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Overview I: Economic Report on Africa 2007

Written by: United Nations Economic Commission for Africa

Article Overview: Moderate world growth and the threat of macroeconomic imbalances

Overview I: Economic Report on Africa 2007

Growth in the world economy improved slightly in 2006 relative to 2005, from
3.5 per cent to 3.8 per cent. It is driven by the strong performance by Asian economies,
which continue to post growth rates above 8 per cent. In contrast, growth in
advanced economies remains modest and is yet to reach the pre-2001 level. Key
constraints to growth include the massive global macroeconomic imbalances along
with tight macroeconomic stances in advanced economies, which prevent demandled
recovery. High oil prices undermine growth in both advanced and developing
countries through high production costs.

Developed countries, especially the United States, face the challenge of rising current
account, government, and private sector deficits which threaten domestic economic
recovery as well as global financial stability. The US current account deficit has risen
systematically since the 1990s, reaching 6.6 per cent of GDP in 2006. Meanwhile,
its budget balance has moved from a surplus in 2000 (1.9 per cent of GDP) to a
deepening deficit that stood at 2.5 per cent of GDP in 2006. Moreover, the US private
sector position continues to deteriorate due to insufficient savings partly driven
by the easy credit that fuels consumption.

Thus far, the widening deficits in the US have been financed by savings in the developing
world, especially Asia and the oil-exporting emerging economies in the Middle
East. Asia, the Middle East, and Latin America increased their current account surpluses
since 2000. In particular, China’s surplus increased from 1.7 per cent of GDP
in 2000 to 7.2 per cent in 2006, making it the largest single financier of the US
deficit. Central banks in developing countries have accumulated massive US dollardenominated
reserves partly as a means of preventing national currency appreciation.
Given the low world interest rates, these reserves have earned low returns to
the asset holders. Low world interest rates have also allowed the US to accumulate
debt at low cost.

However, the willingness of central banks to continue to accumulate low-return
reserves may be limited. Markets will need to be convinced that policymakers will
not let the imbalances go out of hand. This will require concerted and coordinated
efforts in industrialized economies and the developing world to achieve a smooth correction of the imbalances. The adjustment mechanism will involve a decrease
in the US deficit, an increase in investment in other countries (a decline in savings
in high-surplus countries), as well as a weak value of the dollar, which will allow
adjustment of the US trade deficit and reduce incentives for reserves accumulation.
Most importantly, it is critical to accelerate growth in advanced economies as well
as developing countries, which will require loosening of the policy stance to foster
demand-led recovery.

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Article Tags: Asian economies, current account, Growth in the world economy, private sector



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