The world’s economic outlook for 2005 is uncertain at best. Pessimists may worry about worst-case scenarios, but economic disasters, unlike natural disasters, can be prevented through better planning and management. Much depends on how major economic powers — particularly the United States, Europe, Japan and China — handle domestic and international problems in the year ahead.
One immediate concern is how the U.S. dollar will move in foreign-exchange markets. Lately the greenback has lost some of its exchange value, reflecting financial market worries about America’s bloated twin deficits: in the budget as a result of massive tax cuts and the mounting military costs in Iraq, and in the current account involving trade. The question being asked is whether the second-term administration of President George W. Bush can stop the hemorrhaging.
The American currency has followed a zigzag course in recent weeks. Typically, it has declined as the trading week drew to a close but then rebound early the next week following a statement by a U.S. administration official that Washington supported a “strong dollar.” Such flip-flop movements reflect a lack of market confidence in the dollar.
The dollar will continue to weaken unless the Bush administration tackles the deficit problems in real earnest. President Bush can do so if he presents specific and effective plans for deficit reduction in his budget message to Congress. In reality, though, such options appear to be extremely limited. The yen is already trading close to 100 yen to the dollar. Sooner or later, it may break through this level.
Mr. Alan Greenspan, the chairman of the U.S. Federal Reserve Board, faces a difficult task ahead. The FRB, which has shifted the focus of its monetary policy from staving off deflation to guarding against inflation, is likely to raise interest rates gradually so as to brake the dollar’s slide.
With the American economy showing signs of slowing, however, Mr. Greenspan will have to perform a delicate balancing act so that he doesn’t aggravate a downtrend.
China, a key engine of global growth, is also beset with problems, and how it manages them will affect the course of the world economy. One problem is the widening gap between the rich and poor. In particular, those in underdeveloped interior regions are increasingly unhappy with their lives, as demonstrated by farmers’ revolts and riots. The growing social anxiety, if left unresolved, could stunt the country’s growth.
Trade disputes between the U.S. and China, epitomized by the worsening trade imbalance, also cast a shadow over the global economy. The crucial question is whether China will revalue its currency, the yuan, in response to demands from the U.S. and other trading partners.
In December, Beijing is scheduled to host a ministerial meeting in Hong Kong on the Doha round of international trade talks. Having recently joined the World Trade Organization, Beijing must ensure that the meeting succeeds. For that to happen, the yuan probably will have to go up.
Prospects for Japan’s economy are also cloudy. The driving force that has led the latest recovery — booming exports to the U.S. and China — has been losing steam. Some analysts say the economy may have already entered a recessionary phase. In fact, key economic indicators such as industrial production, as well as business confidence indexes, point to a possible downturn. Domestic demand remains too weak to offset falloffs in external demand.
Consumer spending has received a boost from higher incomes and a spike in the number of available jobs, but the scheduled rollback of flat-rate cuts in the national income tax and in the residence tax could choke off growth in this most important area of internal demand.
The sense of uncertainty is reinforced by the fact that drastic pension reform has been postponed. The public is also uneasy over other parts of Prime Minister Junichiro Koizumi’s reform agenda, especially his plans for privatizing postal services. Mr. Koizumi continues to make an impassioned appeal for postal reform, but just how the proposed changes are supposed to benefit Japanese society in general and the lives of ordinary people in particular remain frustratingly vague.
Meanwhile, the Koizumi initiative for “structural reform” appears to skirt a problem that has become more pronounced in recent years: growing disparities in income and wealth. The income tax system is now skewed in favor of the rich. One wonders whether Mr. Koizumi and his economics minister, Mr. Heizo Takenaka, are fully aware of this.
Structural reform will not truly succeed if this problem is ignored. Since the economic pie is not likely to expand much in coming years, policymakers ought to put greater emphasis on the redistribution of income and wealth. In 2005, Mr. Koizumi’s reform lines must be subjected to a critical review.
By subscribing, you can help us get the story right.