- International Monetary Fund. Research Dept.
- Published Date:
- January 1990
©1990 International Monetary Fund
World economic outlook (International Monetary Fund)
World economic outlook: a survey by the staff of the International Monetary Fund.—1980– —Washington, D.C.: The Fund, 1980–
v.; 28 cm.—(1981–84: Occasional paper/International Monetary Fund ISSN 0251–6365)
Has occasional updates, 1984–
ISSN 0258-7440 = World economic and financial surveys
ISSN 0256-6877 = World economic outlook (Washington)
1. Economic history—1971– —Periodicals. I. International Monetary Fund. II. Series: Occasional paper (International Monetary Fund)
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Assumptions and Conventions
A number of assumptions have been adopted for the projections in the report. It has been assumed that the average real exchange rates for the major currencies in August 1990 will prevail through the end of the forecast period: that “present” policies of national authorities will be maintained: that the average price of oil will be $20.59 a barrel in 1990 and $22.75 a barrel in 1991 and thereafter the oil price will remain constant in real terms; and that the six-month U.S. dollar LIBOR will average 8.4 percent in 1990 and 8.0 percent in 1991. These are, of course, working assumptions rather than forecasts, and the uncertainties surrounding them add to the margins of error that would in any event be involved in the report’s projections. The estimates and projections themselves are based on statistical information available on or before September 10, 1990.
The following conventions have been used throughout this report:
… to indicate that data are not available;
— to indicate that the figure is zero or less than half the final digit shown:
– between years or months (e.g,. 1989–90 or January-June) to indicate the years or months covered, including the beginning and ending years or months;
/ between years or months (e.g., 1989/90) to indicate a crop or fiscal (financial) year.
“Billion” means a thousand million.
Minor discrepancies between constituent figures and totals are due to rounding.
* * *
The term “country” used in this report does not in all cases refer to a territorial entity that is a state as understood by international law and practice. The term also covers some territorial entities that are not states but for which statistical data are maintained and provided internationally on a separate and independent basis.
The projections and analysis contained in the World Economic Outlook are the product of a comprehensive interdepartmental review of world economic developments by the staff of the International Monetary Fund. This review is carried out biannually and draws on the information the Fund staff gathers through its regular and special consultations with member countries, as well as the application of econometric modeling techniques. The project is coordinated in the Research Department and draws on the specialized contributions of staff members in the Fund’s five area departments, together with those of staff in the Exchange and Trade Relations and Fiscal Affairs Departments. The World Economic Outlook has been published annually since 1980 and biannually since 1984.
An earlier version of the material in this report was the basis for a discussion of the world economic outlook by the Fund’s Executive Board on September 5 and 7, 1990. The present version has benefited from comments made by Executive Directors. However, the descriptions of developments and policies that the report contains, as well as the projections for individual countries, are those of the Fund staff and should not be attributed to Executive Directors or their national authorities.
After several years of rapid expansion that brought many countries to historically high levels of resource utilization, the growth of the world economy is projected to slow to about 2 percent in 1990 from 3 percent in 1989. The global slowdown would reflect a moderation of growth in both industrial and developing countries and a contraction of output in Eastern Europe and in the Union of Soviet Socialist Republics. In 1991, the expansion in world output is expected to pick up to 2½ percent, reflecting stronger growth in the developing countries.
Real GNP in the industrial countries would rise by 2½ percent in both 1990 and 1991, down from an average of almost 4 percent in 1988–89. Significantly slower growth is projected in 1990–91 in North America and the United Kingdom, but growth is expected to remain relatively strong in other countries, including, in particular, Japan and the Federal Republic of Germany. With rates of capacity utilization remaining relatively high, and reflecting higher energy prices, consumer price inflation in the industrial countries would increase somewhat to 4¾ percent this year and would register a modest reduction in 1991.
In the developing countries, real GDP growth is expected to decline from 3 percent in 1989 to 2¼ percent in 1990. This slowdown would reflect in part the short-run effects of the recent tightening of financial policies in response to serious macroeconomic imbalances in a significant number of countries, as well as unfavorable external conditions, including a less rapid expansion of world trade, declining prices for non-oil primary commodities, and continuing high international interest rates. Assuming that recently initiated stabilization programs are implemented successfully, output growth in the developing countries is projected to rebound to 4¼ percent in 1991. The average annual rate of inflation for the developing countries as a group would remain very high in 1990. Inflation is projected to decline sharply in 1991, but this projection hinges crucially on the assumption that current stabilization efforts in the high-inflation countries will be sustained.
Recently, financial market developments and economic prospects have been affected by the sharp increase in the world price of oil and the heightened uncertainty that has resulted from tensions in the Middle East. Following a cumulative decline of 27 percent from January to June of this year, oil prices almost doubled to an average of $26 a barrel in August following the meeting in late July of the Organization of Oil Exporting Countries (OPEC) and the invasion of Kuwait by Iraq on August 2.1 In the six weeks following, oil prices fluctuated in a range of $23 a barrel to $33 a barrel.
The future course of oil prices is highly uncertain as it depends crucially upon the evolution of the political and military situation in the Middle East. The Fund staff projections presented in this report assume that most of the production shortfall in Iraq and Kuwait would be gradually offset by increased supplies by other members of OPEC. On this basis oil prices would average $26 a barrel for the remainder of 1990 before coming down gradually to the new OPEC reference price of $21 a barrel by the fourth quarter of 1991. These assumptions imply that the annual average oil price would increase by 20 percent in 1990 (to $20.59 a barrel) and by 10½ percent in 1991 (to $22.75 a barrel).
The experience of previous oil shocks indicates that attempts to prevent or to limit the pass-through of oil price increases to domestic energy prices would be counterproductive. Subsidizing domestic oil consumption would have undesirable effects on the government’s fiscal position; and efforts to cushion the impact of higher world prices on energy users by resorting to domestic price controls would distort the functioning of markets and give rise to shortages of oil products. Previous experience also indicates that attempts to mitigate the adverse short-run economic effects of higher oil prices by easing monetary policy could give rise to even stronger price pressures and to market expectations that such pressures would evolve into an inflationary process of increasing severity. In the current situation, where many industrial countries are still operating at high levels of resource utilization and where cost/price pressures have been evident for some time, a further escalation of inflation and expectations about inflation would ultimately require a sharp tightening of monetary conditions, as occurred in the early 1980s. As a result, interest rates would be higher, and output and employment would be lower, than if the stance of monetary policy had not been altered in response to the oil shock.
The lower level of economic activity and the higher interest rates that are expected to result from higher oil prices and other developments associated with tensions in the Middle East will tend to have adverse effects on the fiscal position in most industrial countries. While these developments are likely to complicate the task of fiscal correction in a number of countries, they do not alter the urgent need for a credible plan to lower fiscal deficits over time.
In a number of oil importing developing countries, including several that are currently engaged in stabilization efforts and structural reforms in the context of Fund- and Bank-supported adjustment programs, the effects of persistently higher oil prices, aggravated by lower external demand and higher interest rates, could be serious. For these countries, there is a need for a careful evaluation of the implications for external viability of the changed external environment, and the appropriate adjustment/financing mix will have to be determined in light of the particular circumstances of each country.
While developments in oil markets could have significant implications in the short run, the medium-term outlook for the world economy remains strongly influenced by the far-reaching changes currently taking place in Europe. The short-term prospects in this region are affected by the restructuring of the economies in Eastern Europe and the U.S.S.R. from relatively inefficient production and distribution systems based on central planning toward more market-oriented systems. Output is expected to decline in most of these countries in 1990 and to stagnate in 1991. owing in part to the short-run impact of the stabilization measures and the economic reforms being implemented. Over the medium term, however, economic performance should improve significantly as market-based incentives, including trade at world-market prices, become more widespread.
Economic conditions in Europe also will be affected by the unification of the German Democratic Republic with the Federal Republic of Germany. As in the other Eastern European countries, the short-run adjustments in the Democratic Republic are expected to result in a temporary fall in output and employment. At the same time, however, aggregate demand, particularly for imported investment goods, is expected to expand sharply as the economy is transformed along market-oriented lines. The impact of German unification on the world economy will involve a rise in global investment relative to world saving. With large parts of the industrial world, including the Federal Republic, operating at high levels of resource utilization, this would result in some upward pressure on prices, interest rates, and the value of the deutsche mark.
The analysis of the international ramifications of German unification presented in Chapter II suggests that, although these effects would be concentrated in Germany, they would also spill over to other countries. However, it appears that some of these effects already have been reflected in financial markets, and that any further pressures are unlikely to put undue strain on the world economy. Over the medium to longer run, the prospective growth of the capital stock and the more efficient allocation of capital and labor in the Democratic Republic will raise productive capacity in a united Germany. Over time, the short-run aggregate demand effects of unification would gradually be offset by the increase in productive capacity, Germany’s investment demand relative to saving would diminish, and the interest rate and price pressures arising from unification would gradually subside.
Economic prospects in Europe will continue to be heavily influenced by the ongoing movement toward economic integration among the twelve member countries of the European Community (EC). The process of integration, and particularly the scheduled completion of the single internal market in 1992, is expected to boost investment and sustain output growth near capacity limits for the next several years. Over this period, developments within the EC—as well as the Community’s relations with other countries and regions—are also likely to be affected by the far-reaching changes associated with economic and monetary union (EMU). The first stage of the transition toward EMU, which began on July 1, 1990, will include the full participation of all EC currencies in the narrow band of the exchange rate mechanism of the European Monetary System and enhanced policy coordination among member governments, in addition to completion of the single market.
The specific institutional arrangements and the timing of subsequent stages in the process of unification will be clarified by the intergovernmental conferences, scheduled for December 1990, to frame the EMU within the EEC Treaty and to deal with the political union of the EC countries. Over the longer term, the outlook for the Community is likely to benefit from economic and political liberalization in Eastern Europe and the growing interest among non-EC countries in Western Europe—as well as countries outside the region—in strengthening trade and financial ties with the Community. In this context, it is in the interest of both the EC and the international community as a whole to ensure that the policies of the Community retain an outward-looking orientation.
As in continental Europe, economic activity in Japan has remained relatively strong, and the economy has weathered well the turbulence that affected equity and foreign exchange markets earlier this year. The prospects for continued, albeit somewhat slower, growth are favorable. Inflation is projected to remain low by the standards of other countries, but the tight condition prevailing in labor markets indicate that restraint on the part of monetary policy will be required to keep cost and price pressures under control. Structural reforms in a number of important areas would also contribute to the achievement of price objectives while increasing the efficiency and the openness of the Japanese economy.
In North America and the United Kingdom, economic activity has slowed considerably and growth is expected to remain sluggish in the near term. Inflation in these countries is expected to remain relatively high in 1990–91, even though it is projected to decline in the United Kingdom. In the near term, the weakness of certain economic sectors and the difficulties encountered by some financial institutions—including, in particular the savings and loan institutions in the United States—will remain a source of concern. But these concerns should not obscure the need to direct monetary policy toward reducing inflation over the medium term.
In the United States, the federal fiscal deficit continues to be a major source of preoccupation. Recently, official estimates of the deficit have been revised upward sharply, partly because the evolution of economic activity and interest rates has been less favorable than had been anticipated earlier. The federal deficit for fiscal 1990 (ending September 30, 1990) is now projected by the Administration at $163 billion, and it is now clear that the objective of balancing the federal budget by FY 1993—as mandated by the Gramm-Rudman-Hollings law—will not be achieved on the basis of present policies. In light of the magnitude of the fiscal problem, a “budget summit” that includes representatives of the Congress and the Administration has been seeking to achieve agreement on a budget plan that would provide for sizable reductions in the federal deficit through a combination of expenditure and revenue measures.
Achievement of a satisfactory growth performance in the industrial countries over the long run requires monetary policies aimed first at controlling inflation and then at achieving steady progress toward price stability; fiscal policies directed at fostering adequate levels of national saving and capital formation; and structural policies aimed at increasing efficiency, notably through trade liberalization. The major political and economic developments of the past year underscore the importance and urgency of implementing this strategy, particularly as regards the need to contain inflation and raise global saving.
The importance of dealing with the problem of inflation has been highlighted by the significant rise in interest rates in most industrial countries over the past year. This rise reflected in part the anticipated increase in the demand for funds associated with the reconstruction of Eastern Europe and the unification of Germany, but it also appears to have reflected expectations of higher inflation. This worsening of expectations suggests that market participants remain highly sensitive to news concerning possible inflationary disturbances. In these circumstances, a significant relaxation of monetary policy would yield neither an enduring reduction in interest rates nor a lasting improvement in employment. Instead, the market’s concerns about increasing inflation should be allayed by providing clear and credible signals that wage and price pressures will be brought under control and that the authorities are determined to resume tangible progress in reducing inflation.
The rise in the demand for resources associated with unification in Germany and reform in Eastern Europe, together with the pressing needs of the indebted developing countries, underscore the importance and the urgency of increasing world saving. Full consideration should be given to the removal of existing distortions that discourage private sector saving. However, the most effective way to achieve a substantial rise in national saving would be to accelerate the process of fiscal consolidation, particularly in those countries where fiscal deficits remain high, such as Canada, Italy, the United States, and many of the smaller industrial countries. A reduction in the absorption of saving by governments would tend to lower interest rates, thereby encouraging private investment and helping to reduce the debt-service burden of developing countries. It would also help to ease the burden currently borne by monetary policy in resisting price pressures in the industrial countries.
Economic policies have played a critical role in the performance of the indebted developing countries in recent years and they remain a key element in the medium-term outlook. Growth has been strong and inflation has remained relatively low in the developing countries that have avoided debt-servicing difficulties, in part because most countries in this group have pursued cautious financial policies and have reduced structural rigidities and distortions. By contrast, growth generally has been slow and inflation has tended to accelerate in the countries that have encountered debt-servicing difficulties. The restoration of sustained growth in these countries depends critically on the strengthening of macroeconomic stabilization. Moreover, the analysis provided in Chapter III indicates that outward-oriented trade strategies and structural reforms aimed at reducing market imperfections have a significant beneficial impact on economic growth. A few countries have made considerable progress in these areas in recent years, and others have strengthened adjustment policies more recently. While these are encouraging signs, it is essential to avoid the policy slippages that have been a serious problem in the past.
Recent experience has confirmed that sustained implementation of sound economic policies is likely to elicit the necessary support of external creditors. For example, Costa Rica, Mexico, and the Philippines have concluded negotiations on financing packages that include debt and debt-service reductions, and Morocco and Venezuela have reached preliminary agreements with their commercial bank creditors that provide for such reductions. Furthermore, in Chile, Mexico, and Venezuela, private borrowers have been able to obtain foreign credits on a limited but voluntary basis, and Mexico and Chile have experienced sizable inflows of private capital. Official and multilateral creditors have continued to provide support to countries undertaking strong adjustment programs. The recent increase in the World Bank’s capital and the forthcoming increase in the fund’s quotas will enable both institutions to meet members’ requests for financial assistance and thereby catalyze assistance from other sources.
Further progress in implementing the strengthened debt strategy in highly indebted countries will require persistent efforts on their part to achieve macroeconomic stability and enhance overall economic efficiency in order to restore balance of payments viability over the medium term. A necessary complement to these efforts will be the continued commitment of the international community. Official creditors will need to continue to reschedule debts and provide concessional development assistance and, in some cases, to consider alternative approaches to debt rescheduling. Commercial banks will need to demonstrate greater flexibility in order to expedite negotiations with debtor countries. Finally, policies in the industrial countries will need to foster an external environment that is conducive to continued growth, higher world saving, and greater openness of world markets.
The international trading system is now at a crucial stage. A successful conclusion of the Uruguay Round of multilateral trade negotiations would have wide-ranging, favorable consequences, including a significant reduction of tariffs, improved market access for all countries, a reduction in protection for agriculture and textiles, and the extension of multilateral disciplines to services, intellectual property rights, and trade-related investment rules. In contrast, a failure to conclude the negotiations could have serious adverse repercussions for the world economy. It would not only prevent the achievement of large gains from liberalization, but could also intensify protectionist pressures, aggravate existing disputes among trading partners, and encourage unilateral and bilateral solutions to trade problems. It is clear that much remains to be done in only a few months, and a decisive effort by all parties involved is now required to conclude the Uruguay Round successfully by the end of the year.
This report is organized as follows. Chapter I reviews recent economic developments and presents the staff’s latest forecasts for 1990 and 1991. The chapter also discusses briefly recent trends in world commodity markets, world trade and payments, and developments in the international debt situation. The revised method of normalization used in computing real effective exchange rates in this report is described in a Box. An appendix to the chapter presents a scenario illustrating the possible effects of the rise in the world price of oil.
In Chapter II, the staff presents its medium-term baseline projections for industrial countries and addresses a number of key policy issues, including the outlook for global saving, the need for continued fiscal consolidation and monetary restraint, and the challenge of trade liberalization. This chapter also includes an examination of the likely implications of German unification and a review of recent progress toward economic integration in the EC. It discusses major policy issues in individual industrial countries in the concluding section. A Box examines policy issues raised by the recent rise in world oil prices.
Chapter III presents the staff’s medium-term baseline scenario for developing countries and reviews the conditions required to restore sustained growth in the indebted countries. The staff presents an alternative scenario on the basis of a less optimistic set of assumptions about domestic economic policies than those underlying the baseline projections. The chapter reviews the macroeconomic and structural reforms required in developing countries and indicates their potential benefits. It also stresses the importance to the developing countries of a successful conclusion of the Uruguay Round and evaluates progress in the debt strategy.
Systemic reform issues in Eastern Europe and the U.S.S.R. are reviewed in Supplementary Note 1. Supplementary Note 2 deals with the sustainability of fiscal policies in the major industrial countries, and Supplementary Note 3 discusses the present state of the Uruguay Round of Trade negotiations.