation. Of course, the Fed chief has cited other culprits: A global savings glut partly related to the growing size of the high-savings Asian economies, rising foreign central bank holdings of U.S. debt, shifting demographics, and rising pension-fund fixed-income investments.
The graph below shows the global trend in "real" long-term yields in the five major advanced economies. It displays the bond market conundrum as a global phenomenon that gained steam this year. It's equally clear that fears of moderating economic growth haven't played a big role in the global downtrend in "real" bond yields, as GDP growth has posted two back-to-back years of impressive gains. In our view, it's a falling global-inflation rate, and reduced uncertainty in global fixed-income markets, that's a more likely contributor.
In total, world growth slowed modestly in 2005 and is poised for a further modest easing in 2006, though the rate of growth for world GDP remains robust overall. And although the global focus has shifted to surging commodity prices, and energy prices in particular, world measures of inflation suggest that price gains overall remain under control.
While the markets talk about recession risks and soaring prices, the world economy is still best characterized as exhibiting widespread, solid growth, against a backdrop of restrained inflation.
Englund is chief economist for Action Economics