The key economic features of 2007

<a href="">Juan Carlos Martínez Lázaro</a>. Professor. IE Business School

30 May 2007

The biggest threat this year to world economic growth could come from the dispute over Iran’s nuclear programme.

In general, 2006 was a good year for the Spanish economy. Despite rising oil prices, which peaked over the summer, and higher interest rates in the United States and the euro zone, the world economy expanded around 5% for the third year running. For 2007, most forecasts point to more modest growth, since the North American, European and Japanese economies will not perform as well as in 2006, leaving emerging-market countries to pick up the slack.

Whatever the case, oil prices will grab the spotlight again this year. Although prices have remained stable since summer, the price per barrel is unlikely to fall below the $50 mark unless the US economy slows sharply. Oil producing countries have come to realise that oil prices of around $60 per barrel shave only a few tenths of a percentage point a year off of world economic growth, yet still generate substantial revenues. Therefore, these countries are likely to reduce production (the OPEC cut production twice last autumn), if they see prices continuing to fall.

In the United States, the steady weakening of the economy over the last few months, coupled with a cooling property market and inflation of less than 3%, suggest that interest rates have hit a ceiling of 5.25%. Indeed, the Federal Reserve could begin to cut rates in the spring, to around 4% or 4.25% by the end of the year. If that happens, it wouldn’t be surprising for the dollar to weaken against the euro, helping to tame the gigantic US trade deficit. The other deficit—on the fiscal side--appears to be more under control since the Democrats seized control of the two legislative chambers. Events at the White House, especially with regard to Iraq, suggest that the Bush-era spending spree has come to an end. Furthermore, the forecasts show employment growth of 3%.

With the exception of the incorporation of Rumania and Bulgaria, the European Union will have little joy in 2007. Nicolas Sarkozy’s election in France, Tony Blair´s departure from Downing Street in Britain and attempts to revive the European constitution will set the political agenda. Similarly, the VAT increase in Germany and the speed at which monetary policy is tightened will determine the EU economic agenda. Accordingly, interest rates could easily end the year 2007 at around 4%, despite fading concerns over the impact of rising oil prices on inflation. To the despair of the European export sector, the euro is likely to remain strong. Consequently, the incipient recovery now underway in the European economy, particularly in Germany, is unlikely to be sustainable, and growth rates will remain somewhat mediocre, at between 2% and 2.5%.

The fiesta continues

Meanwhile, in Spain, the fiesta is likely to continue. Although the rising interest rates are beginning to affect household economies, nothing points to the end of the growth cycle that the country has enjoyed for the last eleven years. The tax cut made just one year before the general elections, the half million new jobs created and a 1% budget surplus will be the main features behind the Spain is all right slogan. Once again, economic growth will be around 3.5%.

But clouds are on the horizon: The ever-present imbalances—a sort of chronic disease that nonetheless enables us to lead a more or less normal life; an inflation rate that is steadily above the European average; a seemingly intractable trade deficit; low productivity growth and a property bubble that could either burst or deflate gently. Elsewhere, 2007 is the first year in which the inflow of European funds begins to taper off.

China will again be the driving force in Asia and the engine of growth for the world economy. The 10% increase in economic growth that Beijing predicts for the Chinese economy—fuelled above all by the export sector—will boost growth in other countries in the region and help maintain raw material prices at all time highs. For its part, India is earning its credentials for becoming the world’s next economic powerhouse. The economy—which unlike the industrial model of the South East Asian tigers and dragons is based on a rapidly developing service sector—has been gathering steam since 2003 and this year will expand more than 8%, spurred by domestic demand, growing exports and the inflow of foreign capital. However, like China, India suffers from dramatic poverty levels and deeply entrenched social inequality.

In the case of Japan, the economy is unlikely to take off, despite the good omens and expectations of new reforms. Once again the country seems poised to wallow in its own private crisis for another year.

Latin America after the polls

After a year of elections in Latin America, it will be interesting to see the political direction taken by countries such as Mexico, where Calderón is expected to consolidate his political position and undertake a complex reform program; Peru, where Alan García has been given a second chance to rule; Nicaragua, where an apparently transformed Daniel Ortega has returned to power after 16 years in the opposition; Ecuador, where Correa must choose between populism or stability; Argentina, where Kirchner must decide whether he or his wife will stand for re-election; Cuba, with Castro apparently out of the picture; Bolivia, with Evo Morales engaging in international legal battles over natural resources while his authority is increasingly questioned at home; and, above all, Venezuela, where a re-elected Chávez seems ready to charge down the delirious road leading to socialism of the 21st century, even at the risk of miring the country in an even deeper crisis.

As far as the region’s economy, 2007 will be the fourth year of 5% or so growth. With raw material prices at maximum levels, a hitherto unknown macroeconomic stability (average inflation of 5%, primary fiscal surpluses, etc.) and a return of foreign investment, the region should focus its efforts on sharing the macroeconomic bonanza with its citizens. And as far as trade is concerned, its performance will depend on the three pillars of the region´s trade policy: the free trade treaties with the United States, the growing relations with Asia and the regional integration processes, especially Mercosur, which Venezuela joined last summer.

While the price of oil and of the other raw materials that Africa exports remain at all-time highs, the continent will enjoy nominal economic growth rates of around 6%. Unfortunately, political instability, corruption, armed conflicts such as those currently ravaging Sudan and Somalia and diseases such as AIDS will keep most of the population of Africa immersed in misery for years to come.

Dangerous nuclear ambitions

In short, 2007 is unlikely to produce any great surprises on the economic front. Only the dispute between Iran and members of the international community over the development of its nuclear programme could upset the forecasts. The Teheran regime is determined to enrich uranium, apparently for civil use—a move that is opposed by the United States and the European Union, who believe that Iran’s ultimate goal is to equip itself with atomic weapons. At the same time, Israel has announced it won’t tolerate Iran acquiring the know-how to become a nuclear power. Given this situation, it isn’t unreasonable to think that the next crisis to strike the world economy will again originate in the Middle East.


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