World Economy—Growth Prospects and Risks

The current state of the world economy and the medium-term prospects for world growth are key concerns for the 42^nd Parliament. This is particularly the case given the impact world growth has on domestic economic conditions in a small open economy like Australia.

At the time of writing, the world economy continues to grow strongly. The International Monetary Fund (IMF) has projected global growth for 2007 to reach above 5 per cent, well above the long-term average of 3.7 per cent.

The very strong recent world growth is a testament to the strength of emerging market and developing country economies. Very high growth has continued to be recorded, particularly in the Chinese, Indian and Russian economies, which are growing at projected rates for 2007 of around 11.5 per cent, 9 per cent and 8 per cent respectively. In combination, these three economies are likely to account for half of the total world economic growth over the previous year. China remains the standout performer. In 2007, for the first time, China made the largest contribution to world growth in both market and purchasing power parity terms (IMF 2007, p. 1).

This strong global growth performance has occurred despite a weakening of economic conditions in the United States economy, where growth has been running at around 2.5 per cent over 2007. The US housing sector continues to act as a drag on growth, with the drop in residential investment alone taking 1 percentage point off growth over the previous year (IMF 2007, p. 10). A further slowing of US growth into 2008 is widely anticipated, due in part to the effects of falling housing values on consumer confidence and spending, and higher oil prices. 

Looking forward to 2008, strong global growth appears likely to continue in the medium term, albeit at levels slightly lower than in the previous two years. Latest IMF forecasts are for global growth to total 5.2 per cent in 2007 (down from the 5.4 per cent growth experienced in 2006) and then fall slightly to 4.8 per cent in 2008. Significantly, the forecast for 2008, made in October 2007, represents a downward revision by 0.5 per cent compared to its earlier forecast in July. Some commentators have suggested that a moderate slowing of global growth in 2008 is desirable, given that the very healthy growth levels of 2006 and 2007 have acted to put pressure on energy and raw material prices.

Both the Organisation for Economic Co-operation and Development and the IMF cite a number of key risks to growth in the coming period. The IMF emphasises the ongoing uncertainty in financial markets following recent credit market turbulence as a main concern. The full effects of the credit crisis are yet to be clear, both in Australia and elsewhere. Perhaps not surprisingly, the largest downward revisions in IMF forecasted growth have been in countries that are most likely to be affected by the credit market downturn, including the US, Canadian, and Mexican economies, together with some emerging Asian countries. Other key risks that the OECD and IMF cite are rising world food prices (in part due to the increased use of some food items as a source of fuel), continued oil market instability and ongoing concern about global external account imbalances.

The implications of this outlook for the Australian economy are mixed, but overall there are clear grounds for cautious optimism. While the full effects of the global repricing of credit on local financial markets remain unclear, overall exposure may be smaller relative to many other countries. Further, Australia appears better placed than many other countries to benefit from the continued emergence of China as a global economic superpower, and from the rapid expected growth in other East Asian countries such as India and Indonesia.

Documentation

International Monetary Fund, World Economic Outlook, October 2007.
Organisation for Economic Co-operation and Development, Economic Outlook, no. 81, May 2007.
Organisation for Economic Co-operation and Development, What is the economic outlook for OECD countries? An interim assessment, 5 September 2007.
Reserve Bank of Australia, Statement on Monetary Policy, November 2007.