Each May and November the Organization for Economic Cooperation and Development issues economic forecasts for its 30 members and selected emerging economies. Prior forecasts for 2006 and 2007 were updated while a forecast for 2008 was issued for the first time. The organization was upbeat in its outlook for its members. It opined that the world economy is facing a rebalancing of growth across OECD regions. Indeed, recent data have pointed to slower activity in the United States and Japan, while at the same time Europe has gathered speed. The OECD area has benefited from a prolonged period of non-inflationary growth despite rising oil and commodity prices. Persistent wage moderation has provided for both price stability and strongly rising profits as well as vigorous job creation in the main OECD regions. However, inflationary pressures have now been gathering in many countries including the U.S., UK and Australia.
The OECD notes that year-on-year growth rates in the U.S., the eurozone and Japan are currently healthy and almost identical for the first time in six years. Even more encouraging than balanced growth rates in the world's large economies, Chief Economist Jean-Philippe Cotis says there are tentative signs that the threat from global trade imbalances is decreasing. The OECD did not say that risks to the world economy have disappeared, but that developments in the past six months have encouraged it to think that an orderly unwinding of imbalances is now more likely.
OECD refined its 2006 and 2007 forecasts for many of the 30 countries that make up its membership and added its first look at 2008. Two issues have affected these forecasts in the past year - inflationary pressures and the dramatic slowdown in the U.S. housing market. In its twice-yearly Economic Outlook, the organization said it now expects 2007 growth of 2.5 percent in the OECD area, down from May projections of 2.9 percent. But for 2008 it is forecasting a bounce back to 2.7 percent.
GDP growth disparity lessens
Third quarter 2006 growth improved after the soft patches that occurred earlier in the year for most countries. Rather than a major slowdown, evidence points to a rebalancing of growth across regions. The graph below shows that while U.S. and Japanese growth eased in successive quarters, the UK regained strength and the eurozone finally began to show positive growth. As a result, the U.S. forecast has been lowered for 2006 while that of the eurozone has been lifted.
To illustrate the narrowing spread between 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 is no longer the weak link
The European Monetary Union (EMU) which encompasses 12 national economies but relies on the big three - Germany, France and Italy - has finally begun to pick up steam. While structural problems especially in the labor markets still exist, unemployment rates have been declining steadily since May 2005. Part of the EMU's difficulties lie in 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. And they have been quite vocal in stating their opposition to the ECB's interest rate increases. Fiscal restraint was thrown to the wind in favor of fiscal stimulus as growth eroded. As a result, deficits for the major EMU countries were over the 3 percent of GDP limit as required by the Growth and Stability Pact that sets fiscal standards for the EMU. Of the big three, Germany overtook France in third quarter GDP growth while Italy still lags behind.
The OECD has based its 2007 and 2008 EMU forecasts on a pick-up in business investment, which in turn has benefited from improving foreign and domestic demand. However, OECD expects private consumption to underpin the recovery going forward, with business and residential investment playing less of a role than currently. OECD offered support to the EMU. It advocates the removal of monetary stimulus should the recovery remain strong. It also forecasts deficit reductions in Germany, France and Italy to below the mandated 3 percent level. OECD's projections for the EMU are for GDP to rise 2.6 percent in 2006, 2.2 percent in 2007 and 2.3 percent in 2008.
Germany has finally entered a sustainable economic recovery and is expected to grow above its potential during the forecast period. Growth is expected to slow in 2007 following a January 1 increase in the value added tax (VAT). Consumption is expected to replace investment and exports as the main growth driver as unemployment continues to decline and real incomes increase. A contributor to improved consumption should come from the expansion of retail shopping hours in Berlin (a move that is expected to spread over the entire country). The deficit is expected to fall below the 3 percent of GDP ceiling in 2007 and 2008. OECD expects that GDP growth should pick up to 2.6 percent in 2006 but dip to 1.8 percent in 2007 (because of the VAT increase) and perk up to 2.1 percent in 2008.
France has been more successful in introducing structural reforms (such as the 35-hour workweek) and has promoted growth, competitiveness and employment. Even though growth stalled in the third quarter it is expected to regain momentum during the forecast period. With firmer growth, unemployment is expected to continue its decline while wage growth is likely to pick up. The government deficit here is expected to decline as well. GDP is projected to grow 2.1 percent in 2006, 2.2 percent in 2007 and 2.3 percent in 2008.
Italy's recovery in 2006 ended over four years of stagnation. The main stimulants have been strong export growth, easy credit, reform-led employment growth and overall improving confidence. The OECD envisages 1.8 percent GDP growth for 2006, 1.4 percent in 2007 and 1.6 percent in 2008.
The UK economy continues to grow thanks to buoyant domestic demand. But strengthening investment and exports should provide additional stimulus for the economy. Labor force growth has been driven by high immigration and a high participation rate. These two factors have combined to push the unemployment rate up after years of ultra-tight labor market conditions. The economy continues to operate close to capacity even though manufacturing continues to stumble. The UK continues to perform better than the EMU. OECD sees 2.6 percent growth in 2006, 2.6 percent in 2007 and 2.8 percent in 2008.
Asia thrives on exports, Australia on domestic demand
Australia's economy slowed markedly in 2006 as higher interest rates bit into the bubbly housing and construction markets. 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 has raised interest rates by 75 basis points to 6.25 during 2006 as higher inflation took hold. Third quarter CPI was up 3.9 percent on the year and above the RBA's inflation target zone of 2 to 3 percent. Affecting prices and growth has been the devastating drought that has cut sharply into agricultural production. Partially offsetting this has been the close to insatiable lust for commodities especially in China. This has boosted demand for Australian products while at the same time, the rising Australian dollar made the country's exports more expensive especially in the United States. GDP is projected to grow 2.6 percent in 2006, 3 percent in 2007 and 3.4 percent in 2008.
Japan's current economic recovery is now the longest in post-war history. Business investment has been helped by record corporate profits and private consumption. Exports especially to China and the U.S. continue to make a major contribution to growth as well. OECD proffered advice to the Bank of Japan. It said that the BoJ should not increase interest rates until inflation is firmly positive and the risk of renewed deflation is negligible. The organization also recommended that the Bank increase the lower limit of its price stability range, which is currently zero to 2 percent. Third quarter GDP was up 2 percent when compared with last year. Japan is projected to grow at 2.8 percent in 2006 and 2.0 percent in both 2007 and 2008.
Americas - Canadian and U.S. economies flourish
The Canadian economy has been resilient despite its appreciating currency and is operating near full capacity as demand for its commodities including crude oil continue apace. The economy is expected to continue to operate close to potential. Third quarter GDP was up 2.5 percent on the year 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 signs that the dollar is affecting manufacturers. OECD advises the Bank of Canada to keep its policy interest rate stable as long as wage pressures remain subdued. GDP was forecast to be up by 2.8 percent in 2006, 2.8 percent in 2007 and 3.1 percent in 2008.
United States growth has been vigorous thanks to stimulative monetary and fiscal policies. While the U.S. no longer leads the Group of Seven in growth, it remains a 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 keep their reviving economies on track. 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 narrowing spread in interest rates between the U.S. and the EMU and Japan. GDP is expected to grow 3.3 percent in 2006, 2.4 percent in 2007 and 2.7 percent in 2008.
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 on an even keel in 2007.
The important thing for Asia and Europe is that they proceed with badly needed structural reforms despite the recovery. Japan, where growth weakened perceptively in the third quarter, has to somehow ensure that the deflationary cycle has ended. The country's export induced gains have spread to include investment, employment and to a lesser degree domestic consumption. Although progress has been made, Europe needs to continue to reform its sclerotic labor sector and change antiquated market rules to stimulate domestic demand and take pressure off of export sectors. In Germany, Berlin took the first step in liberalizing retail trading hours.
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