Several of the sharpest debates about global long-term growth prospects will be settled over the next 12 months Published: January 2 2001 19:45GMT | Last Updated: January 2 2001 19:57GMT This is, for the purist, the first year of the third millennium. As befits such a year, it will be a challenging time for the world economy. The first test is for Alan Greenspan. Views on the chairman of the US Federal Reserve fall into two camps. The larger one believes his institution has mastered macro-economic fine-tuning. The smaller camp believes he has helped create a bubble economy. If the growth of US demand slows smoothly to about 3 per cent, with no big declines in the stock market and a modest depreciation of the dollar, the first group can feel vindicated. If not, it cannot. The second test is of the "new economy". Not long ago, believers thought that the business cycle was dead, profits were irrelevant to technology companies and the US was in the middle of an unparalleled technological revolution. 2000 gave the lie to the first two propositions. But what is the plausibility of the third? Even the Organisation for Economic Co-operation and Development accepts that the potential rate of growth of the US economy is 4 per cent. This implies long-term growth in labour productivity of a little below 3 per cent, close to double the 1973-95 trend. If so, productivity growth should remain robust even during this year's slowdown. The third test is for the US stock market. Those who believe that the US miracle is just another bubble economy point to the extraordinary valuations in the stock market. This, they insist, generated unsustainably high rates of private sector investment and unsustainably low rates of private sector savings. At minus 11.6 per cent, total returns on US stocks last year (with dividends reinvested) were the lowest since 1974. Yet even this was but a modest offset to the staggering 270 per cent cumulative return enjoyed over the previous five years (a compound rate of 30 per cent a year). If the bubble story is right, last year's negative return will be followed by more miserable years. If not, returns will soon be back to positive, albeit presumably more modest, levels than in the second half of the 1990s. What happens in 2001 will indicate which it will be. The fourth test is for the euro. Launched with optimism, it spent almost all of its first two years sinking abjectly against a currency its founders had hoped it would rival. Finally, towards the end of 2000, the euro began to show some strength as the US economy weakened, bouncing back from a low of $0.83 on October 25 to $0.94 by the end of the year. 2001 will indicate whether this is a durable reversal or a temporary respite for what one analyst rudely labelled a "toilet currency". If the former, the euro's proponents would feel great relief. The European Central Bank would also enjoy greater freedom of manoeuvre in response to a sharp slowdown than if the currency had continued to remain weak. A fifth test concerns unemployment in the euro-zone. After years of high and rising unemployment, the trend started to turn in 1997. Since then the unemployment rate has fallen from a peak of 11.7 per cent in 1997 in the euro-zone as a whole to 8.9 per cent in October 2000. Employment rose from 118.5m in 1997 to an estimated 125.4m last year. The test for the European economy is whether it can continue to generate jobs and lower unemployment. This depends partly on how far the ECB stabilises the economy but also on whether the recent rise in the employment-intensity of growth will be sustained. The sixth test is for Japan. Here, yet again, there are polar views: one is that the economy is finally on the mend; the other is that it remains on the critical list, with the semblance of vitality solely explained by unsustainable fiscal transfusions. The optimistic view of Japan rests on an expected recovery in consumption along with increasingly strong investment driven by the adoption of information technology and the need to replace outdated capital. This will more than offset the weakening of the external account as the US economy slows. Meanwhile the fiscal deficit is set to remain unchanged: the OECD forecasts general government financial deficits at about 6 per cent of gross domestic product over the next two years. The counter is partly that the financial sector remains very weak. Worse, just as inflation makes the profitability of net debtors appear worse than it is, so deflation makes it appear better. Smithers & Co, a London-based investment adviser, estimates that the true return on non-financial corporate equity was 2.7 per cent in fiscal year 2000, not the published figure of 6.5 per cent, hardly the ideal backdrop for a needed surge in investment. The underlying challenge remains that of balancing demand with potential supply. This is an economy with a gross national savings rate of about 30 per cent of GDP but it also has a declining labour force, an unprofitable corporate sector and an exceptionally high ratio of capital to GDP. A return to recession this year would force policymakers to try something radically new. The seventh test is for emerging market economies. Russia is particularly intriguing. Goldman Sachs estimates economic growth last year at 7 per cent, after 3.2 per cent in 1999. True, this is a modest turnaround given the huge decline of 44 per cent in the (admittedly defective) measures of GDP between 1989 and 1998. Yet it is at least a sign that the bottom has been reached. Another such year would suggest that the recovery is more than a temporary reversal helped by a jump in oil prices. Also important this year will be whether Turkey remains on its exchange rate peg, how Latin America, particularly Mexico, copes with a US slowdown and whether east Asian economies dependent on US markets are able to sustain their recoveries from crisis. More broadly, the ability of emerging market economies to survive a slowdown in the US will be the clearest possible test of how far they have strengthened after the financial crises of the 1990s. My last test is for the UK. Here everything looks almost bewilderingly healthy, with a strong fiscal position, robust currency, low inflation, modest unemployment and a manageable current account deficit. The International Bank Credit Analyst even described the country as a safe haven in its December review. A turbulent 2001 would show whether the economy has been transformed or not. Yet 2001 will be first and foremost the testing year for the US. Is the world about to witness the popping of a bubble economy or a smooth adjustment from temporary overheating to sustained and rapid growth? If, after a record-breaking nine years of expansion and a modest slowdown the US takes off yet again, we can reasonably conclude that the notion of a new economy is more than mere fool's gold. FT.com _______________________________________________ Crashlist resources: http://website.lineone.net/~resource_base To change your options or unsubscribe go to: http://lists.wwpublish.com/mailman/listinfo/crashlist
