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Reasons for optimism about world economy

Ashley Seager

It looks like continuing a boom that equals the post-war heyday.

THE WORLD economy looks set for another year of robust growth. There are plenty of reasons to be optimistic that the impressive performance of the past few years, since the world emerged from the mess of the dotcom bust, will continue uninterrupted this year and possibly for the rest of the decade. Having grown by an average of more than three per cent a year so far this decade, the noughties look set to be the world economy's best decade on record, eclipsing even the golden years of the 1950s and 1960s.

There are risks of course. Doomsayers continue to warn of a slump in the dollar, a renewed surge in the oil price or a collapse in the housing market in the United States that could throw the world off course. They are right that the risks exist, but the world economy has proved its resilience admirably in recent years.

Booming stock markets

Who would have thought, for example, that the tripling of oil prices in the past three years would fail to tip the world into a recession combined with soaring inflation?

In those three years the world economy has grown by almost five per cent annually — the fastest for more than 30 years. World stock markets are booming as investors show their confidence.

The main reason for optimism is that growth has broadened out from relying on the good old American consumer who, boosted by the ultra-cheap money and rising house prices of recent years, kept the world economy motoring while regions such as the eurozone and Japan were sluggish.

Now both of those regions, along with China and India and other emerging economies, are performing well. They should be able to withstand the slight slowdown that many analysts are expecting in the U.S. In short, the world is rebalancing.

The U.S. economy, still by far the largest in the world, looks certain to slow this year. Its housing market slipped last year and the house price boom of recent years is a distant memory. House-building has slumped, prices are down everywhere and a lot of newly built homes are standing empty. But other parts of the American economy appear to have taken up the slack.

Exports are healthy, thanks to a strong world economy and a weaker dollar; business investment and non-residential construction are also doing well. The Organisation for Economic Cooperation and Development (OECD) expects U.S. growth to slow to 2.4 per cent this year, from 3.3 per cent in 2006. It expects a sluggish first half of the year before a rebound later in the year. It does not predict a U.S. recession, nor does the International Monetary Fund, which is forecasting a growth of close to three per cent for the U.S. this year.

Indeed, the Federal Reserve, which raised interest rates from their low point of one per cent in 2004 to 5.25 per cent last August in an attempt to rein in the frothy housing market and keep inflation in check, still thinks high inflation is more of a danger than slow growth. Last week, news from the U.S. showed that sales of homes had begun to rise again and stocks of unsold homes had started falling. If the housing market recovers, the U.S. economy could even return to surprisingly robust growth in 2007. The Fed looks likely to keep interest rates on hold for the foreseeable future, but it has room to cut them if the economy looks weak.

The eurozone, long the sick man of the world economy, turned in a surprisingly respectable performance in 2006, growing by around 2.6 per cent, well above 2005's rate of 1.4 per cent. The OECD and the IMF expect growth to be closer to two per cent this year and next, partly because the European Central Bank has made it clear it intends to continue raising interest rates from their current 3.5 per cent. That growth rate may sound paltry, but it is decent by the standards of recent years.

Germany has been the particular star in Europe, as its companies have responded to the strong world economy by raising exports, although questions remain about the strength of domestic demand. Wage growth has been sluggish as firms have used the threat of moving production abroad to keep pay rises to a minimum. A rise in value added tax (VAT) today from 16 per cent to 19 per cent is not going to help consumer spending, but is unlikely to derail the economy. Spain and Italy look a little less secure, with the former experiencing a property market bubble which looks vulnerable to a burst while the latter is suffering from a lack of competitiveness and high inflation. There are also some question marks over the strength of the French economy.

Few such doubts exist over China. Its economy is likely to grow by 10 per cent again this year, as it has done for many years, taking it to number four in the world economy ranking. It is now big enough to make its growth matter for the whole world. Taken together, emerging markets including India, Russia, and Brazil now account for 70 per cent of world growth. They accounted for 50 per cent a decade ago. The world is much less dependent on the U.S. than it used to be. Japan, still the world's second largest economy, seems to be recovering steadily from its decade-long slump although there are still concerns about whether its deflation problem has been solved in spite of rock-bottom interest rates of just 0.25 per cent.

Which brings us to Britain, the world's fifth largest economy. Here, too, things look solid. Growth was better than expected last year, at around 2.6 per cent, and the economy looks to have powered into the New Year in rude health. The Bank of England, which raised interest rates twice last year to their current five per cent, may even be tempted to nudge them up again, although I am not convinced it will have to.

The year here is likely to be dominated by the rise and rise of house prices, particularly in London and the south-east. At some point the great noughties housing boom will have to end. Another interest rate rise or two might just be enough to do that, given how indebted the average Briton has become. That could turn out to be the nasty surprise of this year.

There will also be the small matter of a change of the guard at the Treasury, as Gordon Brown looks set to move to Number 10 Downing Street in the first half of the year. His March budget is likely to be his swansong after a decade as Chancellor of the Exchequer.

Rosy scenario

All in all, it is a pretty rosy scenario for the world and one that will allow company profits to keep increasing. The main cloud on the horizon is not the U.S. current account deficit or a potential run on the dollar (it is likely to continue to slide, but not crash) but rather the emerging crisis surrounding Iran. If the country's bellicose leadership continues to defy the United Nations with its nuclear programme and responds to sanctions by carrying out its threat to shut the Straits of Hormuz and prevent a fifth of the world's oil getting to market, the price of crude could easily shoot through $100 a barrel and finally rattle the confidence of world stock markets.

— © Guardian Newspapers Limited 2006

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