THE GLOBAL CONTEXT AND THE SITUATION IN THE WESTERN MARKET ECONOMIES

__________________________________________________________________________________________________ 13
CHAPTER 2
THE GLOBAL CONTEXT AND THE SITUATION IN
THE WESTERN MARKET ECONOMIES
2.1 The global context
The cumulative effects of these successive crises
on world economic activity has been considerable. Real
(i)
The broad pattern
GDP in the world economy rose by only 2¼ per cent in
1998, a marked slowdown from the growth rate of 4.2
Uncertainties in international financial markets
per cent the previous year. This was the lowest growth
have continued to prevail after the decision of the
rate of world output since 1991 (chart 2.1.1). This
Brazilian government on 15 January 1999 to abandon
outcome reflects in the main the deepening recession in
the exchange rate peg and to float the domestic
Japan and the sharp contractions of economic activity in
currency, the real, which has since depreciated sharply.
several other east Asian countries, developments which
The Brazilian crisis is the latest episode in a succession
have been mutually reinforcing as a result of the strong
of contagion effects from the Asian crisis which were
regional trade links. But there was also a marked
also an important factor in the Russian crisis which
deceleration in economic growth in other parts of the
unfolded in mid-1998.46 Basically, all these crises have
world economy, viz. Latin America, the Middle East
to do with a major reappraisal of risk exposure by
and the transition economies, which contrasts with
international investors, which has been mirrored in a
continuing robust growth in western Europe and,
sudden and large-scale redirection of short-term capital
especially, in North America for the year as a whole.
flows from emerging markets to safe havens in
industrialized countries. Reduced net capital inflows, or
It not only proved very difficult to anticipate
even net capital outflows, have been associated with a
correctly the deflationary effects of the Asian crisis but,
considerable rise in the costs of borrowing, often
with hindsight, the choice of the traditional policy
tantamount to a “credit crunch” for emerging markets.
response seems to have been inappropriate.47 In any
High short-term interest rates required to check capital
case, the much deeper than expected economic crisis in
flight and defend established fixed or quasi-fixed
Japan and in the east Asian emerging markets and its
exchange rates, in turn, have had considerable domestic
adverse spillover effects to other regions has been the
economic costs, often triggering a vicious circle, in
major factor in the successive and significant lowering
which the ensuing recessionary tendencies reinforced
of growth forecasts for the world economy in 1998 and
the selling pressure on the currency.
beyond (chart 2.1.2).
The adjustment policies implemented in emerging
The slowdown in world output growth has also led
markets to cope with these changes have led to a steep
to a marked weakening of the rate of expansion of world
fall in their domestic absorption, which, in turn, has had
trade. World merchandise imports rose in volume by
a deflationary effect on world economic activity. These
only 3¼ per cent in 1998, down from some 10 per cent
deflationary effects have also led to a considerable fall
in 1997.48 Import demand in the developing countries
in commodity prices since the Asian crisis which
was depressed on account of the domestic adjustment
adversely affected real incomes in those countries for
measures required to cope with reduced capital inflows
which commodity exports are a major source of foreign
and a significant deterioration in their terms of trade.
exchange. These adverse effects have only been partly
These adverse effects on world trade were amplified by
offset by the potential stimulus of falling interest rates –
the steep fall in import demand in Japan and a
associated with the retreat of capital flows to “safe
slowdown in import growth in North America and
havens” – and the gains in real income, ensuing from
western Europe.
the fall in commodity prices, in western Europe and
North America.

47
UNCTAD, Trade and Development Report, 1998 (United Nations
publication, Sales No. E.98.II.D.6), p. 69.

48
IMF, World Economic Outlook and International Capital Markets.
46
UN/ECE, Economic Survey of Europe, 1998 No. 3.
Interim Assessment (Washington, D.C.), December 1998, p. 164, table 5.

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14 _________________________________________________________________ Economic Survey of Europe, 1999 No. 1
CHART 2.1.1
TABLE 2.1.1
Changes in world output, 1990-1999 a
World commodity prices, 1995-1998
(Percentage change over previous year)
(Percentage change over previous year)
Weights a 1995
1996
1997
1998
5
Food and beverages ..............
9.9
1.6
-1.6
5.6
-12.3
Industrial raw materials .......... 29.5
16.3
-12.1
-1.8
-14.5
Energy .................................... 60.5
8.3
15.4
-3.9
-29.0
4
Crude oil .............................. 55.5
8.6
17.1
-3.6
-31.1
Total ....................................... 100.0
9.6
3.3
-1.4
-22.3
Average annual growth rate,
1980-1989
Total, excluding energy ......... 39.5
12.0
-9.8
1.3
-13.8
3
Source: Hamburg Institute for Economic Research (HWWA).
Note: Growth rates calculated on the basis of current dollar prices.
a Weights refer to average commodity shares in total imports of western
2
industrialized countries in 1989-1991.
The sharp fall in international commodity prices in
1
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
1998 was the main factor behind these differential
changes in the terms of trade. Oil prices declined by
Source: IMF, World Economic Outlook and International Capital Markets,
some 30 per cent to their lowest level in more than 20
Interim Assessment (Washington, D.C.), December 1998, p. 160, table 1.
years.50 Non-oil commodities fell at about half that rate
a Real GDP. Data for 1998 and 1999 forecasts.
(table 2.1.1). These price developments are largely due
to the direct and indirect effects of the Asian crisis,
CHART 2.1.2
including the deep recession in Japan, on the demand for
Changing forecasts of world output growth, 1998-2000
commodities.51 This shortfall of demand amplified an
(Annual percentage change)
already existing oversupply in a number of commodity
markets, notably for oil, which was reflected in rising
stocks. Oil demand was also dampened by the mild
1998
1999
2000
winter of 1997/98 in the Northern Hemisphere and the
5
economic downturn in the CIS in 1998. Some OPEC
countries stepped up oil production in an unsuccessful
attempt to offset the impact of falling oil prices on
4
revenues.52 In the markets for several other commodities,
producers also appear to have expanded output in
response to the appreciation of the dollar vis-à-vis
3
domestic currencies. Commodity producers, in general,
have been reluctant to cut back output to limit or reverse
the fall in prices; instead, they have preferred to build up
2
stocks which has led to a large overhang. The
completion of new plants has also added to the downward
pressure on metal prices.
1
Oct. 1997
Dec. 1997
May 1998
Oct. 1998
Dec. 1998
Seen in a longer-term perspective, recent
developments continue the tendency for commodity
Source: IMF, World Economic Outlook and International Capital Markets,
Interim Assessment (Washington, D.C.), December 1998, p. 7, table 1.1.
prices to fall in real terms, i.e. relative to changes in the
Note: The dates refer to the issue dates of the IMF, World Economic
prices of manufactured goods exported by developed
Outlook.
market economies (chart 2.1.3). This reflects a
combination of supply and demand factors, inter alia,
World trade prices in dollar terms fell by some 4.5

per cent in 1998, following a decline of more than 6 per
50
cent in 1997. The terms of trade of industrialized
The average price of the OPEC crude oil basket fell to $12.44 in
countries improved by some 1 per cent in 1998, while
1998, its lowest level since 1977, when it was $12.40.
those of developing countries deteriorated by 5 per cent.
51
Net imports of commodities into East Asia rose strongly during the
Since 1990, the terms of trade of developing countries
period of rapid economic growth since the mid-1980s with the result that
the region’s share of global raw material consumption was larger than its
have fallen by a cumulative 12 per cent.49
corresponding share in world output. But with the onset of recession,
commodity consumption has been falling.
52

Economic and Social Commission for Western Asia, Preliminary
Overview of Economic Developments in the ESCWA Region in 1998
49
Ibid.
(United Nations document E/ESCWA/ED/1998/6), p. 8.

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The Global Context and the Situation in the Western Market Economies _______________________________________ 15
CHART 2.1.3
Changes in international energy and non-energy commodity prices, 1970-1998
(Indices, 1990=100, quarterly average)
Current dollar prices
Relative prices
Energy
Non-energy
300
300
250
250
250
200
200
200
150
150
150
100
100
100
50
0
50
50
1970
1971
1972
1973
1974
1975
1976
0
0
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Source: United Nations, International Trade Statistics Yearbook, various issues and Monthly Bulletin of Statistics, January 1999; Hamburg Institute for Economic
Research (HWWA).
Note: Data are annual averages. Relative prices are nominal prices divided by the United Nations unit value index of exports manufacture from developed countries.
reduced raw material and energy intensity of production,
benchmark government bonds in the United States and
substitution by other materials and the fall in production
other western countries. This effectively prevented new
costs of commodities themselves.53 These long-term
borrowing by the former countries in the international
factors will continue to exert downward pressure on
bond markets in September and October 1998.56 But the
commodity prices in the future, underlying the cyclical
general sense of uncertainty which had afflicted financial
movements of prices.
markets also became visible in a perceptible widening of
interest rate differentials between private sector corporate
(ii) Lingering instability in financial markets
bonds and government bonds within the industrialized
countries themselves. In the United States, the yield
The Russian devaluation and debt default in mid-
difference between triple-A rated corporate bonds and
August 1998 triggered severe tensions in international
10-year treasuries rose from some 1.1 percentage points
financial markets.54 These tensions were reflected in a
to 1.84 percentage points between June and October
sharp rise in the risk aversion of international investors
1998. This combined with a marked increase in
vis-à-vis emerging markets, a feature which had
investors’ preference for more liquid instruments and
occurred, albeit less pronounced, already in the aftermath
concerns about the possible risks of a credit crunch if
of the Asian crisis. The Russian crisis accelerated the
banks were to tighten lending standards.
flight to quality (i.e. to financial instruments in
industrialized countries) and this was mirrored in
These tensions in financial markets receded in the
significant downward pressure on long-term interest rates
autumn after the decision of the United States Federal
in the western market economies.55 At the same time
Reserve to lower interest rates in three consecutive steps
there was a substantial widening of yield spreads between
between end-September and mid-November 1998 and an
bonds issued in emerging markets and comparable
easing of monetary policy in western Europe, which
reflected the need for convergence of short-term interest
rates among the prospective member countries of the

euro area prior to the start of EMU on 1 January 1999.
53
Technological change in production methods and the larger scale
of operations have caused productivity to increase and costs to fall over
Nevertheless, as yet there has been no return to the
the past two decades. This has been especially the case for oil exploration
status quo ante. Although yield spreads on emerging
and extraction and for metal mining, smelting and refining, which have
market bonds have fallen again, they remain significantly
also benefited from the deregulation of energy markets in some producing
countries. At the same time, advances in agronomic and genetic research
above the levels prevailing in the months before the
have led to higher yields in agriculture.
Russian crisis. And in the United States, the differential
54
between yields on triple-A corporate bonds and 10-year
UN/ECE, Economic Survey of Europe, 1998 No. 3, pp. 15-18.
55
The general sense of enlarged risk and uncertainty engulfing
investors was probably also related to the near failure of a large United

States hedge fund, which was averted by a rescue operation organized by
the United States monetary authorities. To this was added the shock that
56
Institute of International Finance, Inc., Capital Flows to Emerging
Russia was not considered, as widely believed, to be “too big to fail”.
Market Economies (Washington, D.C.), 27 January 1999.

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16 _________________________________________________________________ Economic Survey of Europe, 1999 No. 1
CHART 2.1.4
International share prices, January 1994-February 1999
(Indices, January 1994=100)
Hong Kong
Republic of Korea
Germany
United States
Japan
Indonesia
Malaysia
Thailand
230
150
210
130
190
110
170
90
150
70
130
50
110
90
30
70
10
1994
1995
1996
1997
1998
1999
1994
1995
1996
1997
1998
1999
Source: Reuters News Service.
Note: National currency basis; data are monthly averages. Germany: CDAX; Japan: Nikkei 225; United States: New York Stock Exchange Composite; Hong Kong:
Hang Seng; Indonesia: Jakarta Composite; Malaysia: Kuala Lumpur Composite; Republic of Korea: Korea Composite Exchange; Thailand: Bangkok SET.
treasuries was still 1.5 percentage points at the end of
Inflation did, indeed, fall to quite low levels and it is
January 1999, about half a percentage point more than
against this background that the government strongly
during the months before the Russian crisis. In contrast,
resisted speculative attacks on the currency which
United States share prices, which fell sharply in August
occurred as part of the contagion effects of the Asian
and September 1998, have more than recovered their
crisis in the autumn of 1997 by tightening monetary
losses. Share prices also recovered in western European
policy. But the combination of a large budget deficit and
markets (chart 2.1.4).
a large current account deficit, together with evidence
that the real was overvalued,58 made the currency
The increasing risk aversion of international
vulnerable to speculative attack. The trigger for this was
investors towards emerging markets is reflected in the
the Russian crisis, which led to massive capital outflows
sharp drop of net private credit flows to some $38.5
and associated selling of the currency. In response,
billion in 1998, down from $119 billion in 1997 and $196
official interest rates were raised to nearly 50 per cent and
billion in 1996. There was also a sharp fall in portfolio
the government announced fiscal austerity measures. But
investment. But foreign direct investment has remained
the high interest rates created a vicious circle by
relatively stable, a reflection both of the longer time
depressing domestic activity and, given the strong
horizon of investment decisions pertaining to fixed assets
reliance on variable interest rates for financing the budget
and also of the favourable asset prices prevailing in
deficit, by significantly raising the cost of domestic debt
emerging markets, notably in East Asia. In the event,
servicing. The immediate consequence was a further
total net private capital flows to emerging market
deterioration in the public finances.
economies fell to $152 billion in 1998, a decline by
nearly $90 billion from their level in 1997.57
Against the background of lingering instability in
the international financial markets in the second half of
(iii) The crisis in Brazil
1998, there were concerns that a disorderly devaluation
of the real would have significant adverse contagion
Brazil had introduced a new currency, the real, in
effects on other countries of Latin America, with
July 1994 as part of a wider plan (the Plano Real) to
concomitant risks to other regions as well. An
achieve price stability following a long period of
emergency support package of $41.5 billion was agreed
extremely high inflation during the 1980s and early
with the IMF in mid-November 1998 to support domestic
1990s. The main element of the monetary policy strategy
policies designed to defend the exchange rate policy and
was to peg the exchange rate of the real to the dollar in
to curb the budget deficit. But when domestic political
order to anchor the domestic wage-price process.


57
Ibid. For an analysis of recent changes in net capital flows into the
58
The cumulative inflation in Brazil was significantly higher than in
transition economies see chap. 3.7.
the United States since the onset of the Plano Real.

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The Global Context and the Situation in the Western Market Economies _______________________________________ 17
support for the fiscal retrenchment programme faltered,
Overall economic developments in Latin America
capital outflows resumed on a massive scale in January
in 1998 were strongly affected by the repercussions of the
1999 and the attempt to defend the exchange rate
Asian crisis on international capital flows and commodity
threatened to exhaust the stock of foreign reserves. The
prices. Monetary policy was tightened significantly to
key official interest rate was raised to 39 per cent to arrest
prevent capital outflows and the associated loss of
these outflows. On 13 January 1999, the government
international reserves. On current trends a recession in
attempted a controlled devaluation by widening the
1999 cannot be excluded.62
fluctuation band for the exchange rate which immediately
This episode can be seen as a confirmation of
fell to its new floor. In the face of persistent strong
lessons for the ECE transition economies already drawn
selling pressure the authorities decided on 15 January
from the Asian crisis.63 Strong dependence on short-term
1999 to float the real. By the end of February 1999 the
foreign capital can lead to an inherently unstable
Brazilian currency had depreciated by some 40 per cent
economic situation once foreign investors start pulling
against the dollar.
out. The increase of official interest rates, even to very
In early March 1999, the Brazilian government
high levels, is then no guarantee for arresting capital
concluded the renegotiation of the support package
outflows, in fact, it may even make matters worse, given
agreed with the IMF in November 1998. The basic
the adverse consequence of tight policies for domestic
policy strategy is to keep inflation in check and to avoid
activity levels. Any official exchange rate peg,
an extended wage-price spiral. This will also depend on
moreover, must be backed not only by an adequate level
the extent of the currency depreciation. As in the Asian
of foreign reserves but, more importantly, by credible
emerging markets, high real interest rates are expected to
economic policies designed to prevent the emergence of
arrest and reverse capital outflows, with concomitant
major domestic and external imbalance. Otherwise,
positive effects on the exchange rate. The earlier
governments simply sow the seeds for a speculative
tightening of monetary and fiscal policy has now pushed
attack on the currency with attendant risks of a serious
the economy into recession. Current forecasts are for real
overshooting of the ensuing depreciation. More
GDP to fall by some 3-4 per cent in 1999 compared with
generally, when significant imbalances begin to emerge,
1998, but this may prove to be too optimistic. The
governments must design credible adjustment policies and
contagion effects on other emerging markets have so far
be seen to implement them in order to maintain or restore
been much more limited compared with those that
investor confidence. Governments should also be prepared
followed the Russian devaluation and default. This
for contagion effects if a financial crisis occurs in another
probably reflects the fact that the currency depreciation
country in the region or beyond. This holds independently
had been widely anticipated and that the exposure of
of the state of the so-called “fundamentals” given that
investors to emerging markets, notably as regards highly
international investors in times of crisis often fail to
leveraged investments, had already been substantially
differentiate between national markets.
reduced in the final months of 1998.
The large currency depreciation has significantly
(iv) Recent developments in East Asia
improved price competitiveness of Brazilian firms and
In Japan, the economic situation deteriorated
this could lead to tensions within Mercosur, the free trade
significantly in the course of 1998. Real GDP fell in the
zone which, besides Brazil, includes Argentina, Paraguay
four consecutive quarters64 since the final quarter of 1997
and Uruguay. In fact, foreign trade and investment links
and for 1998 as a whole a decline by some 2¾ per cent is
can constitute an important channel for contagion.59 But
estimated, the worst recession since 1974, when there
Mercosur is a relatively closed trade area,60 which
was a decline of nearly 1 per cent. The unemployment
accounts only for some 3 per cent of United States and
rate rose above 4 per cent, a postwar record. Deflationary
extra-EU exports. This means that the trade effects will
tendencies are discernible, inter alia, in a very large and
be largely felt inside Mercosur. The main impact will be
rising output gap, falling wholesale and producer prices
on Argentina, the third largest economy in Latin
as well as asset prices, a severe crisis in the banking
America, which relies strongly on the Brazilian market
sector, a credit crunch for small- and medium-sized
for its exports. Argentina has raised interest rates to
enterprises, and depressed business profits. Private
defend its own currency, the peso, which is pegged to the
households’ spending behaviour has become very
dollar in the framework of a currency board.61
cautious on account of the worsening outlook for jobs


59
R. Glick and A. Rose, “Contagion and trade: why are currency
crises regional?”, NBER Working Paper, No. 6806 (Cambridge, MA),
62
Economic Commission for Latin America and the Caribbean,
November 1998.
Preliminary Overview of the Economies of Latin America and the
Caribbean 1998 (United Nations publication, Sales No. E.98.II.G.15).
60
The degree of openness (measured as the arithmetic average of the
sum of merchandise exports and imports as a proportion of total GDP) is
63
UN/ECE, Economic Survey of Europe, 1998 No. 1, pp. 73-75.
only about 8 per cent compared to some 35 per cent of the aggregate of
64
five Asian economies most affected by the recent crises.
At the time of writing, national accounts data were available only
for the first three quarters of 1998. But forecasts are for a further fall in
61
There has even been a proposal by the government to “dollarize”
real GDP in the fourth quarter of 1998. This would then be the fifth
the economy, i.e. to introduce the United States currency as legal tender.
consecutive quarterly decline in aggregate output.

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18 _________________________________________________________________ Economic Survey of Europe, 1999 No. 1
CHART 2.1.5
rate was reduced to 0.25 per cent in September 1998.
The effects of this monetary easing, if any, were probably
The exchange rate of the yen against the dollar,
offset by the appreciation of the yen. There was a further
January 1994-February 1999
(Monthly averages)
lowering of the lending rate to 0.15 per cent in mid-
February 1999 and in early March, the bank pushed it
down to 0.02 per cent. This move led to a fall in long-
150
term interest rates as investors shifted funds from the
money market to the bond market. But, since for some
140
time there has been no evidence that the monetary
transmission mechanism is still effective, there have been
demands for an outright monetization of government debt
130
by the Bank of Japan, a demand which it has so far
resisted.
120
Reform of the banking sector is underway, but
Yen
110

small- and medium-sized companies continue to be
faced with the restrictive lending policy of banks
(“credit crunch”). Public funds were made available in
100
the autumn of 1998 to enable banks to tackle the bad
loans problem, but although they have made large write-
90
offs, the volume of bad loans did not change
significantly in the first half of 1998, as new firms
80
became insolvent.
1994
1995
1996
1997
1998
1999
In the five Asian economies most affected by the
Source: United States Federal Reserve.
crisis in the region (Indonesia, Malaysia, Philippines,
Republic of Korea and Thailand) there was a sharp fall in
output in 1998, except in the Philippines, where the
recession was rather shallow (table 2.1.2). The current
and incomes and concerns about the pension system. As
account balances of these countries have moved from
a result, the savings propensity rose markedly in 1998.
deficit in 1997 into surplus in 1998, reflecting the
Weak domestic demand has translated into a marked fall
domestic adjustment process to the net outflow of private
in imports. Exports to western Europe and North
capital from the region. Falling import demand has
America rose strongly but this was more than offset by
played a major role in this reversal of the current account
the continuing weak demand from other countries in the
balance. Export values have remained depressed with, in
region. The current account surplus rose to some $140
some countries, a strong recovery in export volumes
billion or 3.3 per cent of GDP in 1998.
offset by falling dollar prices. National currencies have
The sharp appreciation of the yen between the
tended to appreciate against the dollar in 1998, thus partly
beginning of August 1998 and mid-January 1999 has
reversing the earlier sharp depreciations. Exchange rate
raised concerns about its adverse impact on export
pressures were also reduced on account of the strong
growth, the mainstay of economic activity in the current
appreciation of the yen against the dollar in the second
malaise. The Bank of Japan intervened in early January
half of 1998. This provided scope for lowering domestic
1999 to arrest the strengthening of the yen against the
interest rates, which was supported in some countries
dollar, which has since been partly reversed (chart 2.1.5).
(Indonesia, Republic of Korea, Thailand) by a more
The appreciation of the yen has probably offset to a large
accommodative stance of fiscal policy. Equity prices
degree the potential effects of the new fiscal stimulus
have also edged upwards but displayed considerable
package adopted in April 1998. In any case, significant
volatility in view of the turbulence in international
positive effects of this package were hardly discernible
financial markets (chart 2.1.4). The recession is expected
until late 1998, when there were signs of a strengthening
to bottom out in 1999 reflecting the more conducive
in public investment. A further package of fiscal
stance of economic policy and improved prospects for
measures, which envisages additional public works
export earnings, but this will also depend on the extent of
spending as well as income and corporate tax reductions,
the cyclical slowdown expected in western Europe and
was adopted in November. Given the persistence of
North America.
recessionary forces, the successive fiscal stimulus
Among other Asian emerging market economies,
packages have propelled the budget deficit and
Hong Kong moved into deep recession in 1998, while the
government debt to high levels. Gross general
forces for growth have weakened significantly in
government debt rose to about 100 per cent of GDP in
Singapore, driving the economy to the brink of recession.
1998, compared with some 75 per cent in 1995.
In contrast, the Taiwan economy has displayed a striking
Official interest rates in Japan are at very low
resilience to the recession in the region, although the
levels. The discount rate has been at a historic low of 0.5
financial sector has started to experience some difficulties
per cent since September 1995. The overnight lending
(table 2.1.2).

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The Global Context and the Situation in the Western Market Economies _______________________________________ 19
TABLE 2.1.2
economic environment, the authorities have maintained
their commitment not to devalue the renminbi, which has
Annual changes in real GDP in east Asian countries, 1996-1999
fluctuated within an unchanged narrow band against the
(Percentage change over preceding year)
dollar since May 1994. But the domestic economic costs
1996
1997
1998
1999
of this exchange rate policy have been increasing and its
sustainability will depend strongly on a recovery not
Asean-4 ..................................
7.1
4.6
-8.9
-1.2
only of demand in the neighbouring Asian economies
Indonesia .............................
8.0
4.6
-13.7
-3.9
Malaysia ..............................
8.6
7.7
-6.4
0.2
and sustained import growth in western markets but also
Philippines ...........................
5.8
9.7
-0.5
1.5
on the restoration of domestic consumer and investor
Thailand ...............................
5.5
-0.4
-7.9
0.7
confidence. Growth prospects for 1999 could also be
NIEs ........................................
6.3
6.0
-2.0
0.1
affected by potential adverse spillover effects of the
Hong Kong ...........................
4.6
5.3
-5.0
-1.5
crisis in Brazil, which so far, however, have failed to
Republic of Korea ................
7.1
5.5
-6.1
-2.2
occur.
Singapore ............................
6.9
7.8
1.3
–
Taiwan Province of China ....
5.7
6.8
4.8
4.4
China ......................................
9.7
8.8
7.8
7.3
2.2 The economic situation in western
Japan ......................................
5.0
1.4
-2.6
-0.5
Europe and North America
Total above ............................
7.4
5.6
0.8
2.7
(i)
General economic developments
Source: Consensus Economics Inc., Consensus Forecasts, February 1999
(internet website).
In the western market economies, the contractionary
Note: Growth rates of regional aggregates have been calculated by the ECE
effects of the crisis in Asia and other parts of the world
secretariat as weighted averages of growth rates of individual countries. Weights
were derived from 1996 GDP data converted from national currency units into
economy were increasingly restraining export growth in
dollars using purchasing power parities.
the second half of 1998. In western Europe, this
weakening of exports was not offset by a strengthening of
In China, the pace of economic expansion slowed
domestic demand; instead, the growth of domestic
down further in 1998, although the growth rate of real
demand also slowed down. Real GDP rose by only 0.6
GDP remained very high by international standards.
per cent between the second and third quarters of 1998
Despite the significant adverse trade effects of the east
and was only 2.5 per cent above its level in the third
Asian crisis and the associated repercussions on domestic
quarter of 1997 (chart 2.2.1). Partial data suggest that
employment and income levels, the official target of an
economic growth decelerated further in the final quarter
increase in real GDP by 8 per cent was broadly met.
of 1998: real GDP in the four major economies combined
Strong overall growth, however, contrasts with sluggish
stagnated between the third and fourth quarters, masking
consumer demand and falling consumer and producer
falling aggregate output levels in Germany and Italy.
prices in 1998. It appears that a large part of output is
Rough estimates suggest that economic growth in
simply being added to already large inventories, which
western Europe as a whole was only about one quarter of
may not be saleable. In fact, to counter the slowdown in
a percentage point in the final quarter of 1998. This
economic growth and reverse deflationary tendencies the
stands in sharp relief to developments in the United
stance of monetary policy was eased and the government
States. Propelled by buoyant domestic demand, real
boosted expenditure on public investment projects. These
GDP rose by 1.5 per cent between the third and last
measures appear to have been effective in supporting
quarters. These relative changes have led to an
economic growth in the second half of 1998.
increasing divergence in the cyclical positions of western
Europe and the United States, a tendency which appears
A matter of concern has been the signs of crisis in the
so-called International Trust and Investment Corporations
to have continued in early 1999. For 1998 as a whole,
(ITICs), which have been channelling funds borrowed
real GDP in western Europe is currently estimated to
have increased by 2.7 per cent, down from 2.9 per cent in
abroad to domestic projects. In October 1998, a large ITIC
was declared bankrupt after defaulting on its foreign loans.
1997. Within this aggregate, there was a slight increase
The government announced in early 1999 that most of the
in the average annual growth rate in the European Union
and the euro area to 2.8 per cent in 1998 (table 2.2.1). In
ITICs will have to be restructured. International banks
have reacted to the prospect that their loans might not be
the United States, real GDP rose by 3.9 per cent in 1998,
repaid with a credit squeeze on Chinese corporate
the same as in 1997.
borrowers, refusing to extend new loans and calling in
some existing loans. A matter of dispute remains the
(a) Western Europe
reliability of macroeconomic statistics published by the
Against a background of deteriorating prospects for
Chinese Statistical Office and to what degree output
sales and profits, industrial confidence in western Europe
growth is overstated.65 Faced with a deteriorating domestic
has fallen sharply since mid-1998, a feature which
contrasts with a further rise of consumer confidence to

very high levels (chart 2.2.2). Industrial and consumer
65
See IMF, World Economic Outlook …, op. cit., pp. 147-150, box
confidence have been highly correlated in the past, and
4.1, which tries to reconcile strong output growth with low increases in
the recent divergence between the two is therefore quite
electricity production and falling freight traffic in 1998.

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20 _________________________________________________________________ Economic Survey of Europe, 1999 No. 1
CHART 2.2.1
Quarterly changes in real GDP, 1995-1998
(Percentage change over same quarter of preceding year)
France
Germany
Western Europe
Euro area
United States
Italy
United Kingdom
5
5
4
4
3
3
2
1
2
0
1
-1
1995
1996
1997
1998
1995
1996
1997
1998
Source: National statistics.
Note: Data are seasonally adjusted. Euro area excludes Ireland and Luxembourg. Western Europe: euro area plus Denmark, Norway, Sweden, Switzerland and the
United Kingdom.
striking. To some extent the relative optimism of
This average includes considerably stronger growth
consumers may reflect the prevailing low interest rates
rates in Finland (8.5 per cent), Ireland (16.5) and Spain
and the gains in financial wealth of private households,
(6¼). In view of the sharp slowdown in output growth,
which have supported the purchase of consumer durables
capacity utilization rates fell in the second half of 1998
(notably cars) and favourable financing of residential
and in January 1999 they were nearly 2 percentage
investments. There could be considerable myopia,
points lower than in August 1998 (chart 2.2.3).
however, on the part of consumers. Thus, the effects of
Among the major components of demand, private
the recent deterioration in the short-run economic outlook
consumption held up relatively well in 1998, and
will become visible in the labour markets only with a lag
although the underlying tendency was for a slight
in the course of 1999. It is also striking that, on balance,
weakening in the course of the year (chart 2.2.4), it was
households perceived an improvement in the general
the mainstay of domestic demand. Aggregate
economic situation between September 1998 and
households’ disposable incomes in 1998 were supported
February 1999,66 although forecasts of economic growth
by continued moderate growth in average earnings and
were being steadily revised downwards since last
by stronger gains in employment than in 1997. In several
autumn.
countries, consumers’ expenditure was also supported by
Manufacturing production turned increasingly
falling saving ratios. In addition, real disposable incomes
sluggish in the course of 1998, a marked contrast to its
were boosted by falling inflation and the sharp fall in oil
buoyancy in 1997 (chart 2.2.3). This reflected to a large
prices.
degree the adverse effects of the spreading crisis in
Quarterly changes in real fixed capital formation
emerging markets, including the transition economies,
have been rather volatile since the second half of 1997,
on net exports of manufactures. These effects then
but the momentum which has normally accompanied
spilled over via weaker activity levels and depressed
earlier cyclical upswings has been lacking. The rise in
demand for imported intermediate goods and raw
capacity utilization rates until mid-1998 stimulated
materials between west European countries themselves.
business investment, as did favourable financing
As a result, manufacturing output in western Europe is
conditions and improved profitability. But with the
estimated to have fallen between the third and fourth
deteriorating economic outlook, many firms appear to
quarters of 1998. In view of the significant statistical
have postponed or scaled down their investment plans.
carry-over effect from the end of last year, output rose,
The main focus of business investment has continued to
nevertheless, by some 3.5 per cent for the year as whole.
be rationalization and modernization. Expenditure on

machinery and equipment rose in real terms by some 8
per cent in 1998 (compared with 1997). In contrast,
66
European Commission, Business and Consumer Surveys, First
construction investment remained sluggish with
Results: February 1999 (Brussels), 4 March l999.

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The Global Context and the Situation in the Western Market Economies _______________________________________ 21
TABLE 2.2.1
Growth in real exports of goods and services slowed
down significantly in 1998 from the very high rates of
Real GDP in the developed market economies, 1996-1999
1997, a reflection of the fall in demand from Asia, Russia
(Percentage change over previous year)
and the OPEC countries. But also demand from central
1996
1997
1998
1999 a
and eastern Europe weakened. This general shortfall of
demand was increasingly less offset by rising demand in
Western Europe ............................
2.0
2.9
2.7
1.9
the other west European economies, which was reflected
4 major countries ..........................
1.5
2.3
2.4
1.5
in a weakening of their import growth. In addition there
France .........................................
1.6
2.3
3.1
2.2
were competitive pressures from the recovery of export
Germany ......................................
1.3
2.2
2.8
1.5
growth in Asia, which tended to crowd out producers
Italy ..............................................
0.9
1.5
1.4
1.8
United Kingdom ...........................
2.6
3.5
2.3
0.5
from western Europe in their domestic markets and
abroad.
17 smaller countries ......................
3.1
3.9
3.3
2.5
Austria .........................................
2.0
2.5
3.3
2.1
On average, the changes in real net exports of goods
Belgium ........................................
1.3
3.0
2.8
2.0
and services subtracted somewhat more than half a
Cyprus .........................................
2.0
2.5
5.0
4.0
Denmark ......................................
3.3
3.1
2.4
1.6
percentage point from the growth in total domestic
Finland .........................................
4.1
5.6
4.9
3.0
demand of 3.4 per cent to yield an increase in real GDP
Greece .........................................
2.4
3.2
3.0
3.2
in western Europe of 2.7 per cent.
Iceland .........................................
5.5
5.0
5.6
4.3
Ireland ..........................................
7.4
9.8
8.5
6.3
Developments in the labour markets were relatively
Israel ............................................
4.7
2.7
2.0
1.7
positive in 1998. The rise in aggregate output was
Luxembourg .................................
3.0
4.8
4.7
3.4
associated with an increase in total employment in
Malta ............................................
3.8
4.4
7.6
7.5
western Europe by some 1¼ per cent in 1998 (table
Netherlands .................................
3.1
3.6
3.7
2.3
Norway ........................................
5.5
3.4
2.0
1.0
2.2.3). This was the largest annual increase since 1990
Portugal .......................................
3.2
3.7
3.5
3.0
(chart 2.2.5), but the weakening of cyclical growth forces
Spain ...........................................
2.4
3.5
3.8
3.4
in the course of 1998 increasingly weakened the demand
Sweden ........................................
1.3
1.8
2.9
2.0
for labour.
Switzerland ..................................
–
1.7
2.1
1.5
Turkey .........................................
7.0
7.5
2.4
1.8
Employment growth continued quite strongly in the
North America ...............................
3.3
3.9
3.8
3.0
smaller economies in 1998, also a reflection of rapid
Canada ........................................
1.2
3.8
3.0
2.7
output growth in the past few years. In contrast, changes
United States ...............................
3.4
3.9
3.9
3.0
in employment were more divergent among the four
Total above ....................................
2.7
3.4
3.3
2.4
major economies, where the average increase was small
Japan ...........................................
5.0
1.4
-2.9
-0.5
(about half a percentage point). There was, however, a
strong upturn in the demand for labour in France, in fact
Total above, including Japan ..........
3.0
3.1
2.3
2.0
the largest annual increase in employment in this decade.
Memorandum items:
European Union ...........................
1.8
2.6
2.8
1.9
This reflected the combined effect of robust economic
Euro area .....................................
1.6
2.5
2.8
2.1
growth and special labour market measures aimed at
providing jobs for young persons in the public sector.67
Source: National statistics and national economic reports.
Employment growth also remained relatively strong in
Note: All aggregates exclude Israel. Growth rates of regional aggregates
have been calculated as weighted averages of growth rates in individual
the United Kingdom, but weakened in the course of the
countries. Weights were derived from 1991 GDP data converted from national
year in response to the cyclical downturn. In Germany,
currency units into dollars using purchasing power parities.
the fall in employment since 1991 petered out into broad
a Forecasts.
stagnation in 1998. There was, however, a rise in
manufacturing employment in the course of 1998 but this
levelled off in the final months of the year as output
growth weakened. Employment in eastern Germany
persistent excess capacities in many countries. Falling
continues to be supported by special job creation
mortgage interest rates stimulated households’
programmes. In Italy, sluggish economic activity
residential investment and there was also a stronger
produced only a slight rise in employment.
growth of investment in industrial buildings. On
Increased employment was also reflected in a
average, however, construction investment rose only by
further small decline in the average unemployment rate to
some 1¼ per cent in 1998. Altogether, total real gross
9.2 per cent in 1998, down from 9.9 per cent in 1997
fixed capital formation increased by 4.7 per cent in
(table 2.2.4 and chart 2.2.6). Some offset to the falls in
1998, up from about 3.4 per cent in 1997 (table 2.2.2).
unemployment was due to the growth in the labour force,
Changes in stockbuilding tended to support
which was also influenced in many countries by the
domestic activity in 1998, although there was a
increased incentives for “discouraged workers” to seek
weakening in stock accumulation in the second half of
the year. For the year as a whole, stockbuilding

contributed half a percentage point to the overall growth
67
This accounted for about one third of all the additional jobs created
of GDP.
in 1998 and was reflected in a decline of youth unemployment.

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22 _________________________________________________________________ Economic Survey of Europe, 1999 No. 1
CHART 2.2.2
Business cycle indicators for the European Union and the United States, January 1994-February 1999
European Union
United States
Industrial confidence
Consumer confidence
Business confidence
Consumer confidence
10
140
130
120
110
100
90
0
80
70
60
50
40
30
-10
20
10
0
1994
1995
1996
1997
1998
1999
Purchasing Managers' Index
60
-20
50
-30
40
1994
1995
1996
1997
1998
1999
1994
1995
1996
1997
1998
1999
Source: Data for the European Union: Commission of the European Communities, European Economy, Supplement B (Luxembourg), monthly and direct
communications. Data for the United States: consumer and business confidence: the Conference Board, New York (internet website), and direct communications.
Purchasing Managers’ Index: website of the National Association of Purchasing Management, Arizona, and direct communications.
Note: European Union data show net balances between the percentages of respondents giving positive and negative answers to specific questions. For details see
any edition of the source. United States: consumer confidence is measured in index form with base year 1985=100. Business confidence is compiled on the basis of
answers to specific questions, with the following scale applying: 100 = substantially good; 75 = moderately good (+); 50 = moderately good (-); 25 = moderately bad; (0) =
bad. The Purchasing Managers’ Index (PMI) is a composite index pertaining to the business situation in manufacturing industry. An index value above (below) 50 per
cent indicates that manufacturing industry is generally expanding (contracting). A PMI above (below) 44.5 per cent, over a period of time, indicates that overall economic
activity, as measured by real GDP, is generally expanding (contracting).
jobs again against a background of tighter labour
should be translated into National Action Plans for
markets. On the other hand, special labour market
employment. The 1999 version of these guidelines
measures also played a role in reducing unemployment in
reaffirms the tenets of the strategy and puts the accent on
France and Germany. Given the modest recent declines,
active measures (e.g. changes in benefits and taxes so as
the average unemployment rate has remained close to its
to provide incentives for unemployed or inactive people
peak of the past two decades in France, Germany and
to seek and take up work and training opportunities and
Italy. This contrasts with the sharp fall of the
to reduce recourse to early retirement schemes) and on
unemployment rate in the United Kingdom since the start
lifelong learning (especially in the area of information
of the cyclical upswing in 1993, to 6.3 per cent in 1998, the
and communication technologies). However this process
lowest rate in the past two decades. Unemployment rates
is still incipient and the shift in the focus of policies is
have fallen significantly in many of the smaller economies
likely to take place only in the medium term.68
and to relatively low levels in 1998 (table 2.2.4).
Consumer price inflation in western Europe
The negative social and economic consequences of
continued the declining trend established at the beginning
persistently high unemployment rates in most of western
of the decade and in 1998 reached its lowest level in
Europe has increased the pressure on governments to
almost 40 years (see chart 2.2.7). The main factor
strengthen their labour market policies. At the “Jobs
Summit” of November 1997 the European Union

launched the Luxembourg process, which aims at
68
reorienting policies towards a more preventive and active
European Commission, European Commission Adopts 1999
approach to the problem. Guidelines were agreed, which
Employment Guidelines, IP/98/887 and European Commission Adopts
1998 Joint Employment Report, IP/98/889 (Brussels), 14 October 1998.

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