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Scottish Economic Report: March 2004
1.2 Global Developments
1.2.1 Overview
This section first provides a short summary of global developments before going on to discuss performance in greater detail. As a result of the conflict with Iraq, economic trading conditions and confidence during 2003 have not been as strong as would have been hoped. However the OECD and the IMF forecast that economic recovery has developed in the second half of 2003, as confidence returns to markets and consumers alike.
Consumer expenditure accounts for a considerable proportion of GDP. In general it accounts for over 50 per cent of all spending in the economies of the UK and its competitors. Determinants of consumer expenditure are closely related to confidence of both consumers and business. These could relate to labour market performance and monetary & fiscal policies. Therefore these aspects will be touched upon throughout this chapter.
The US economy has shown remarkable growth over 2003 Q3 and 2003 Q4. After a long period of difficulty the Japanese economy has been demonstrating that the recovery is under way, experiencing five successive quarters of growth to 2003 Q3 (year on year). Growth in the Euro-zone has been positive over recent quarters, though the performance has been much more sluggish than the US. Additionally, monetary policy in the US, Euro area and the UK has been aggressive in trying to stimulate economic activity in these areas. Box 1.2 shows the trend for interest rates for the UK, US and ECB over recent times, while also placing the recent changes into some form of context by comparing current levels of UK interest rates back to 1990.
Box 1.2 Interest Rates |
The 0.25 percentage point rise in the Bank of England base rate in November 2003 was the first rise in British rates for over 4 years. Even before the November rise, UK official interest rates were still significantly above those in other major economies, such as the US, Japan and the Eurozone. This has been the case for much of the previous decade. UK interest rates have been relatively high - peaking at 15 per cent in the late 1980s and early 1990s. This was necessary to restrain inflation, which was also at double digit levels during the boom seen in the late 1980s, and also an attempt to keep Sterling within the limit set by the Exchange Rate Mechanism. Once the pound left the ERM in 1992, interest rates were free to fall, which they did steadily over the next few years. |
Chart 1.4 UK long term Interest Rates |
After the Bank was granted operational independence in 1997, and allocated a new inflation target of 2.5 per cent, the first movement of rates was upwards. The highest level of rates since independence was the 7.5 per cent seen in 1998, since then the trend has been almost universally downwards. Although UK interest rates are low by historical standards, they still remain at a relatively high level by current international standards. Many commentators view this as a display of confidence about the future prospects for the UK economy, as the UK was one of the few major economies which avoided recession in the wake of the technology slowdown and the effects of the events on 11 September 2001. As growth remained positive, the MPC saw no need to reduce interest rates to the very low levels observed in the US and Eurozone, as seen in Chart 1.5 overleaf. The comparison of the rationales of the MPC, and the Federal Reserve and ECB is not strictly valid, as these organisations have different specific objectives when setting interest rates. The ECB is committed to keeping consumer price inflation below 2 per cent, whereas the Federal Reserve has no specific inflation target, although its remit includes the "long-run goals of price stability and sustainable economic growth". In order to meet the unique needs of the UK economy, interest rates have consistently been set at a different level from those in the rest of the world. |
Chart 1.5 International Interest Rate Comparisons |
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1.2.2 Euro area developments
Output in the Euro area has been somewhat subdued in the second half of 2003. This was undoubtedly exacerbated by the conflict in Iraq, though performance has been struggling for some time now. Chart 1.6 shows the growth rates since 1998 (percentage change on a year earlier). Growth in output has been sluggish in recent quarters, especially relative to the performance over the period 1998 Q1 to 2001 Q3.
Both the IMF and the OECD forecast that growth will be strong over 2004 and 2005 (Charts 1.7 & 1.8). The key factors that underpin output are private & government consumption, investment and exports. Of these indicators it is anticipated that they will all grow over 2004 and 2005, with the exception of net exports (exports minus imports).
In the Euro area private consumption accounts for over 50 per cent of all final demand, and is forecast to grow by 1.7 per cent and 2.4 per cent in 2004 and 2005 respectively. The OECD suggest that it will be gross fixed investment which will have the biggest impact on overall output in the next couple of years in the Euro area. In 2002 and 2003, total investment declined by 2.4 per cent and 1.0 per cent respectively. However it is anticipated that this short term trend will be reversed, with growth of 2.3 per cent and 3.9 per cent forecast for 2004 and 2005 respectively.
The net export position in the Euro area is not strong. As can be seen from Chart 1.9, the US dollar has been depreciating against the Euro. The result of this is that US products have become relatively cheaper than Euro area products, and the projected position for net exports may reflect this development. OECD forecast that net exports from the region will be stagnant in 2004, before improving marginally in 2005 to growth of 0.1 per cent.
The unemployment picture is not forecast to improve immediately. The OECD estimate the Euro area unemployment rate at 8.8 per cent in 2003, and this is forecast to increase in 2004 to a rate of 9.0 per cent, before falling marginally in 2005 to a rate of 8.7 per cent (Table 1.7). However this unemployment forecast should be placed in context, as the increase in unemployment since 2001 in the Euro area has been minor.
The OECD suggest that this trend has developed due to the cost of recruitment. For example, it may have been unwise to shed labour when economic prospects in the short-term were not clear.
1.2.2.1 Germany and France in Focus
As demonstrated earlier, Germany and France are crucial to Scottish exports. Further, Germany is responsible for around 30 per cent of Euro area output. Therefore the performance of the German economy is not only important for the future of the Scottish economy, but also for economic prospects of the Euro region.
Recent official data 2 shows that output in the German economy grew by 0.2 per cent over the most recent quarter (2003 Q3), though there was a decline of 0.2 per cent over the year to 2003 Q3. Labour market performance has been weak over recent times, with those that are registered unemployed standing at 4,317,000 (rate 10.4 per cent 3) in December 2003. Although the main economic indicators have not been performing strongly, the OECD indicate that there are signs of recovery in the German economy (Table 1.8).
The OECD have indicated that German growth picked up in the second half of 2003, and it is likely to continue into 2004. Although stagnant GDP was predicted for 2003, it is forecast that growth will be positive in 2004 and 2005, standing at 1.4 & 2.3 per cent respectively.
However threats to stability in the German economy remain. As the OECD note, the general government deficit is likely to exceed 4 per cent of GDP in 2003 and will remain at around 3.5 per cent in 2005. On this basis, policy changes and additional reforms may be required to reduce the structural deficit in a sustainable way. If these issues are not tackled, they may result in further delays to projected recovery, and place further pressures on the German and Euro area economies.
The position in France is not dissimilar. According to official data 4 GDP increased by 0.4 per cent over the quarter to 2003 Q3. However over the year to 2003 Q3, GDP decreased by 0.3 per cent. The OECD suggest that GDP will grow marginally in 2003, at a rate of 0.1 per cent. In 2004 and 2005 the performance should pick up, with forecast GDP growth of 1.7 per cent and 2.4 per cent respectively.
An area that it is anticipated will perform strongly, and will contribute significantly to the French economy, is the export of goods and services. It is forecast that exports will grow by 4.6 per cent and 7.1 per cent over 2004 and 2005 respectively. However this should be viewed in the context that the Euro is appreciating against the dollar and therefore the relative costs of goods and services may prove uncompetitive. However exports from France could be to other euro area countries, and therefore the exposure to exchange rate fluctuations may not be as significant.
In addition the impact that consumer confidence could have should not be under-estimated as, like Germany, private consumption will be the main driver of demand in the French economy. It accounts for more than 50 per cent of GDP and therefore the forecasts of growth of private consumption of 1.6 per cent and 2.2 per cent in 2004 and 2005 respectively are crucial to the overall forecasts being met.
1.2.3 Developments in the US5
Not only is Scotland's economic performance highly reliant on the strength of the US economy, so too is overall global activity. Therefore GDP growth of 8.2 per cent in 2003 Q3 was encouraging. This has continued with the most recent data for the US (2003 Q4) indicating growth of 4.0 per cent. All the key determinants of demand have had a strong impact on the continued growth of the US economy. Exports of goods and services increased 19.1 per cent in the fourth quarter, compared with an increase of 9.9 per cent in the third. This suggests that the exchange rate variations are having an impact on the US economy. As discussed, the US dollar exchange rate has been on a continued slide against the Euro, while the UK pound relative to the US dollar (Chart 1.10) has also been appreciating. At the moment there are few indications as to how long this trend might continue. Ultimately it would be expected that the depreciation of the US dollar will have a negative impact on exports from the Euro area to the US, although it should be noted imports in 2003 Q4 were still up by 11.3 per cent.
It would appear that aggressive fiscal and monetary policy has had a positive impact on the US economy. This can be witnessed by the considerable increases in consumption (2.6 per cent 2003 Q4 & 6.9 per cent 2003 Q3) as the tax reductions led to an increase in disposable income; and increases in investment (6.9 per cent 2003 Q4 & 12.8 per cent 2003 Q3) as the cost of capital declined via lower interest rates. In addition, the labour market position appears to have picked up in the US. As can be seen from Chart 1.11, unemployment has been falling steadily since June 2003 and employment increasing in the final quarter of 2003. It would appear that this was linked to the significant increase in GDP in 2003 Q3 and Q4.
However, although the main indicators are positive it is worth noting that threats to the US economy still exist. Government finances have deteriorated as a result of tax cuts, and the large deficits projected over the coming years underline a threat to the future success of the US economy. In addition, inflationary pressures may become more prevalent if demand for US products continues to accelerate at the current rate. Finally, not only has the consumer demonstrated an increase in confidence via their consumption levels, but also business appears to have reacted positively by the recruitment of additional staff. In order for consumption and investment to remain strong it is important that confidence from consumers and business continues.
1.2.4 Developments in Japan
Output in the Japanese economy has been positive in recent times. Chart 1.12 shows the GDP growth rates since 1998 (percentage change on a year earlier). The Japanese economy showed negative growth for a considerable period, 2001 Q3 to 2002 Q2. However the economy returned to positive growth in 2002 Q3. Over recent times the performance has been reasonably strong, with GDP for 2003 Q3 growing by 1.8 per cent.
The OECD and IMF both forecast positive times ahead for the Japanese economy. The OECD expect GDP to grow by 1.8 per cent in 2004 and 2005, while the IMF forecast that GDP will increase by 2.0 per cent in 2003, followed by growth of 1.4 per cent in 2004. The recent recovery of the Japanese economy has been underpinned by increasing levels of business investment and exports. Potential threats to continued recovery include any decrease in confidence by the business sector, coupled with continued exposure to exchange rate fluctuations. However the OECD indicate that although exports of goods and services will continue to grow in 2004 and 2005, the levels of growth witnessed in 2003 will not continue. It is forecast that investment will increase marginally in 2004 by 0.2 per cent, and will be stagnant in 2005. The recent performance has not led to an end to deflation. Although the position is approaching zero, it is still forecast that the consumer price index will fall by 0.2 per cent in 2004 and 2005.
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