The latest views of Morgan Stanley Dean Witter Economists, February 16, 2001
Global: A World Without an Engine by Stephen Roach (New York)
As the US economy slips into recession, the world is left in a very uncomfortable place. The American boom was the driving force behind the global economy in the latter half of the 1990s and into 2000. But now that engine has been derailed. With no obvious candidate to fill the void, there is good reason to wonder whether the $32 trillion global economy will ever revisit its recent glory days.
The numbers leave little doubt of America’s role in driving the world economy in recent years. Over the four-year period, 1997 to 2000, there was a one-percentage point gap between average growth in the US (4.5%) and that elsewhere in the world (3.5%). By our estimates, the direct effects of the American boom accounted for 26% of cumulative world GDP growth over the past four years.
Adding in the indirect effects attributable to the world’s trade linkages with America, and the total US contribution to global growth since 1997 would be a good deal higher -- possibly on the order of 40%.
That was then. Based on our prognosis of a mild US recession in the first half of this year, our latest estimates point to just a 0.9% increase in American GDP for 2001. That represents a 3.6 percentage point shortfall from the average gains over the preceding four years, sufficient in and of itself to knock 0.8 percentage point off total global growth. At the same time, Japan -- the world’s second-largest economy -- has also probably slipped into renewed recession. According to Robert Feldman’s estimates, Japanese real GDP declined in the final two quarters of 2000 and should rise only 0.3% in calendar 2001. Of course, a relapse in Japan does not represent nearly the same type of shock to the world economy that a US contraction would, as the Japanese economy has been mired in relative stagnation for over a decade, with real GDP growth averaging just 1.4% since 1991.
If we’re right on the US and Japan, that would leave the world’s two largest economies -- collectively accounting for 30% of world GDP -- in recession. Even if we’re wrong, I would argue that the upside in both regions is limited -- still leaving a huge portion of the global economy in a very sluggish growth mode. The rest of the world will not be unscathed by weakness in such a large portion of the global economy. The increased cross-border trade linkages of globalization point to significant ripple effects in most regions of the world. After all, the US and Japan together make up about 21.5% of global merchandise trade -- imports and exports, combined.
At the top of the vulnerability list are America’s NAFTA partners -- Canada and Mexico. US exports account for fully 32% of Canadian GDP, and the share in Mexico is 25%. NAFTA’s trade linkages are primarily Old Economy manufacturing, especially motor vehicles. As inventory adjustments to a US demand shortfall are transmitted quickly through the NAFTA supply chain, it’s hard to imagine how Mexico and Canada (accounting for another 4% of world GDP) won’t be hit hard.
The same can be said of non-Japan Asia. With reforms lagging in the aftermath of the wrenching crisis of 1997-98, the region has been unable to generate meaningful support from domestic demand. That means Asia’s trade linkages to the US take on even greater importance. And these linkages are quite significant. US exports account for 26% of Hong Kong’s GDP, 26% in Singapore, 24% in Malaysia, 14% in the Philippines, 13% in Taiwan, 11% in Thailand, and 7% in Korea. Andy Xie, head of our Asian economics team, has estimated that surging exports to the US -- primarily IT -- have accounted for approximately 20% of Asian growth over the past couple of years. As the US IT cycle turns, the globalization of the IT supply chain has led to a dramatic export compression in non-Japan Asia. In most countries, annualized export comparisons went from 20–30% in mid-2000 to single-digit territory by year-end; the comparisons actually turned negative in Singapore and Malaysia. While US trade linkages have been decisive in triggering this export downshift, deteriorating demand in Japan also played a role. Consequently, lacking in support from domestic demand, non-Japan Asia -- another 23% of the world economy -- is also in trouble.
As I scan our global forecasts, I am hard-pressed to find a candidate to fill the "growth void" now being left by the United States. Europe comes closest, but not close enough. Unlike the NAFTA bloc and Asia, Europe’s exposure to US and Japanese demand is limited. US exports account for just 2% of Euroland GDP, and exports to Japan account for less than 1% of the region’s GDP. Moreover, domestic demand in Europe is benefiting from the combined impacts of a fiscal stimulus worth 0.6% of GDP and a structural decline in the unemployment rate. While this speaks of relative resilience of the Euroland economy in 2001, it is not a compelling case for absolute resilience. Moreover, as Joe Quinlan has pointed out, Europe’s relatively small trade linkage to the US could well understate its overall exposure, which is more heavily dependent on the considerably higher earnings dependency of Euro multinationals on American markets. Our current forecast calls for just 2.2% growth in pan-European GDP this year. While that’s more than double the gain we expect in the US, it’s 0.5 percentage point short of the average pace of European economic growth over the preceding four years. With Europe accounting for 21% of world GDP, our 2001 growth forecast works out to a 0.5 percentage point contribution to global growth. That’s only half the contribution that the US economy made over the 1997 to 2000 interval. In short, don’t look for Europe to be the world’s next growth engine.
Maybe this is all just a temporary derailment of the world’s growth locomotive. Indeed, a V-shaped rebound in the US economy -- the scenario still favored by most investors these days -- would certainly bring the magic back for the broader global economy. The great debate over the shape of the US business cycle -- V or U -- is obviously key. I’ve been at this long enough to know that anything is possible. But I continue to believe that the structural excesses in the US economy -- a negative personal saving rate, a record current-account deficit, and a huge IT overhang -- should restrain recovery. A renewed growth spurt, by contrast, would exacerbate these excesses and heighten the risks of a far more deflationary purging down the road. That paints a picture of a U-shaped trajectory for an "engineless" global economy over the next few years. The world is going to have to learn to live with slower growth, and all the stresses and strains that are unmasked in a more sluggish economic climate.
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