Each May and November the Organization for Economic Cooperation and Development issues economic forecasts for its 30 members. Forecasts for 2005 and 2006 were updated while a forecast for 2007 was issued for the first time. And while the organization was upbeat in its outlook for all of its members, it warned that the global economy was still fragile and needed to be handled with care.
OECD refined its 2005 and 2006 forecasts for many of the 30 countries that make up its membership and added its first look at 2007. Two issues have impacted these forecasts in the past year - the (now) rising value of the dollar and the stabilizing but high price of crude oil. The dollar has gained despite the twin trade and fiscal deficits. The deficits are usually a red flag in the currency markets but the dollar has gained on the widening interest rate spread between interest rates in Europe and Japan. The price of crude reached its low point in February 1999 ($11.38 per barrel) and has been climbing in fits and starts ever since, reaching to a high of over $70 a barrel in the aftermath of Katrina. At this writing (December 5, 2005) crude is about $60 a barrel and fluctuates on the weather reports for the northern hemisphere winter.
GDP growth disparity continues
Third quarter 2005 growth was an improvement over the soft patches earlier in the year. As a result, 2005 forecasts for Australia, Japan, Canada, Italy and France have been revised slightly higher while forecasts for remaining Group of Seven countries have been nudged lower. Only the U.S. forecast remained unchanged. And into 2006, only the EMU forecast has been lowered.
To illustrate the wide range of worldwide growth rates, the first two graphs below show recent year-over-year gross domestic product (GDP) growth rates for the major industrialized economies. In the first graph are the United States, Britain, the European Monetary Union and Japan. The second graph includes the EMU's three largest economies - Germany, France and Italy - plus Australia and Canada. The third graph shows the November 2005 OECD forecasts for the G-7 and Australia. Although the graph shows a point forecast, a more prudent approach would be to consider a range around that point.
Europe continues to be the weak link
EMU - The European Monetary Union (EMU) which encompasses 12 national economies but relies on the big three - Germany, France and Italy - continues to lag the U.S., UK and Japan in GDP growth. Part of the problem is structural, especially in the labor markets. But another part of the problem is the dichotomy between fiscal and monetary policy. While the European Central Bank (ECB) is responsible for monetary policy, fiscal policy is left to 12 individual governments who do not always see eye to eye with the ECB. Fiscal restraint has been thrown to the wind in favor of fiscal stimulus, with the result that deficits for the major EMU countries are in excess of 3 percent of GDP as required by the Growth and Stability Pact that sets fiscal standards. Of the big three, France is currently performing better than either Italy or Germany. OECD's projections for the EMU are for GDP to rise 1.4 percent in 2005, 2.1 percent in 2006 and 2.2 percent in 2007.
The OECD based its 2006 and 2007 forecasts for the EMU on a moderate pick-up in business investment thanks to improving foreign and domestic demand. Europe, and especially Germany, would have to find more domestic demand to achieve higher growth. However, some stability in oil prices and exchange rates is a must also. This in turn would allow the eurozone to start catching up with more vigorously growing economies.
While some progress has been made, many of Germany's economic ills can be traced back to reunification in 1989-90 when appropriate economic policies to deal with its aftermath were not developed. Progress has been made in structural reforms especially in the labor market, but Germany's reliance on exports to stimulate its economy has not helped stir the still moribund level of domestic demand (even though there are signs that investment is strengthening). OECD expects that GDP growth should pick up to 1.1 percent in 2005, 1.8 percent in 2006 and 1.7 percent in 2007.
France has been more successful in introducing structural reforms (such as the 35-hour workweek) and has promoted growth, competitiveness and employment. Despite this, the economy sank into a recession thanks to sinking exports and weaker domestic demand. And a massive August 2003 heat wave and drought depressed demand further. Growth slowed in the second half of 2004 but the upswing resumed in 2005 and should continue in 2006 despite weak employment gains that will have little impact on unemployment. GDP is projected to grow 1.6 percent in 2005, 2.1 percent in 2006 and 2.2 percent in 2007.
Italy's recession ended in the spring of 2005. Domestic demand has been stimulated by employment, disinflation and fiscal ease along with supportive monetary conditions. Exporters are benefiting from the weaker euro as well as recovery elsewhere in the EMU. OECD thinks that the pass through of higher oil prices will limit the recovery in 2006, but as these effects dissipate, household consumption should help growth in 2007. The OECD envisages 0.2 percent GDP growth for 2005, 1.1 percent in 2006 and 1.5 percent in 2007.
The UK economy continues to slow largely due to weaker consumption related to the end of the boom in house prices. But strengthening investment and exports should provide stimulus for the economy. Employment remains high and unemployment remains low and the economy continues to operate close to capacity even though manufacturing continues to stumble. OECD sees 1.7 percent growth in 2004, 2.4 percent in 2006 and 2.7 percent in 2007.
Asia thrives on exports, Australia on domestic demand
Australia's economy slowed markedly in the last quarter of 2004 and the first quarter of 2005 as higher interest rates bit into the bubbly housing and construction markets, which in turn had boosted domestic spending. Relatively low mortgage rates had boosted residential construction, which spilled over to more purchases of household furnishings and electrical appliances. The Reserve Bank of Australia raised interest rates in both November and December 2003 in an attempt to reign in the over exuberant housing market and consumer spending. The first half of 2005 was buoyed by business investment. The close to insatiable lust for commodities especially in China boosted demand for Australian products while the rising Australian dollar made the country's exports more expensive especially in the U.S. OECD is bullish in their forecast for Australia. GDP is projected to grow 2.6 percent in 2005, 3.2 percent in 2006 and 3.6 percent in 2006.
Japan's economy staggered in the fourth quarter of 2004 and the first quarter of 2005. Exports suffered from the rising yen (at that time) and slower Chinese growth. However, the yen has been falling of late, much to the glee of government officials and exporters. The yen's decline has been based primarily on the ever-widening spread between Japan's zero interest rates and the steadily rising rates in the United States. Japan imports virtually all of its crude oil, but despite this upward pressure on prices, deflation continues unabated. The export boom has masked many problems in the domestic economy that need to be addressed. However, the Bank of Japan thinks it sees the end of deflation and the resumption of a more normalized monetary policy as soon as mid-2006. Third quarter GDP was up 2.9 percent when compared with last year. Japan is projected to grow at 2.4 percent in 2005 and 2.0 percent in both 2006 and 2007.
Americas - Canadian and U.S. economies flourish
The Canadian economy has been resilient despite its appreciating currency and is operating at near full capacity. And the economy is expected to operate close to potential in the next two years. A slowdown in the domestic economy is expected to be offset by rising prospects in global markets. Third quarter GDP was up 2.8 percent on the year as the economy picked up steam thanks to strong international demand for its commodity exports especially crude oil. The appreciation of the Canadian dollar against the U.S. dollar has thus far not been a deterrent to growth, although there have been some recent signs that the dollar is affecting manufacturers. GDP was forecast to be up by 3.0 percent in 2005, 3.2 percent in 2006 and 3.1 percent in 2007.
United States growth has been vigorous thanks to still stimulative monetary and fiscal policies. The U.S. remains the driver of worldwide growth with its voracious appetite for foreign goods. Exporting countries such as Japan and Germany are especially dependent on the U.S. to revive their economies given the weakness of domestic demand. And U.S. consumers have done their part by maintaining demand for imports of consumer goods. International markets continue to fret over the twin deficits - trade and fiscal - but have been focused of late on the widening spread in interest rates between the U.S. and the EMU and Japan. GDP is expected to grow 3.6 percent in 2005, 3.5 percent in 2006 and 3.3 percent in 2007.
Bottom line
The forecasts are basically good news for investors - the worldwide economy has not only turned the corner but is experiencing a sustainable recovery despite lingering problems and risks. Assuming no exogenous events, growth should continue to pick up during 2006.
The important thing for Asia and Europe is that they proceed with badly needed structural reforms despite the recovery. Japan, where growth is faltering, has to continue to reform its debt-plagued banking sector and somehow end virulent deflation. It has to expand on export gains to include other critical sectors of its economy - investment, employment and finally consumption. Europe needs to continue to reform its sclerotic labor sector and change antiquated market rules to stimulate domestic demand and take pressure off of their export sectors.
And the U.S. has to find a way to finance its twin deficits so they are more manageable and less of a problem for foreign investors. At present, the deficits are being financed in large part by Asian nations who are buying Treasuries with extra dollars earned from exports.
Although China is not a member of the OECD, it would seem inconceivable to omit the country given its huge role in feeding world growth today. The momentum of this recovery will benefit from continued Chinese dynamism and vitality. Economic activity continues to expand at a rapid pace following a desirable slowdown during the first half of the year.
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