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The Global Economy: Survey of the United States, Japan and European Union, 2003-04

OBJECTIVE

There are many interesting and complex components that make up the economies of the United States, the European Union, and Japan, as there would be in any developed economic system. The building blocks that form the foundation of our understanding of these economies are to look at each region in the broader context of three very important macroeconomic themes: output, unemployment and inflation.

The goal of this paper is to summarize the current and unique macroeconomic pictures we saw in each region as of 2003-04; highlight any changes noticed in their macroeconomic conditions since the turn of the 21st century and now; and make a forecast of the anticipated macroeconomic conditions in each of the three regions for the near future based on empirical evidence.

THE UNITED STATES

In late 2001, the initial fears of a recession in the world economy faded, as a modest turnaround the following year had been anticipated. The world economy has been increasingly dependent on growth in the U.S. economy because it is the source of nearly one-third of global demand. Unfortunately, these hopes of a turnaround in the economy became quickly overshadowed by the many stumbling blocks that consequentially brought about lackluster growth throughout the U.S. and beyond. Concerns over the real financial position of corporate America sent shock-waves through the U.S. economy after the controversial bankruptcy filing in December 2001 of energy trader and market leader, Enron Corporation. This is the second largest corporate bankruptcy to date in U.S. history, and harbored justifiable fear in investors over the real financial position of corporate America. Like a house of cards, WorldCom also came crashing down in July 2002 as it made the largest filing for bankruptcy protection ever in the U.S. after buckling under the pressure of a massive scandal involving a nearly $4 billion accounting fraud which made the company look profitable when it was not. Other giant firms under investigation for accounting irregularities include Xerox Corp., Arthur Andersen, Bristol-Meyers, and Johnson & Johnson.

These events exasperated an already serious problem concerning sluggish employment and business investments. Corporate America slashed nearly 250,000 jobs between September 2002 and January 2003, as the global economy failed to show signs of a strong recovery from the onset of recession in March 2001. The unemployment rate increased from 4.8% in 2001 to 5.9% the following year due to the lackluster aggregate demand for U.S. goods and services by the rest of the world. Pricing powers of financially weak U.S. corporations has also been limited as deflationary pressures in roughly one-third of the world economies has sent prices and wages on a downward spiral. The labor market also appeared to be soft and lackluster, preventing the robust external demand from the U.S. needed to boost growth. Further evidence of global stagnation is reflected in data collected by the United Nations citing a scant 1.7% expansion in the world economy since 2002, which many economists consider to be very close to bordering a recession. Also, the economy-wide GDP implicit price deflator increased by less than one percent for the four quarters through the third quarter of 2002. The annual GDP deflator has not been at this level since 1949, which is at tell-tale sign of global deflation.

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Consumer spending increased steadily, assisting the U.S. economy in leading the sustained recovery since 2002, even amidst corporate scandal. Yet, record levels of national debt exceeding over $2.3 trillion (~20% real GDP) has been accumulated as a result and a trade deficit in excess of 4% of real GDP requires over $1 billion a day foreign capital inflow to compensate for this widening trade deficit. U.S. foreign policy has greatly contributed to a heightening deficit as defense spending increased dramatically upon America's commitment to fight the war on terror. U.S. military activities in Iraq between January and September 2003 are expected to cost in upwards of $58 billion, according to top budget officials at the Pentagon. Rebuilding costs for America's postwar commitment to Iraq likely will cost as much as $100 billion and take three years to accomplish. The Defense Department has indicated that military actions in Afghanistan are costing Americans $1 billion each month. This raises concern that much of this burden could fall on taxpayers' shoulders and cause a drag on the economy.

The Fed has stepped in to assist in encouraging consumer spending and stimulating overall growth in the lowering of interest rates to 45-year lows of 1.0% compared to 6.0% during the onset of 2001. The central bank intends on leaving rates low for a considerable period, as the impact on the economy takes nine to 18 months to feel the effects of Fed rate cuts. The fiscal policy, which includes federal income tax cuts, child tax credits and repeals the double taxation of dividends, has come out at a timely period, as consumer confidence and the labor market have been consistently lackluster. This supportive monetary and fiscal policy should result in moderate growth at around 2-1/2% in 2003, rising strongly to 4% in 2004. One concern is how this record deficit spending, which the Congressional Budget Office has put at $480 billion for 2004. This is a very major change from the $127 billion surplus of the 2001 fiscal year and the actual impact of such fiscal policy has yet to be measured out in the U.S. economy over the coming year.

JAPAN

While there has not been a serious economic crisis in the Japanese economy recently, there has not been any move toward sustainable growth either. Deflation has continued to punish the economy and in July 2002, companies filed for bankruptcy at a rate of 58 per day. This not only caused spikes in the unemployment rate, which was near a post-war record of 5.67%, but it also resulted in consumers and investors fearing a possible Japanese meltdown. During all four quarters prior to the April-June 2002 quarters, the Japanese economy contracted, which is the first time this has happened since such data began to be collected in 1980. In February 2002, the Nikkei 225 dropped below the Down Jones Industrial for the first time since 1957. Also, on September 4, 2002, the Tokyo exchange dropped to its lowest levels in approximately 19 years as the world markets also plunged. Also, prices have fallen for four consecutive years, which is unprecedented for industrial countries in the last half century. These and other economic indicators are reflecting the economic stagnation in Japan throughout 2002. In fact, banks have actually shrunk the amount of credit being generated in the form of loans due to the estimated 150 trillion yen in bad outstanding loans according to the Financial Services Agency. Also, the deflation has limited the monetary flexibility of the Bank of Japan, which is evident by the fact that they sent interest rates as low as 0.001%. For those who have borrowed, the burden of the debt becomes heavier with each passing day. Deflation is also dissuasion for consumers to spend because their money is growing more valuable when stuffed under their mattresses because real rates are higher than the nominal rates.

Upon taking a first glance at the Japanese economy in 2003, it appeared as if there was going to be an ongoing cycle of grotesque hardships that plagued the world's second largest economy last year. During the first quarter, the unemployment rate was 5.4%, the Nikkei Exchange suffered declines, war on Iraq dampened confidence and the SARS outbreaks furthered pessimism toward the prospect of a growing Japanese economy. Nonetheless, global economic growth, especially in the United States, helped to boost corporate profits and increase consumer confidence. Global economic growth this year is projected to be 3.2% and this upward trend

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in growth is expected to continue next year, reaching a forecasted 4.1% in 2004. Japan is currently on a continued recovery path despite still sluggish consumer spending. Evidence of this economic outlook is seen in recent data that shows the Japanese economy expanding for the sixth straight quarter at an annualized rate of 2.3%. Also, the rise in July output reflects a recover in exports and an uptick in capital spending. The number of employed, including self-employed, rose for the third straight month, by 70,000 to 63.81 million employed in Japan. In fact, the unemployment rate was 5.3% in July, which was down for the second straight month. The only real negative economic indicator was Japan's core nationwide Consumer Price Index (CPI), which fell 0.2% in July from a year earlier, its 46th straight month of decline. The boost in job growth will hopefully result to increased consumption and thus larger output for Japan in 2004.

The major issue still lurking over their economy resides in the continued deflation, which cannot be properly dealt with unless much-needed structural reform of the banking system occurs. Fortunately, the Bank of Japan has recently taken measures, though desperate as such, to take steps in restructuring the banking system in declaring the purchase of three trillion yen of shares (or $24.5 billion in U.S. dollars) held by at least ten major financial institutions for a minimum holding period of ten years.

EUROPEAN UNION

For the year 2002, the Euro area experienced significantly weaker economic growth than anticipated. Consumer confidence continued to be negatively affected by geopolitical tensions, in particular the conflicts in Afghanistan and Iraq, depressed equity prices and higher oil prices. A lackluster domestic demand was also attributed to poor profitability by firms as well as concerns about unemployment, hurting their ability to shake off the debilitating effects of the global economic slowdown in 2001. Between 1996 and 2002, living standards in the Euro area were lower than those of the United States, and the gap will likely persists for at lest the next five years due to their weaker economic recovery.

In 2003, overall growth has been relatively moderate so far, although there have been divergent intra-regional trends. Germany, Portugal, Italy and the Netherlands are lagging with 1/2%-1% growth this year, while France, Finland, Austria and Spain are showing a stronger growth level of 1.4%-2%. Given the high unemployment rate that is creeping toward 9% this year and euro strength over the dollar, inflation is actually moderate at roughly 1 1/2 %, causing consumption to strengthen and consumer confidence to be somewhat restored. At the same time, the existing exchange rates between the euro and U.S. dollar are a major cause for concern. Drops in the price levels are causing European firms to lose market share as U.S. good become cheaper, making it very difficult for these European firms to compete. These profit pressures are causing the European companies to cut prices and have especially hurt major German and French firms such as DaimlerChrysler, Volkswagen, Alcatel and Michelin. An upcoming issue has surfaced in the euro area as Germany, which accounts for approximately 28% of European GDP, faces risks of deflation and stagnation.

Demand has been considerably weak in the European Union and monetary policy is proving ineffective. Weak exports are partially blamed for this development. Also, the unemployment rate, which registered 9.2% in March 2003, represents over 4 million lost jobs. Growth is expected to remain below trend in all economies in 2004 with stronger growth in the U.S. than Europe. Fortunately, major American companies, such as Intel and Johnson & Johnson produce up to 30% of their business from Japan and the European Union. This could be integral toward efforts in stimulating their economy. Economists believe that in order to maintain stronger growth throughout the European Union in 2004, they should rely on the higher real incomes due to lower inflation, and aggressive structural reform would be needed in the labor.

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RECAP OF FORECAST OF MACROECONOMIC CONDITIONSFOR NEAR TERM IN U.S., JAPAN AND EUROPEAN UNION

In the U.S., low interest rates, rising consumer retail spending, household consumption and rising industrial production in both the auto and high-tech sectors are driving the economy forward. Real GDP growth reached two and one-third percent growth in the first half of this year, driven by personal consumption, defense spending and residential and non-residential fixed investment. The one major economic concern is over the slow reconstruction efforts in Iraq, which is decreasing consumer confidence and delaying faltering U.S. economic recovery. This could possibly result in holding back recovery in the rest of the world.

Japan is seeing improved corporate profits and increased business fixed investments. Yet, persistent weakness and a continued dependency on the U.S. economic growth have allowed only marginal increases in global output. Due to the fact that acceleration in the growth rate of overseas economies is needed to jump-start an economic recovery in Japan, who is not in a position to generate a self-sustained recovery, domestic demand is unlikely to gain momentum. According to the International Monetary Fund, unemployment in 2003 could reach a historical high of 5.6 percent. The only foreseeable means of reversing the depressing demand over the long-term is two-fold: better job training in order to increase output per capita, and a significant reform to increase flexibility in the labor market.

In the European Union, personal computers replacements led to increased investments and a strengthening of consumption throughout this year. Rea GDP grew by one-tenth of a percent in the first quarter of 2003, supported by an increase in private consumption. Doubts of the sustainability of increased economic activity in the eurozone have led to projections of seven-tenths of a percent increase in real GDP, down from the two percent originally predicted. The U.S. between 1996 and 2002 has outpaced living standards in the European Union by four-tenths of a point a year, and the gap is expected to persist for the next five years. Despite structural unemployment expected to decline quite little over the near future, there is a possibility of a mild recovery in 2004, depending on the speed of the recovery of the U.S. economy and improvements in global business investments.

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BIBLIOGRAPHY

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Beams, Nick. "World economy like a house of cards." 27 September 2002.

Cotis, Jean-Philippe. "Toward Sustainable Economic Growth in Japan: The New Mix of Monetary and Fiscal Policy." Policy Research Institute. June 26, 2003.

Elliot, Larry. "OECD calls for reforms in eurozone." 1 August 2003.

Grimond, John. "What Ails Japan? A Survey of Japan." 20 April 2002.

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