Since the initiation of economic reforms in the late 1970s. China has achieved impressive economic growth coupled with significant structural transformation (Figure 32). During 1978–96, real GDP grew on average by over 9 percent a year, contributing to a near quadrupling of per capita income and the lifting of millions out of poverty. Over the same period, many of the distortions and rigidities of the former central planning system were eliminated and market forces came to play an increasingly important role in economic decision making. Concomitantly, the state’s role in the economy was gradually reduced and a dynamic non-state sector emerged that now accounts for almost two-thirds of GDP.1 In addition, as part of the normal process of economic development, employment in agriculture has declined substantially while a thriving manufacturing sector has emerged.
This annex builds on the discussion in Chapter III and further explores the implications for Europe and the rest of the world of alternative assumptions about labor market reform, fiscal adjustment, and product market liberalization under EMU. While necessarily speculative in nature, the resulting scenarios are meant to illustrate the profound impact that EMU can have on macroeconomic performance depending on progress in these three policy areas.1
The May 1992 World Economic Outlook examined the role played by balance sheet adjustments in the nonfinancial sectors of the economy in constraining the pace of recovery in the United States and the United Kingdom.1 It also examined in less detail similar adjustments in Japan and in the smaller industrial countries. This annex updates the earlier work and then focuses on the corresponding adjustments in the financial sectors of Japan, the United States, and several of the Nordic countries.
The global expansion is losing speed in the face of a major financial crisis. The slowdown has been greatest in the advanced economies, particularly in the United States, where the housing market correction continues to exacerbate financial stress. The emerging and developing economies have so far been less affected by financial market turbulence and have continued to grow at a rapid pace, led by China and India, although activity is beginning to moderate in some countries. In the baseline, the U.S. economy will tip into a mild recession in 2008 as a result of mutually reinforcing housing and financial market cycles, with only a gradual recovery in 2009, reflecting the time needed to resolve underlying balance sheet strains. Activity in the other advanced economies will be sluggish in both 2008 and 2009 in the face of trade and financial spillovers. Growth in the emerging and developing economies is also projected to slow, although it should remain above long-term trends in all regions. Risks to the global projections are tilted to the downside, especially those related to the possibility of a full-blown credit crunch, while emerging and developing economies will not be insulated from a serious downturn in the advanced economies. Against this background, policymakers in the advanced economies must continue to grapple with the task of restoring stability to housing and financial markets while addressing downside risks to growth, without jeopardizing inflation performance or longer-term policy goals. Many emerging and developing economies still face the challenge of avoiding overheating or any buildup in vulnerabilities, but policymakers should be ready to respond judiciously to a deteriorating external environment.
Thus far, economic recovery is proceeding broadly as expected, although downside risks remain elevated. Most advanced and a few emerging economies still face major adjustments, including the need to strengthen household balance sheets, stabilize and subsequently reduce high public debt, and repair and reform their financial sectors. In many of these economies, the financial sector is still vulnerable to shocks, and growth appears to be slowing as policy stimulus wanes. By contrast, in emerging and developing economies prudent policies, implemented partly in response to earlier crises, have contributed to a significantly improved medium-term growth outlook relative to the aftermath of previous global recessions. However, activity in these economies, particularly those in emerging Asia, remains dependent on demand in advanced economies. In this setting, global activity is forecast to expand by 4.8 percent in 2010 and 4.2 percent in 2011, with a temporary slowdown during the second half of 2010 and the first half of 2011. Output of emerging and developing economies is projected to expand at rates of 7.1 percent and 6.4 percent in 2010 and 2011, respectively. In advanced economies, however, growth is projected to be only 2.7 percent and 2.2 percent, respectively. Risks to the forecast are mainly to the downside. Sustained, healthy recovery rests on two rebalancing acts: internal rebalancing, with a strengthening of private demand in advanced economies, allowing for fiscal consolidation; and external rebalancing, with an increase in net exports in deficit countries and a decrease in net exports in surplus countries, notably emerging Asia. The two interact in strong ways. Increased net exports in advanced economies imply higher demand and higher growth, allowing more room for fiscal consolidation. A number of policies are required to support these rebalancing acts. In advanced economies, repair and reform of the financial sector need to accelerate to allow a resumption of healthy credit growth. In addition, fiscal adjustment needs to start in earnest in 2011. Specific plans to cut future budget deficits are urgently needed to create new room for fiscal policy maneuver. If global growth threatens to slow appreciably more than expected, countries with fiscal room could postpone some of the planned consolidation. Meanwhile, key emerging economies will need to further develop domestic sources of growth, with the support of greater exchange rate flexibility.
After a deep global recession, economic growth has turned positive, as wide-ranging public intervention has supported demand and lowered uncertainty and systemic risk in financial markets. Nonetheless, the recovery is expected to be slow, as financial systems remain impaired, support from public policies will gradually have to be withdrawn, and households in economies that suffered asset price busts will continue to rebuild savings. Risks to the outlook remain on the downside. Premature exit from accommodative monetary and fiscal policies is a particular concern because the policy-induced rebound might be mistaken for the beginning of a strong recovery. The key requirement remains to restore financial sector health while maintaining supportive macroeconomic policies until the recovery is on a firm footing. At the same time, policymakers need to begin preparing for an orderly unwinding of extraordinary levels of public intervention. Policies also need to facilitate a rebalancing of global demand, because economies that experienced asset price busts will need to raise saving rates, and there is a need to bolster potential growth in advanced economies, which has suffered as a result of the major financial shocks. Rising unemployment and setbacks to progress in poverty reduction pose social challenges that also must be addressed.
Notwithstanding recent financial market nervousness, the global economy remains on track for continued robust growth in 2007 and 2008, although at a somewhat more moderate pace than in 2006 (Figure 1.1). Moreover, downside risks to the outlook seem less threatening than at the time of the September 2006 World Economic Outlook, as oil price declines since last August and generally benign global financial conditions have helped to limit spillovers from the correction in the U.S. housing market and to contain inflation pressures. Nevertheless, recent market events have underlined that risks to the outlook remain on the downside. Particular concerns include the potential for a sharper slowdown in the United States if the housing sector continues to deteriorate; the risk of a deeper and more sustained retrenchment from risky assets if financial markets continue to be volatile; the possibility that inflation pressures may revive as output gaps continue to close, particularly in the event of another spike in oil prices; and the low probability but high cost risk of a disorderly unwinding of large global imbalances. From a longer-term perspective, a number of trends—including the aging of populations, rising resistance to increasing globalization, and the environmental consequences of rapid growth—could undermine the buoyant productivity that has underpinned recent favorable outcomes. While remaining vigilant to short-term macroeconomic risks, policymakers should take advantage of the continuing strong performance of the global economy to press ahead with more ambitious efforts to tackle deep-seated structural challenges.