The short-term outlook for the global economy has deteriorated very significantly following the terrorist attacks on the US in September.
Even before then, the global economy was fragile. Growth in the US economy had ground to a halt and a number of Asian economies – including Japan, Taiwan and Singapore were already moving into recession. Europe was faring better, but even here we had seen a sharp slowdown in some economies – notably Germany and Italy.
The events of 11 September – and the military response that has followed – are likely to tip the US economy from stagnation into recession, deepen the downturn in Asia and reinforce the slowdown in Europe. The downturn could be short-lived, as lower interest rates, tax cuts and higher government spending will provide a boost next year. But with the course of the “war against terrorism” still unclear, there is much uncertainty about the timing and pace of any recovery.
The US economy has been hit by a triple whammy as a result of the terrorist attacks. Economic activity in key sectors of the economy – notably finance and air travel – was seriously disrupted in September, while the closure of US airspace and international borders had wider knock-on effects, disrupting international trade and interrupting manufacturers’ supply-chains.
On top of this, security concerns are causing a continuing reluctance to fly – both within the US and internationally. The major US carriers are reporting very poor passenger loads on domestic services, despite the fact they have already cut their schedules by around 20%. International services have been hit too, with UK-US passenger traffic down by 30-40%.
However, the biggest economic impact is likely to come from the effect on US consumer confidence. In the first half of this year, the resilience of the consumer was supporting the growth of the US economy in the face of a downturn in world trade and manufacturing output. This consumer resilience has now been undermined – with confidence and retail spending both registering sharp falls in September.
Lower interest rates and tax cuts will help to offset this loss of confidence – but will take time to filter through. In the meantime, there is a serious risk of a downward spiral of falling consumer spending, job losses and weakening confidence.
Though these effects will be most pronounced in the US, other regions will also be hit. The impact of security concerns on air travel and weaker consumer confidence are apparent in Europe and Asia, too. Demand for exports from these regions will also be cut by the weakness of the US economy.
Asia looks more vulnerable than Europe – partly because its economies were clearly weaker before the crisis and also because Asian exporters are heavily dependent on the US market. Prospects for Japan are particularly bleak. The current forecast consensus is that GDP will fall in Japan both this year and next, with 2002 likely to see the first full year of recession since the Asian crisis of 1997-98.
At this stage, it is difficult to predict the length and depth of the downturn. The most optimistic scenario is one in which security concerns around air travel abate relatively quickly (within six to nine months) – as they did after the Gulf War – and lower interest rates, tax cuts and higher public spending provide a strong boost.
But we cannot rely on this optimistic scenario and a more prolonged downturn appears likely – especially so since there is little sign of a quick conclusion to the war against terrorism and early economic indicators point to a sharp contraction in the US. It is probably more realistic to look to 2003 rather than next year for a significant upswing in the global economy.
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Europe has a key role. Though growth is likely to slow, recession should be avoided and the UK is currently forecast to be one of the better performing economies in the region. However, further interest rate cuts may still be needed to sustain growth and governments should also be prepared to relax their spending plans and bring forward tax cuts to stimulate activity.
If Europe does weather the current economic storms, this should provide a boost to confidence in the euro and the management of the European economy.
This provides one potential silver lining to the rather gloomy economic scene which confronts us at present.