U.S. and Hong Kong (1997)

24 November 1997

U.S. INDUSTRIAL TRADE OUTLOOK FOR 1998

Continued strong U.S. economic growth predicted

Washington -- The U.S. Department of Commerce, in its report, "U.S. Industry and Trade Outlook," predicts continued strong growth for the U.S. economy in 1998 with a 2.4 percent annual growth rate expected in 1997, the same as in 1996.

Although the report noted the overall strength of the world economy, it also pointed out that the growth rate for world trade was lower in 1996 than in the previous two years. The International Monetary Fund (IMF), however, has estimated that overall trade volume expanded by 6.7 percent in 1996.

The report, a collaboration between the Commerce Department and the McGraw-Hill Companies, also said growth in the developing world will be somewhat faster in 1997 than 1996 while the developed economies are expected to grow at about the same or at a slightly faster rate in 1997 than they did in 1996.

The Japanese economy, in marked contrast to the U.S. economy, experienced a rapid decrease in the annual growth rate in 1996, although growth did increase by year's end and Japan is expected to stage a gradual recovery in 1997.

The Commerce Department's report on the state of the economy, which had not been issued for several years, has been reinstated by the department in a revised format. "The World Economic Outlook," a chapter from the report, follows:

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After slowing slightly in 1995, the world economy grew in 1996 by an estimated 3.8 percent, according to the October 1996 World Economic Outlook of the International Monetary Fund (IMF). Preliminary indications reveal that the world economy will grow at a similar if not a slightly higher rate in 1997. Barring unforeseen developments, growth should increase moderately in 1998 as well. The developed industrial countries, together, are expected to grow somewhat more rapidly in 1997, compared with 1996, as are the emerging market economies. Collectively, the transition economies of Eastern Europe, Central Europe, and the former Soviet Union are expected to finally show significant growth in 1997, providing the world with most of the added overall growth that is expected for the next two years.

In addition to the positive outlook for world growth, other indicators point to a world economy that is generally in very good condition. Perhaps most notably, worldwide inflation is at its lowest level in three decades. That situation can be attributed largely to the continuing efforts of many emerging markets to impose fiscal and monetary discipline on their economies and to improve economic competition through restructuring and deregulation. The successful efforts to curb inflation are especially notable in South America's emerging markets and the former planned economies of Central and Eastern Europe. With the expectation of continued sound monetary and fiscal policy, the outlook for inflation in the near term is good. Besides stable macro policies, most commodity prices -- with few exceptions, oil and coffee, for example -- have been steady in the last year. Finally, many important industrial countries are operating well below capacity, which tends to keep a lid on price increases. Among the seven major economies, only those of the United States and the United Kingdom were operating at or near full capacity at the beginning of 1997.

In contrast to the increase in world economic growth in 1996, the growth rate of the volume of world trade was less in 1996 than in the previous two years. The IMF estimates that trade volume expanded by 6.7 percent in 1996. In each of the two previous years trade expanded by nearly 9 percent. A slight increase in the rate of trade growth is predicted for 1997, as growth in some of the industrial countries picks up after the lethargy of 1996.

Most of the economies of the industrial developed countries are expected to grow at about the same or at a minimally faster rate in 1997 than they did in 1996. The most important exceptions to that trend are Japan and the United States. In Japan, rapid deceleration of growth at midyear followed very rapid growth in the first quarter of 1996. Growth, however, did pick up in the fourth quarter, and a gradual recovery is expected in 1997. On a year-over-year basis, 1997 growth will be less than 1996 growth.

In the United States, strong growth in the first half of 1997 is expected to result in an annual growth rate for the year that should be about 2.4 percent, the same as the rate for 1996. For Europe, a moderate increase in growth is anticipated in 1997, about a half percentage point above 1996's anemic expansion of 1.6 percent. Tight fiscal policies are being applied throughout much of Western Europe in an effort to meet the self-imposed goals of monetary unification in 1999. Canada, meanwhile, is in the middle of a fairly strong recovery and should grow nearly twice as rapidly in 1997 as in 1996, when growth was about 1.5 percent.

The developing countries, as a group, are expected to grow slightly more rapidly in 1997 than in 1996. In all regions -- Asia, Africa, Western Hemisphere, the Middle East, and Europe -- the 1997 outlook anticipates growth to remain at or slightly exceed 1996 levels. In Asia, growth rates, which slipped slightly in 1996, are expected to rebound slightly as policies to reduce inflationary pressures, especially in China, have been reversed. Also, exports from the region should return to more normal levels following a sharp slowdown in 1996 as demand from Western economies slackened and the important electronics trade was hit by lower prices.

In the transition economies of Eastern and Central Europe and the republics of the former Soviet Union, 1996 growth came in well below expectations, largely because the economy of Russia failed to revive during the year, as was expected, and instead contracted again. Growth was also slightly slower in some of the Central European economies. Central and Eastern European exports to markets in the European Union were trimmed as a result of that region's slow growth. On the positive side, significant advances were made throughout the region in reducing inflation, and several of these economies have successfully managed the transition process to market economies. Three of which -- Poland, Hungary, and the Czech Republic -- have been accepted as members of the OECD.

Growth in the 20 countries that are the top export markets for U.S. manufactured goods increased sharply in 1996, compared with 1995. On a trade-weighted basis, the growth of those 20 countries increased from 2.6 percent in 1995 to 3.5 percent in 1996. Most of the improvement occurred because of the significant improvement in the growth of two of the three top markets -- Japan and Mexico. The average growth for these countries should be even faster in 1997, although Japan's growth is expected to be below its 1996 level. Canada, the top market for U.S. exports and the destination for nearly a quarter of U.S. manufactures shipments, is expected to grow at a much faster pace in 1997. Most of the European countries that are in this group are also expected to grow at accelerated rates in 1997.

NAFTA ECONOMIES: NORTH AMERICA

An increase in the rate of economic growth in North America is expected during 1997 because of improved economic performance in Canada and Mexico. The United States should grow by about 2.4 percent in 1997, as it did in 1996. Looking ahead, faster growth in the region is forecast for 1998, with the increase coming entirely from Canada and Mexico.

Canada

Among the seven major industrial economies, Canada may show the fastest growth in 1997 -- a little more than 3 percent. Although corporate restructurings and government spending cuts have resulted in heavy job loss and a high-around 9 percent-rate of unemployment, as well as a drop in consumer confidence, most other major economic indicators are very good. Inflation is half the rate of U.S. inflation, exports are booming, interest rates are at a 30-year low, government deficits have been reduced sharply, and the Canadian dollar has strengthened in recent months. Increased levels of investment and export growth have propelled the Canadian economy in recent years, and the reductions in interest rates are expected to fuel growth over the next year or two. Recently, consumption has picked up as well after a long period of sluggish growth.

Despite all of the good news about Canada's economy, there are areas of concern. First, much of the recent success of the economy has been realized in the western provinces. Quebec and the Maritime provinces have enjoyed little growth, and unemployment rates are well into the double digits in these areas. Second, Canada's strong increase in international competitiveness has resulted in a rapid growth of the export sector of the economy, from around 31 percent of GDP in 1991 to more than 44 percent in 1996. A slowdown in the U.S. economy, Canada's primary export market, would therefore dampen Canadian growth. Third, the implementation of NAFTA and the low value of the Canadian dollar fueled the export boom; little of Canada's international competitiveness has come from increases in productivity.

Mexico

Mexico's economy recovered very rapidly from late-1994 when the peso devalued sharply as international capital drained from the country. The economy plunged 6.9 percent in 1995, Mexico's sharpest recession ever. In 1996, largely because of strong export growth, the economy grew by an estimated 5.1 percent. Growth is expected to moderate slightly in 1997. Despite the impressive turnaround, the recovery remains fragile and uneven. Most of the benefits of the recovery have gone to the export-oriented areas of the north, while average Mexican workers in the capital and in regions to the south have seen their real income erode sharply. Average real wages have fallen by about 20 percent since the peso crisis, and another decrease is projected in 1997. Also, because of the rapid increase in the labor force, 5.1 percent growth is not large enough to reduce unemployment rates. Small businesses are burdened by heavy debt loads and cannot obtain additional credit from the banking system, which is encumbered with large amounts of non-performing loans. As in the case of most Latin American countries, Mexico remains heavily dependent on foreign capital for its investment requirements. Compounding those difficulties are the ongoing activities of rebels in the south and the uncertainty of the outcome of midyear elections.

Foreign investors have responded positively to Mexico's restructuring plan following the peso crisis, but given the uncertainties, the international money could be turned off again should the political situation deteriorate. On the trade front, the current account was in balance in 1996, and only a small deficit of about 1 percent of GDP is expected in 1997.

INDUSTRIAL ECONOMIES: WESTERN EUROPE

After a disappointing 1996, which saw economic growth fall from 2.5 percent in 1995 to an estimated 1.6 percent in 1996, the economies of Western Europe are projected to expand at around 2.5 percent in 1997. Of the four major economies, only the United Kingdom enjoyed good economic growth in 1996. Germany, France, and Italy all grew less than 2 percent.

In many countries, efforts to meet the Maastricht criteria for monetary union have resulted in fiscal tightening, which has slowed economic growth throughout the region. (To join the European Monetary Union countries are expected to implement fiscal policies that will lead to fiscal deficits that are no greater than 3 percent of GDP and to reduce the total outstanding public debt of the country to less than 60 percent of GDP. As a point of interest, the United States federal debt as a percent of GDP was 1.4 percent in 1996, whereas the total publicly held federal debt is just over 50 percent of U.S. GDP.) Cuts in social welfare programs and record high levels of unemployment have left consumers pessimistic and spending little, but the new fiscal austerity has driven down inflation and interest rates across the continent. The monetary union is scheduled for January 1, 1999. The German- and French-led effort at currency unification has been the central focus of economic policy. The rush to join the EMU (European Monetary Union) has galvanized the public and governments across the region. Policies to trim government spending, raise taxes, and cut inflation have received wide support, although increasingly questions are being raised about the value of the effort as social spending cuts have started to bite.

Germany

With its dominating economy and currency, Germany has been at the center of the economic unification effort, but the German economy has struggled in the last two years. In early 1996, however, following the decline in the value of the deutsche mark in the spring of 1995, export orders began to pick up. Exports helped lift the economy in the second half of the year from the 1 percent growth rate of the first six months. Growth in 1996 was around 1.6 percent, well below the forecast at the beginning of the year. For 1997, it is predicted that the economy will grow by 2 to 2.5 percent, with exports again providing much of the impetus. Investment spending has been weak as has consumer spending. Few dents will be put in Germany's high unemployment figures, which jumped to a post-war high of 12.2 percent in January 1996. Growth will be too slow to increase the number of jobs enough to significantly reduce the unemployment rate. Current forecasts expect unemployment to average 11 percent of the labor force in 1997.

The high cost of German labor and government controls have been blamed for the slow rate of investment growth (negative in 1996), despite very low interest rates and virtually nonexistent (1.5 percent in 1996) inflation. German industry has been investing increasing amounts in foreign production facilities to escape Germany's high labor costs. The government has responded with a host of proposals to reduce these costs, but only a few have been adopted to date. Meanwhile, the German reunification effort has stalled. Growth in the east has slowed for two consecutive years and is expected to fall below west German growth rates in 1997 for the first time since reunification. Efforts to boost productivity in the former East Germany have had little success. With the high labor costs in the region, German and foreign investors alike have been more willing to locate plants in the Czech, Hungarian, or Polish economies where labor costs are much lower. Officially the unemployment rate in the east is 15.5 percent, but counting subsidized jobs and early retirement programs it may be closer to 30 percent.

France

In France, efforts to meet the EMU criteria have faced barriers similar to those in Germany: The French government's actions toward reducing welfare programs and restructuring the economy have provoked a general strike. Nevertheless, considerable progress has been made in fiscal consolidation, and recent projections (including those of the OECD) have France's fiscal deficit falling to 3 percent of GDP by 1998.

French economic growth in 1996 was sluggish. Low business and consumer confidence held spending down. Exports, however, have been growing -- up an estimated 5 percent in the second half of 1996 -- and are expected to provide a further boost to growth in 1997. Investment spending is also growing as interest rates have fallen to their lowest levels in 30 years. Inflation is also very low. Consumer prices advanced only 1.8 percent in the 12 months through January 1997. Financial markets evidently feel that France is on track to meet the EMU criteria as French interest rates dropped to German levels by the fall of 1996, eliminating the necessity for an interest rate premium to maintain exchange-rate stability between the franc and the deutsche mark.

Italy

Following its forced withdrawal from the European Exchange Rate Mechanism (ERM) in September 1992, Italy's trade position has improved steadily, and its exports have been the major factor driving economic growth in the last few years. In mid-1995, the lira began to gain strength in response to record trade surpluses, cuts in the fiscal budget, and monetary policy that has reduced inflation. In November 1996 Italy rejoined the ERM with the lira set at 990 to the German mark, more than 25 percent above its low point.

The agreement to rejoin the ERM at the rate of L990 to the D-mark hampers Italy's competitiveness, and slower export growth should contribute to the continued slow economic growth that is expected in 1997. The consensus forecast is that Italy's economy will grow only around 1.2 percent 1997, following growth of less than 1 percent in 1996. Most of the slowdown in export growth in 1996 was not related to the growing strength of the lira but instead was caused by the sluggish economic growth in its two main European export markets: France and Germany. Weak export growth, coupled with fiscal austerity and anemic consumer spending, has produced the current slowdown.

Despite the poor economic performance of late, all major political parties, as well as a majority of the population and the leading labor unions, favor the fiscal reforms that should bring Italy within hailing distance of the Maastricht criteria by 1998. Italy wants to be one of the first members included in European monetary unification when the Euro is launched on January 1, 1999, but Italy, along with Spain and possibly others, will probably not join until at least a year later. For years Italy has been hobbled by one of Europe's largest (relative to GDP) government deficits, but recent fiscal and monetary austerity have lowered inflation and interest rates. Because of the huge size of the government's debt (120 percent of GDP), the interest rate cuts have been a major reason for the reduction in the country's deficit. Italy now has one of Europe's largest primary surpluses (the budget balance, less interest payments), projected to be equal to 4.6 percent of GDP in 1997.

The United Kingdom

The last of the big four European economies, the United Kingdom finds itself in the best economic condition of any country in the region. Growth is projected at around 3 percent over the next two years, and unemployment is low and falling (6.9 percent in November 1996). The current expansion in the U.K. is nearly five years old. In the beginning, it was led by exports, which became competitive after the pound dropped out of the ERM and down in price. In the last year, the pound has strengthened, and export growth has slowed; but weak growth and demand on the Continent have been mainly responsible for the slowdown in exports rather than the pound's strength.

Real incomes are creeping up, residential property, values have also started climbing at a more rapid rate and there is some fear that a boom in consumer spending may ignite a new round of inflation.

Although the United Kingdom is one of the few European economies that is currently near the Maastricht criteria for EMU membership -- both the current budget deficit and the overall government debt outstanding are within shouting distance of the 3 percent (of GDP) and 60 percent requirements -- the U.K. is not planning to join the new Euro currency. A wait-and-see attitude has gradually replaced one of outright opposition to the plan.

Spain

Perhaps the most surprising country that might meet the qualifications for first-round membership in the Euro is Spain. Only the core EMU countries of Germany, France, Belgium, and Luxembourg are rated above Spain for meeting the goals. Economic growth in 1996 was only around 2 percent, down from 2.8 percent in 1995. As in the case of many of Europe's economies, the slow growth of Spain's European export markets dampened growth in late 1995, but exports did pick up in 1996. The growth rate is forecast to rebound to around 2.7 percent in 1997. At 22 percent, Spain's unemployment rate is the highest in Europe; however, inflation as well as interest rates are down. Tight fiscal and monetary policies have reduced Spain's long-term rates, and the 10-year bond rate is only about 1 percentage point above that of Germany's. Despite these fiscal successes, Spain will probably be among the second group of countries to join the Euro.

Denmark, Finland, Sweden, Norway, and Iceland

There will be a convergence of economic growth among the five Nordic countries in 1997. Denmark, Finland, and Sweden all grew at slower rates than the European average in 1996 but are expected to grow more rapidly in 1997. Norway and Iceland, which grew by 4.2 and 5.4 percent, respectively, are expecting slower growth in 1997. Inflation is uniformly low in these countries. At 7.9 percent, Sweden's unemployment rate in 1996 was just above the OECD average of 7.8 percent. Denmark, at 8.9 percent, and Finland, at 16.4 percent, have high rates. In Finland, the process of restructuring their economy away from their close relationship with the former Soviet Union is a primary cause of the high unemployment. The remaining two countries -- Norway and Iceland -- both have unemployment rates that are just above 4 percent.

Although these five countries follow similar social economic policies, their approaches to European unification have differed. Currently Denmark, Sweden, and Finland are members of the EU, but only Finland is actively pursuing early membership in the common currency agreement. Sweden and Denmark could probably qualify, but popular sentiment in Sweden is against it, and Denmark requires a public referendum to join.

The Netherlands, Ireland, Austria, Belgium, and Switzerland

Of the remaining five small and medium-sized Western European economies, only the Netherlands and Ireland grew at rates that were at or above the EU average of 2.5 percent. Ireland's growth was robust for the third consecutive year. The Irish economy grew at an estimated 7 percent in 1996, but unemployment remains high at around 12 percent. The economies of Austria, Belgium, and Switzerland had anemic growth in 1996. The first two grew by around I percent. The Swiss economy actually declined by an estimated 0.4 percent. Switzerland's economy has been stagnant for the last 6 years. Swiss unemployment is at record levels, but its rate of unemployment is only about half that for all of Europe. All these economies, save Ireland's, are expected to grow moderately faster in 1997. Only Belgium (along with its city-state neighbor, Luxembourg) and Austria are scheduled to be first wave participants in the Euro currency.

INDUSTRIAL COUNTRIES: THE FAR EAST

After five years of very sluggish growth, the Japanese economy expanded by 3.6 percent in 1996. This good performance, however, is not expected to be repeated in 1997. Low consumer confidence and fiscal tightening should slow the economy too much to offset expected increases in net exports. Australia's economy is also expected to grow more slowly in 1997, but New Zealand is expecting a much better year in 1997 compared with 1996.

Japan

When the Japanese economy expanded at a brisk annual rate of 12.7 percent during the first quarter of 1996, there was hope that the sluggish economic performance of the previous five years had ended. The boost in growth proved to be short-lived, however, the result of a $130 billion government fiscal stimulus spending package. After the effects wore off, the economy slowed rapidly and actually recorded negative growth during the second quarter. In the third quarter growth was positive, but anemic, at a 0.4 percent annual rate.

The fiscal stimulus package that boosted Japan's economy during the first quarter of 1996 was the sixth such package initiated by the government in the last four years. The combined value of these packages topped one-half trillion dollars. These packages did boost growth temporarily, but at the cost of driving the primary government fiscal deficit (the deficit less net interest payments) to 3.6 percent of GDP, the largest primary deficit among the OECD economies. Current plans call for an increase in the consumption tax in April 1997, which will tend to dampen the economy. Monetary policy has pushed interest rates about as low as they can go. The official discount rate has been at the rock-bottom level of 0.5 percent for more than a year. Investment spending has increased modestly, but the excess capacity in Japan's industry holds little prospect for much more.

Since the yen has depreciated by around 40 percent in the last 18 months, Japan's products are again very competitive, and stronger exports are expected to provide a boost to growth in 1997 and beyond. However, with high unemployment (for Japan) consumers remain pessimistic, and the outlook for Japanese growth in 1997 is that the economy will grow by only around 1.8 percent.

Australia

After five years of economic expansion, accompanied by low rates of inflation, Australia's economy is one of the OECD success stories. The economy grew by 4 percent in 1996 and is expected to grow by another 3.3 percent in 1997. The modest slowdown in projected growth is attributable to an expected slowdown in the growth of agricultural output. In 1996 Australia's agricultural sector recovered from a drought. Also, exports are expected to be weaker, owing to the higher value of the Australian dollar. Australia is on track to reach a balanced budget within the next two years, the economy is increasingly integrating itself into the Asian region, and inflation remains low. Only high unemployment -- currently around 8.5 percent -- mars an otherwise healthy economic environment.

New Zealand

High interest rates and a strong currency put the brakes on New Zealand's economy in 1996 after three successive years of good economic growth. Stronger consumer spending is expected to boost growth to around 3 percent in 1997, even though the central bank is expected to maintain a tight monetary policy.

EMERGING MARKETS: ASIA

Growth in the emerging economies of East Asia slowed for the third consecutive year in 1996. The region grew at an estimated rate of 8 percent, down from a growth rate of 8.6 percent in 1995. The outlook is for a slight rebound in 1997, with overall growth expected to be just over 8 percent. A significant factor behind the recent slowdown in economic growth has been a reduction in the growth of exports from the region. The export slowdown has been blamed on the sluggish growth of Western European markets, a softening in the demand for (and the pricing of) electronics goods, and the tightening of monetary policies in many of the countries in the region -- a move that slowed the recent growth of intraregional trade.

While the slowed economic growth can, in part, be blamed on a lag in export growth, another body of opinion has argued that the economic slowdown is more structural in nature. This view argues that the fast growth of the past two decades had been the result of the rapid accumulation of labor and capital resources rather than increasing productivity. Disagreement with this thesis is strong from those who argue that the recent slowdown has been caused by cyclical factors.

China

Another major reason (besides sluggish export growth) for this region's slower economic growth in 1996 was the deliberate belt-tightening by China. China's economy is by far the largest of the emerging markets in the region. (According to those estimates of exchange rates that use purchasing power parity, China's economy is as large as Japan's.) China's fiscal and monetary tightening slowed economic growth from 10.2 percent in 1995 to 9.7 percent in 1996. China's policies, which were aimed at reducing inflation, succeeded; inflation in China fell from an estimated 15 percent in 1995 to less than 10 percent in 1996.

China's official goal is for the economy to grow by 8 percent in 1997. Monetary policy was relaxed during 1996, and more rapid growth in the West should help exports. While inflation has come down and economic growth is expected to continue at a strong pace, China faces several challenges; perhaps the biggest is the inefficiency of China's state enterprises. Many of these institutions lose money every year, but reforming them will be politically difficult. Related to the problem of the unprofitable state enterprises is the poor condition of many of China's banks, which have been pressured into extending credit to the state enterprises over the years. As a result, China's banks, like the those of other countries in the region, are carrying large amounts of non-performing loans. Reforming the state enterprises (and the financial system) presents China with a daunting unemployment and underemployment problem, as these enterprises employ millions. Another problem is that the fast-paced growth of foreign investment in China's private sector has brought rapidly growing amounts of income to the coastal areas, where these investments are concentrated. But few people in other areas of the country have benefited from this growth, and income inequality has become an issue. Finally, Hong Kong reverts to Chinese rule in July. How the Chinese government handles this transition will be crucial to future growth in Hong Kong as well as in the rest of the country.

Hong Kong, Taiwan, South Korea, and Singapore

As in the case of China, the "four Asian tigers" all grew more slowly in 1996 than in the previous year. A slowdown in export growth was a factor that affected them all to some extent. For 1997, three of the four (except Korea) are expected to grow at about the same pace as in 1996. The slump in the electronics industry has been a major factor in the export slowdown in both Taiwan and Singapore. These two economies, perhaps more than the others, are closely tied to the fortunes of the electronics industry. Taiwan produces a large share of the world's circuit boards, and Singapore specializes in computer disk drives. Both are also dependent on exports of microprocessor chips, and when the prices of the chips plummeted last year, the value of Asian exports fell as well.

Another factor at work to slow exports from these countries has been the fall in the value of the Japanese yen. While the yen was riding high, the emerging Asian economies had a respite from Japanese competition in many product areas, but now that the yen has fallen to 120 to the U.S. dollar, these countries are again facing Japanese export competition. Also, when the yen had been increasing in value, Japanese companies located production facilities in many of the region's economies to produce goods for export back to Japan, but now that the yen's value has retreated, these exports are likely to increase more slowly, or not at all, as Japan's companies shift production back to Japan where there is significant excess capacity. Finally, increasing labor costs have made these economies less attractive production sites than other countries in the region.

Thailand, Malaysia, Indonesia, the Philippines, and Vietnam

The economies of Thailand, Malaysia, and Indonesia all realized slower growth in 1996 than in 1995. As in the case of the four tigers, slowed export growth was largely responsible. Of these four emerging economies only the Philippines realized stronger growth in 1996 -- an estimated 5.9 percent compared with 4.8 percent in 1995. This group of countries is beset with some of the same problems as the original four tigers. Labor costs are increasing, there are serious shortages of skilled workers in several of these economies, and infrastructure bottlenecks are raising costs. In addition, a few of these economies are saddled with large current account deficits which are being financed by costly short-term capital flows. Malaysian and Thailand experienced current account deficits equal to more than 5 percent of their GDP in 1996. Some increase in the growth rate is expected in many of these economies during 1997, except for Malaysia and Thailand where the large current account deficits will require continued monetary tightness, high interest rates, and lower rates of growth.

India and Pakistan

These two giant economies on the South Asian subcontinent are expected to grow in 1997 at approximately 5 percent, the same rate as in 1996. Economic reform has stalled in India, and the country's infrastructure cannot support more rapid growth. Meanwhile, political turmoil in Pakistan would seem to preclude any meaningful economic reform there.

EMERGING MARKETS: LATIN AMERICA

In general, the Latin American economies grew more rapidly in 1996, expanding by an estimated 2.7 percent in 1996, compared with only 2.1 percent in 1995. Most of the increase occurred because Argentina's recovery from recession in 1995. The economies of other major countries in the region -- Brazil, Chile, Colombia, Peru -- slowed slightly in 1996, and Venezuela's economy slipped into recession. More rapid growth of around 3.8 percent is projected for the region in 1997.

Structural reforms are continuing to be implemented across the region. Monetary discipline has cut inflation sharply. This has been especially true in Brazil where inflation has fallen from more than 2,000 percent in 1994 to around 12 percent in 1996. As inflation has decreased and privatization has proceeded, most of the region's economies have also successfully brought fiscal budgets in line. Brazil, however, is a major exception, in part, because the country faces the duel problems of fiscal and current account deficits. Large fiscal deficits have been offset by tight monetary policy, and the resulting high rates of interest have attracted foreign investors. The large inflows of foreign capital have allowed Brazil to cover its current account deficits. The risk is, however, that when economic activity picks up in Europe and Japan and monetary policy tightens in these regions, foreign investors might then withdraw. Even with the generally good condition of most fiscal budgets in the region, only the official debts of Chile and Colombia have been rated as "investment grade" by major credit rating services.

Despite the return of economic growth to the region, average real income levels are still below the levels of 1982, when the debt crisis hit and plunged the continent into a decade of no growth. A recent World Bank study has highlighted the large and growing problem of poverty in the region. The economic reforms and the restructured economies have reduced inflation and encouraged economic growth and foreign investment, but the benefits of the reforms have not reached the poor and middle class. Frustrations and unrest are spreading throughout the region, from Mexico to Argentina. Social unrest remains the region's biggest risk factor. Rebellions, such as those that have occurred in Peru, Colombia, and southern Mexico, may spread to other countries. Economic growth of 6 percent or more per year for several years is needed to improve the economic situation of most people in the region.

EMERGING MARKETS: THE MIDDLE EAST AND EUROPE

For the second consecutive year this region experienced generally good economic growth, with economic expansion of nearly 4 percent in 1996, after growth of 3.6 percent in 1995. Higher energy prices in 1996 helped buoy the region, and they are expected to do so again in 1997. Inflation is also down moderately.

Aside from the more favorable terms of trade that have benefited the oil exporters, structural reform programs are proceeding in many of the countries in the region, and this is boosting foreign investment and growth, particularly in Egypt, which grew an estimated 4.2 percent in 1996. Egypt's reforms have led to debt relief agreements with the IMF and an international debt rating that puts it in the same league as Mexico and Venezuela and above other countries in the region, such as Turkey and Jordan. Egypt's growth for 1997 is forecast between 4 and 6.5 percent.

In contrast to Egypt, Turkey's failure to address macroeconomic imbalances has led to high inflation (85 percent in 1996), large fiscal deficits, trade imbalances, and a depreciating currency. The economy grew by more than 7 percent in 1996, but is projected to slow to around 5 percent in 1997, as a new government attempts to grapple with the country's monetary and fiscal problems.

The oil exporting countries of the region -- Saudi Arabia, Oman, Qatar, U.A.E., Kuwait, and Bahrain -- are being helped by the higher oil prices. However, this development could be a mixed blessing if it further postpones restructuring and economic liberalization efforts.

Undermining the positive economic developments in the region is uncertainty surrounding the Middle East peace negotiations. Israel's economy had been prospering under the peace accords, but recently growth rates have slipped.

EMERGING MARKETS: AFRICA

For the first time in two decades this region will realize an improvement in real living standards. The World Bank estimates that in the 1980s, real per capita income in sub-Saharan Africa dropped by nearly 1 percent per year. African growth in 1996 was around 5 percent, and this growth rate is expected to continue for the next year or two. While higher export prices helped in 1995, prices of many important export items, such as coffee, have fallen recently. Economic liberalization, better trade and exchange-rate policies, and more privatization of economic activity have helped spur growth.

Despite the recent improvement, the region is woefully behind other world areas in terms of economic prospects. Military dictatorships and armed conflicts abound, foreign investment flows are minimal, and continuing economic reform is needed. The continent's biggest economy, South Africa, suffers from very high levels of unemployment and its government has been hamstrung in its efforts to initiate needed economic reforms.

THE TRANSITION ECONOMIES

As a group, these economies were expected to show solid economic growth in 1996 for the first time since the collapse of Communism. However, another year of decline in the Russian Federation and in other former Soviet republics resulted in regional growth of only 0.4 percent in 1996. The countries that made the transition to market economies most quickly (mainly those in Central Europe) have recorded positive growth for several years, but other countries in this group continue to struggle.

The Central European Free Trade Association

The European countries that make up the Central European Free Trade Association (CEFTA) -- Hungary, the Czech Republic, Poland, Slovenia, and Slovakia -- have transformed their economies significantly and have enjoyed several years of positive economic growth. Growth in 1996 declined slightly because of weak export markets in Western Europe. The same weakness of exports, together with growing real incomes, resulted in increased imports and large balance-of-payment deficits.

Capital investment continues to flow into this region at a good pace, improving productivity, export competitiveness, and real incomes. The political situation has been normalized and the region should enjoy several years of growth in the range of 5 to 7 percent per year.

Central and Eastern European Economies

The 5 CEFTA countries are among 28 that the IMF classifies as "transition economies." The IMF has classified 18 as "Central and Eastern European economies." (The IMF placed six ex-Soviet republics in this group: Ukraine, Belarus, Moldova, and the three Baltic states, Latvia, Lithuania, and Estonia. Also included in this group are the republics of former Yugoslavia. Two republics of the former Balkan country -- Serbia and Montenegro -- remain in the current Yugoslav state. Croatia, Slovenia, Macedonia, and Bosnia are independent states.)

Countries in this group, with a few notable exceptions, have made the most progress toward market-based economies. Three -- Hungary, the Czech Republic, and Poland -- are now OECD members. The IMF estimates that as a group the 18 Central and Eastern European economies grew by 1.6 percent in 1996. Albania's economy, which grew by 7 percent, turned in the best performance, whereas the Ukraine's economy, which fell by an estimated 8 percent in 1996, was the laggard. With three exceptions (Bulgaria, Belarus, and Ukraine), the countries in this group are all expected to grow by 2 to 5 percent in 1997.

Trans-Caucasus and Asia

Nine of the remaining former Soviet republics are grouped in the IMF's "Trans-Caucasus and Asia" classification. These countries are among the least advanced in terms of their transition to market economies. Only one, Mongolia, does the IMF consider to be a "more advanced" transition economy. As a group, the economies of these countries expanded by only 0.6 percent in 1996; performances of the individual countries, however, differed greatly. Armenia, Georgia, and Turkmenistan grew at rates that ranged between 6 and 8 percent, while the economies of Azerbaijan and Tajikistan declined by an estimated 3.8 percent and 7 percent, respectively.

The final country in this transition group is Russia. A year ago 1996 was predicted to be the year that the Russian economy would bottom out and begin to show positive economic growth, but the economy shrank again by an estimated 1.3 percent. The year was not without positive economic news: The rate of inflation declined significantly, from around 200 percent in 1995 to roughly 50 percent in 1996. By December 1996, compared with the same month in 1995, prices were up by slightly more than 20 percent. The OECD predicts Russian output to increase by around 2 percent in 1997 and 5 percent in 1998. The health problems of President Yeltzin, widespread corruption, and continuing unrest in parts of the Russian federation make this outlook very uncertain.

SUMMARY AND CONCLUSIONS

The condition of the U.S. economy is as good as it has been in more than three decades. Despite high rates of unemployment in some industrialized countries, the same observation, in many respects, can be made about the world economy at the outset of 1997. Growth is picking up in many regions after a better-than-average performance in 1996. Important structural changes and reforms have been implemented in many countries that have brought inflation under control and have made markets function more efficiently. Foreign investment flows have also responded positively to these changes, and private markets are now supplying the bulk of capital flows into many regions that in the past had relied on official aid transfers. Inflation is in check in most areas, commodity prices are stable for the most part, and few countries face the danger of overheating.

While the overall condition of the world economy is benign, there are risks in the near term that could cause problems. Such potential areas of risk (in no particular order of importance or risk) include the following: the success of progress toward European monetary union, the political instability in Russia and several of the former Soviet republics, the growing disparity of wealth and income in Latin America and other regions, and the ongoing conflicts or danger of conflict in the Middle East, Africa, and the Balkans.

John E. Jelacic, Senior International Economist, Office of Trade and Economic Analysis, U.S. Department of Commerce.

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