Global economic prospects for 2008

Author: Countries and Consumers

Date published: 1 Feb 2008

The global outlook changed markedly during the second half of 2007. The world economy has entered an uncertain period. Difficulties in the US housing market are proving to be unexpectedly severe while the disruption of credit is having a much wider impact than expected. Although the fallout from recent events is not expected to be of a lasting nature, they will have an uneven impact both in a geographical and economic sense. This article singles out five key parameters of the global economy and briefly describes their likely behaviour during 2008. The expected consequences for each of the world's major regions are also discussed.

The world economy will grow more slowly in 2008 than at any time in this decade.

According to the IMF, the world economy grew by 5.2% in 2007 but the rate will drop to around 4.8% in 2008. For the first time, several large emerging economies – China, India and to a lesser extent Russia and Brazil – will become the main drivers. Growth in the world's more advanced economies will be the hardest hit with GDP increasing by only about 2.2% in 2008 (the slowest rate of annual increase during this decade).

On average, the world economy will experience only moderate rates of inflation in 2008 but some regions and large economies will see substantial price increases.

The consensus is that the global rate of inflation will be about 3.6% in 2008 but the probability of larger increases is growing even in rich countries. Volatile oil markets, the rising cost of food, poor climatic conditions in some parts of the world and strong gains in domestic demand in several emerging economies are all threats.

The process of globalisation will continue to provide benefits in terms of world growth but the negative consequences will become increasingly apparent.

In the past, globalisation has operated in a comparatively benign environment with low inflation and fairly stable private capital flows. The world economy, however, is ill-prepared to handle some of the economic shocks that inevitably accompany this process. The rising inequality attributed to globalisation requires better training, education and social services to ensure that workers have access to well paying jobs. The drawback is that the remedy is a long-term one while the problem is of immediate concern.

Energy prices will continue to edge upward in the medium term with the price of natural gas rising somewhat faster than the price of oil.

An unexpected disruption in supplies (either as the result of a natural disaster or conflict) is the most significant risk. The re-emergence of state-controlled energy companies as major players in global energy markets could spark a new race to gain control over more sources of supply.

Foreign direct investment (FDI) will continue to rise with greater involvement by firms in developing countries.

Global flows of FDI have been steadily increasing for several years. The pace is expected to slow in 2008 but further increases are still anticipated.

North America:

The US economy is expected to perform poorly given the problems in the housing and financial markets. Washington expects growth to be slightly less than 2% but many analysts believe this is too optimistic. Canada will feel the effects of financial and trade spillovers from the USA.

Energy security has become a major concern for American policy makers. Canada's economy will have to deal with similar problems in the medium term although its oil output could rise by more than 50% by 2015 as a result of new plans to boost production from oil sands.

The region will continue to be one of the most favoured markets for inflows of FDI. Cross-border investments involving both Canadian and American firms are expected to increase. Almost all this investment will be driven by market-oriented activities, knowledge-intensive manufacturing industries and high-value-added service activities.

Latin America:

Mexico is the economy most vulnerable to a downturn in the USA. Approximately 30% of the Mexican economy depends on a mixture of remittances, exports and tourism from the USA. Brazil, the region's largest economy, is less vulnerable to events in financial markets but it, too, will see slower growth in 2008. The outlook for Argentina, the region's other large economy, is even more precarious, stemming from structural problems which hinder productivity growth, an excessive dependence on volatile external factors and a chaotic energy sector.

The investment outlook for Latin America is less promising than for Asia or the industrialised world. More FDI is expected to move into Brazil, driven by a combination of factors including the large domestic market, cheap labour and an improving investment climate. Mexico should also see some gains in inflows of FDI but in many middle-sized countries the investment environment could become more hostile to foreign capital.

Western Europe:

The overall pace of growth will weaken in 2008. A number of large European banks are now known to be embroiled to a substantial degree in the US sub-prime mortgage problem. The European Central Bank has loosened policy significantly but domestic demand is still expected to weaken. Investment, however, is still strong and should maintain its momentum in 2008.

Energy security is a pressing issue for Western Europe particularly in view of its increasingly tense relationship with Russia. These fears have led policy makers to reopen the debate over nuclear issues. Natural gas is becoming an increasingly important source of energy.

Western European countries are favoured targets for investment in a large number of projects in biotechnology, software, health products and the service sector. FDI will continue here because of the high quality of labour, access to financial markets, effectiveness of governments and stability of the business climate. However, many economies are handicapped by their relatively high labour costs and moderate growth prospects. Some must also deal with relocation pressures on labour-intensive industries, and the need to make up for lost jobs in traditional manufacturing by shifting to innovative and high-value-added operations.

Eastern Europe:

The economies of Eastern Europe are expected to grow at a healthy pace in 2008 but slower than in earlier years of this decade. Russia's economy should continue to expand at a solid pace while the benefits of accession-inspired reforms should bolster investment and growth in Bulgaria and Romania, both of which joined the EU in 2007.

New members of the EU including Hungary, Poland, Slovakia, Romania and Bulgaria are attracting interest among foreign investors in textiles and garments, household electronics, automotives and other consumer goods. The Ukraine will become an increasingly appealing target for investors in natural-resource related industries. Several Central European economies are also beginning to gain the attention of investors looking for new locations for customer service operations. In the past almost all this investment went to India and to a lesser extent the Philippines.

Asia Pacific and Australasia:

This region should see the fastest growth in 2008. Economic gains in China are led by strong investment and net exports while India's economy is driven by buoyant domestic demand. Labour productivity in many Asian countries is significantly less than in the industrialised world, meaning there is considerable scope for improvement. Pakistan's strong economic performance could be at great risk following the assassination of Benazir Bhutto.

Japan and the developing countries of Asia (particularly China and India) will bear the brunt of higher energy prices. The region is especially short of energy resources and Asian countries are generally relatively ineffective users of energy.

This region tops the list for the most foreign investors. The main appeals are growth of domestic markets, the size of those markets, access to the regional market and low labour costs. China and India together will account for the bulk of FDI as they are perceived as sharing the same advantages in terms of labour costs, market size and growth prospects. India is regarded more favourably in terms of skilled labour. Nonetheless, most investors see both countries suffering from the disadvantage of a relatively complicated investment environment. Other attractive markets for investors will be Malaysia, Thailand and Vietnam.

Australia's economy should see solid growth in 2008, albeit slower than in 2007. A weaker housing market and the effects of a severe drought are the main reasons for slower growth in Australia. New Zealand, unlike Australia, lacks strong links with Asian economies (particularly China) and faces a shaper slowdown.

Africa and Middle East:

Africa could see growth rates even higher than recorded in 2007. In Sub-Saharan Africa, the main risks stem from weather, other natural calamities, and commodity prices (including oil). Among oil exporters, the surge in oil prices is driving a steady rise in domestic demand and public spending. Several oil exporters are also using their revenues to pay down debt. They have put in place major programmes to improve social and physical infrastructure.

Most of the world's oil and natural gas is concentrated in Africa and the Middle East The boom in oil revenues also contributes to an increase in remittance flows to labour-abundant economies in the region. In countries such as Egypt, Jordan, Morocco and Sudan, consumer spending receives a big boost.

Very few countries in the Middle East will see increases in FDI inflows over the medium term. Most investment will be related to the energy sector but for other investors the lack of skilled labour and the small-to-medium size of domestic markets are disadvantages. The UAE will be one of the few countries in the Middle East to see a significant increase in FDI inflows in the medium term. African countries also hold only modest attraction to foreign investors. Access to natural resources is one frequent motivation (especially for Chinese firms). Countries in North Africa offer access to cheap labour and proximity to EU markets. They are becoming a popular location for investors from the Gulf which also target real estate, infrastructure and privatisation.