Overview of the global economy
Jayan Jose Thomas
WORLD ECONOMIC SITUATION AND PROSPECTS 2008: Academic Foundation on behalf of the United Nations; 4772/23 Bharat Ram Road, (23, Ansari Road), Daryaganj, New Delhi-110002. Rs. 595.
This is an annual publication of the United Nations, which provides an overview of important aspects of the recent economic growth experience in major countries and regions of the world.
According to its latest report, world economic growth in 2007 was marginally slower than in 2006 but was still healthy at 3.6 per cent. A notable feature of the recent growth experience is the slowdown in the United States’ economy, the main engine of global economic expansion over the past decade. The current troubles affecting the U.S. economy have their origins in the indiscriminate lending of housing loans in that country’s sub-prime mortgage market (which serves clients with poor credit histories or insufficient financial resources). Sub-prime lending has resulted in high levels of defaults, especially as demand conditions in the U.S. housing sector have remained stagnant since 2006. In turn, this has led to a deep credit crunch in the U.S., whose effects are felt immediately across the globe.
U.S. financial crisis
Developed countries, including European economies and, to a lesser extent Japan, have been hit by the crisis in the U.S. Developing countries have been affected as well, but they have, nevertheless, managed to maintain robust rates of economic growth. The greater resilience of developing countries is attributed partly to their growing interdependence, driven largely by the fast growth of China and India. In countries across the world, improvement in the employment situation has only been modest.
The report expresses concern at the possibility of a continuing fall in the value of the U.S. dollar. This assessment is based on the prevailing economic situation in the U.S., with large current account deficits and growing indebtedness. Large current account deficit indicates that the U.S. imports much more than it exports; in this way, the U.S. is a large source of demand for industrial products from the rest of the world.
How does the U.S. meet its large current account deficits? The management of its deficits depends, curiously, on the transfer of financial resources from developing countries to the developed world, particularly the U.S. The mechanism works in the following manner. A number of developing and emerging economies are recipients of substantially large private capital flows. Many of these countries, notably China and other East Asian countries, also have surpluses in their current accounts on the strength of their manufactured exports (India, on the other hand, has a deficit in its current account). In these countries, the combination of positive net private capital flows and current account surpluses translates into the building up of large official reserves. Developing country reserves are normally held in U.S. dollar-denominated assets. Such massive reserve holdings of developing countries sustain the growing external deficits in the U.S.
Any further worsening of the economic turmoil in the U.S. will have a severe impact on the rest of the world, according to the report. First, it will slow down the U.S. demand for goods from the rest of the world, depressing industrial growth in developing countries. Secondly, the credit crunch in the U.S. could lead to a drying up of private capital flows to developing countries. Lastly, in the event of further depreciation of the dollar, developing countries which hold official reserves in dollar-denominated assets would suffer major financial losses.
Interestingly, at the time of writing this review, the crisis affecting the U.S. economy has hit a new low, with the collapse of some of the major financial institutions in that country. At the same time, however, the dollar is maintaining its position as the world’s reserve currency and its value has not fallen, belying, so far, the anxieties expressed by the report in this regard.
Capital flows
Policy makers in India should pay heed to the caution expressed by the report regarding future capital flows to developing countries. Given its large trade and current account deficits, any sudden reversal in capital flows will pose serious macroeconomic difficulties to India.
The report devotes attention to some of the recent developments in international trade and finance. It takes note of the impressive growth of trade in services in developing countries. It discusses how countries such as China and Kuwait are increasingly diversifying their reserve holdings into sovereign wealth funds. In sum, the report, which also has a useful statistical annex, will be a valuable document for academicians and policy makers.
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