The international economic outlook in 1991 - 1991 U.S. Industrial Outlook

The International Economic Outlook in 1991

Two major developments, dominate the outlook for the world economy in 1991 - the slowing of economic growth in the United States and in other industrial economies, and the recent increase in oil prices, kindled by the Iraqi invasion of Kuwait in early August 1990. The following discussion of the world economic outlook for 1991 focuses mainly on the effects of these developments. Other important considerations also cloud the economic picture: the serious economic problems of Eastern Europe and the Soviet Union; the huge drop in Japanese stock prices and the coinciding decrease in Japan's foreign investment flows; and the reunification of Germany and the decrease in German capital exports.

Before the Persian Gulf crisis and the runup in the price of oil, most forecasts called for slightly lower global growth in 1990 than in 1989, and an acceleration of growth in 1991. In general, the pre-invasion forecasts were optimistic.

In 1989, the world economy grew by an estimated 3 percent - more than a percentage point slower than in 1988. Despite that slowdown, the underlying rate of inflation in many major economies began to creep up. Late in the decade world inflation rates accelerated, reflecting the upward pressure on the industrial economies' production capacities that was brought about by their lengthy economic expansion in the 1980s.

Reacting to increased inflationary pressures, central banks and the governments in several countries implemented economic policies, both monetary and fiscal, to slow growth. The hope was to engineer a "soft-landing." In the United States, the Federal Reserve started tightening monetary policy in early 1987. In addition, the economic stimulus of the Federal deficit was dampened as it fell from 5.3 percent of gross national product in 1986 to 2.9 percent of GNP in 1989. In 1989 and early 1990, other industrialized countries followed with their own programs to bring inflation under control.

During the first half of 1990, most signs pointed toward a successful execution of these policies. As expected, U.S. and foreign growth was turning out to be slower in 1990 than in 1989, but not so slow as to cause alarm. It appeared that a successful "soft landing" was in the works, and most economic forecasts reflected this view. Moreover, most forecasters also saw continued slow growth in 1991 for most countries, and oil prices in the $18- to $25-per barrel range.

Then, on August 2, Iraqi military forces invaded Kuwait. The ensuing crisis disrupted world oil supplies, caused a doubling of oil prices, and dampened the world economic outlook for 1991. The increase in oil prices has made it more likely that 1990 and 1991 world growth will be below 1989 rates.

Until the Gulf crisis is resolved, the international economic outlook is fraught with uncertainty. The numerous economic forecasts published here and abroad base their conclusions on assumptions about the nature and timing of the outcome of the Middle East situation. Several scenarios through 1991 are possible. However, as of October 1990, none seems more likely than any other. The following discussion is based mainly on a middle-road assumption that a stalemate will persist through 1991.

Given that scenario, an average winter heating season, and additional production from other countries, crude oil prices are likely to be in the $25-$30 per barrel range, or about $10 higher than if the Gulf crisis had not occurred. Under these conditions, world economic growth in 1990 can be expected to be about 0.5 to 1 percentage points less than in 1989, expanding by 2 to 2.6 percent. The rate of growth will be in the same range in 1991.

If peace comes before 1991 and the embargo on Iraqi oil is lifted, oil prices are likely to drop quickly, and the outlook for the world's economy in 1991 would be about the same as it was before the Iraqi invasion. The price of crude would probably stabilize at $20 to $25 per barrel, and perhaps even fall below $20 if adverse reactions to the crisis dampen economic growth below current trends.

If there is a Middle East war, however, oil prices would undoubtedly soar to $50 to $80 per barrel, and there would be a world recession on a scale equal to that of the two that followed the oil disruptions in the 1970s. In 1973-74, oil prices quadrupled from $3 to $13 per barrel, and the ensuing world recession lopped off about 7 percent from cumulative world growth. In the second oil shock of 1979-80, oil prices tripled from $13 to $39 per barrel and the world lost about 5 percent of cumulative growth in the recession that followed.

The Economic Outlook for the Industrial Economies

On average, 2.4 to 2.6 percent economic growth is expected for the industrial economies in 1991 (Table 1), which is about one half percentage point lower than was expected in July 1990. Most of the relative pessimism for the growth of the group as a whole results from the much slower 1991 growth outlook for the United States. [Tabular Data Omitted]

Before the invasion, the three largest industrial economies - the United States, Japan, and Germany - were in different phases of their respective growth cycles. The U.S. economy was slowing while the economies of Germany and Japan were picking up momentum. Forecasts at that time were that in 1991 the relative growth positions of the three economies would reverse themselves, that is, growth in the United States was expected to accelerate while the German and Japanese economies would slow somewhat. The oil price increase caused forecasts to be revised downward, most drastically where oil prices were assumed to remain high through 1991.

Although the U.S. economy is significantly less dependent on imported oil than either Japan or Germany, the oil price hike threatens more damage to the U.S. economy than to either Japan or Germany. There are several reasons for this. First, Germany and Japan consume much less oil per billion dollars of gross domestic product (GDP) than the United States. Based on 1988 data, the United States uses 179,000 metric tons per billion dollars of GDP while Japan and Germany use 146,000 metric tons and 143,000 metric tons, respectively. Second, since oil taxes are much higher in Japan and Germany than in the United States, crude petroleum prices constitute a much larger share of the final price of the end product in the United States. As a result, when crude prices rise, prices of the end products rise by a larger percentage in the United States. Third, since the Gulf crisis a steep drop in the U.S. dollar has mitigated the price hike of oil to Japanese and German purchasers, since the international oil trade is priced in dollars.

For other industrial countries, higher oil prices will be harmful; the extent depends on the degree of dependency on imported oil. Canada, Norway, and the United Kingdom, each of which have large domestic oil industries, will suffer least.

In line with recent forecasts of slower real economic growth, the outlook for world trade also is less optimistic than in early 1990. The International Monetary Fund (IMF) recently predicted that world trade volume will expand by 5.4 percent in 1990 and 5.3 percent in 1991, compared with an estimated increase of 7.3 percent in 1989. The IMF predicted that U.S. export volume growth in 1991 will fall to 6 percent, a little more than half the actual growth of U.S. export volume in 1989 and the predicted export growth for 1990. The IMF's world trade projection is based on a slightly more optimistic world growth scenario and lower oil prices than the ones discussed here.

Despite the expected slowdown in U.S. export volume, the IMF predicted that the competitive position of the United States will improve vis-a-vis most industrial countries. Therefore, the IMF predicted that U.S. export growth in 1990 and 1991 will be higher than the export growth of most of the other industrial countries.

The Developing Economies

U.S. exports to the developing areas of the world account for around 35 percent of all U.S. exports, including manufactured goods. Among the many developing countries, none is more important to U.S. trade than Mexico and the four Asian newly industrialized countries (NICs).

In Latin America, economic growth in 1989 averaged an estimated 1.6 percent and is predicted to be about -0.5 percent in 1990 and 3.5 percent in 1991. The large swing in the outlook for Latin America, from expected negative growth in 1990 to a prediction of fairly robust growth of 3.5 percent in 1991, is the primary reason for the acceleration of developing country growth in 1991. There are some significant differences in growth among the countries, especially the big three countries of Mexico, Argentina, and Brazil. Mexico has improved the condition of its economy. Under the leadership of President Carlos Salinas, inflation has slowed and economic growth has accelerated. However, the economies of Argentina and Brazil have been badly hurt by internal economic crises, exacerbated by foreign debt problems, and falling export commodity prices. Growth in both countries is expected to be low or negative in 1990 and 1991.

Mexico is the third most important partner of the United States, taking 6 to 7 percent of U.S. exports and accounting for roughly one-half of all U.S. trade with Latin America. Moreover, the United States is by far Mexico's most important market. Around 70 percent of Mexico's non-oil exports are shipped to the United States.

In the past two years, Mexico's economic reforms have had a beneficial effect on growth. In 1988 Mexico's growth was just over 1 percent, but in 1989, on the strength of strong investment and increases in manufacturing, it increased to 2.5 percent. Also, the rate of inflation was but from more than 100 percent in 1988 to around 25 percent in 1989. As of October, price increases in 1990 were moderate. Even before the recent oil price increase, the outlook for growth in Mexico in 1990-91 was very good - 3 to 5 percent.

In recent years Mexico has not invested in additional crude oil production capacity and thus has little excess capacity to increase oil output and exports in the wake of the Mideast crisis. Nevertheless, higher oil prices should stimulate Mexico's economic growth and help its balance-of-payments position, unless the economic slowdown in the United States is more severe than anticipated.

More than 10 percent of U.S. exports are shipped to the four Asian NICs (South Korea, Taiwan, Hong Kong, and Singapore). Before the oil price increase, the outlook for these countries was for continued economic growth in 1990 and 1991 of about 6.4 percent, the same as in 1989. While this projected advance is only about half as large as was achieved in the boom years of 1986-88, these economies were still expecting growth of between 5 and 7 percent in the 1990-91 period, around twice the growth rate anticipated for the rest of the world. Taiwan was the growth leader in 1989 with a rate of 7.2 percent, and Hong Kong was the laggard with a rate of only 2.5 percent.

Since all four of these NICs are heavily dependent on Mideast oil for their energy needs, rising oil prices will adversely affect their growth prospects. Singapore, the largest oil refining center in Asia, is likely to be hurt the least.

In Africa, which experienced two good years of agricultural output in 1988 and 1989, growth is predicted to be around 3 percent in both 1990 and 1991. African growth in 1989 averaged an estimated 3.2 percent. Oil prices, which had been going up even before the August crisis, are expected to boost growth in the oil producing areas of West and North Africa.

Among the countries of the Gulf region and in the Asian subcontinent, the higher prices of oil has had - and will continue to have - dissimilar effects. Oil producers will benefit from the higher oil revenues. Non-oil producers, however, will suffer not only because of the higher energy prices, but also because many of these countries had supplied substantial numbers of workers to Iraq. Most of these workers have now been expelled and their earnings lost. This is placing a heavy burden on these tens of thousands of displaced workers who are now in other countries. Moreover, their home countries no longer receive their repatriated earnings.

Aside from Mexico and the oil-producing Gulf states, only a handful of other oil producing and exporting developing countries will benefit from the higher oil prices, including Venezuela, Nigeria, Malaysia, Indonesia, China and the oil producers in North Africa. The vast majority of developing economies, however, will suffer from the current crisis. Aside from the obvious impact of higher oil import prices, many of these countries, unlike the industrial countries, have significantly increased their dependence on oil imports in recent years.

In addition to raising the cost of imported oil, the crisis exacerbates other economic problems of the developing countries. Those with high debt loads, which includes most of them, face higher interest payments. That is because higher oil prices have raised inflationary expectations and long-term interest rates on the countries' debts. Second, for those developing countries that rely on primary products other than oil for export revenues, earnings in the 1980s were not good. Almost across the board, prices of primary commodities slumped during the decade and the terms of trade of the developing countries thus have moved against them. Slower growth in the industrial countries will again hurt export earnings of the developing countries as slower demand growth in the industrial countries leads to reduced exports of primary products.

Eastern Europe and the U.S.S.R.

The economic outlook for the Eastern European economies, while not very good to begin with, has turned decidedly worse with the increase in oil prices. On top of the problems associated with economic restructuring, the Eastern European economies face an end to deliveries of subsidized oil from the Soviet Union. Beginning in 1991, the former Soviet bloc countries are expected to pay the going world price for their oil imports. As for the U.S.S.R., production problems are limiting its ability to exploit the rise in world oil export prices. Soviet oil production - the world's largest - has actually been falling lately.

The political transformation of Eastern Europe in 1989 unquestionably will have major long-run economic repercussions on the world economy. However, the short-term effects on the United States and most other countries will probably be minor. Aside from the immediate effects of German reunification, the wider economic implications of the pending move to free-market economic systems are difficult to gauge. Recent increases in long-term worldwide interest rates may have partly occurred because of the international financial market's expectation of large Eastern European demands for investment capital. Germany, for example, is expected to supply much less capital to world financial markets because of the task of rebuilding its Eastern sectors. Currently, large, rapid increases in East-West trade and large amounts of Western investment in Eastern Europe in 1990 and 1991 seem unlikely.

The World Oil Market And Inflation Outlook

At this writing, the loss of Iraq and Kuwait oil production and exports may not appear large enough to significantly restrict world economic growth. However, the uncertainty associated with that loss has led to significantly higher oil prices. As a result, and assuming the stalemate in the Middle East continues, the world inflation rate in 1991 is expected to rise 1 to 3 percentage points.

Kuwait and Iraq combined produced 4.6 million barrels per day in 1989, or 7.3 percent of world production. Table 2 shows the major producers and consumers in the world oil market in 1989. [Tabular Data Omitted]

Several important factors tend to minimize the quantitative impact on economic growth of the loss of Kuwait and Iraq oil production on the industrial economies, compared to the oil shocks of the 1970s: (1) use of unused oil production capacity among the other producing nations - especially Saudi Arabia, Mexico, Venezuela, and Nigeria; (2) substantial world oil stocks held in national reserves and private inventories; (3) slower economic growth, even prior to the invasion, which reduced the growth of energy demand; and (4) a significant reduction in oil input required per dollar of industrial production in the industrialized world.

In August 1990, the spot price of oil jumped almost immediately to $25 per barrel, then continued to increase in fits and starts until it reached more than $40 per barrel by mid-October. Between then and late October, the spot price retreated slightly, but it continued to fluctuate in the mid- to upper-$30s. Most energy analysts are predicting oil prices in the range of $25-to $30-per barrel at least through 1991 in the case of a long-term Gulf stalemate. In the case of a peaceful resolution of the crisis, they predicted a retreat of oil prices to $20 to $25 per barrel.

Summary and Conclusions

Although the mid-1990 outlook for world growth in 1991 was not free of concerns and uncertainties, generally speaking, it was relatively optimistic. European Community economic consolidation was proceeding apace; Germany was in the process of unifying; economic reorganization was being planned (if not implemented) in much of Eastern Europe; economic initiatives to free markets in many of the developing economies of Africa and Latin America had been put in place or were being planned; and there were signs that the remarkable economic growth of the last decade that had transformed the economies of the Asian NICs - South Korea, Taiwan, Hong Kong, and Singapore - was about to spread to some of the other nations in the region, such as Thailand, Malaysia, and Indonesia.

The Iraqi attack on Kuwait and the ensuing runup in world oil prices have caused a reassessment of world economic prospects for 1991. The increase in oil prices has and will continue to have an adverse impact on inflation and economic growth in most of the world's economies. In addition, the crisis has changed expectations to a much greater degree than the of the loss of Iraq and Kuwait oil would warrant. To some extent the changes in expectations have led to new and more realistic assessments of the economic benefits to be gained from such developments as the economic integration of the European Community scheduled for 1992, and the transformation of Eastern Europe to market economies.

A quick, peaceful resolution of the Gulf crisis will help to put the world's economy back on a more positive growth path, not necessarily one as optimistic as was expected earlier in 1990, but one that may be more firmly grounded in a realistic view of what is and what is not possible.

COPYRIGHT 1991 U.S. Department of Commerce
COPYRIGHT 2004 Gale Group