The initial reaction to the crises of 1994 (Mexico, Argentina), 1997 (East Asia) and 1998 (Russia, Latin America, East Asia again, including Japan) is to estimate, roughly and quickly, the bilateral trade shares of the afflicted areas vis-(-vis the areas about to experience repercussions and often dismiss the present crisis as too remote, tied by very small bilateral trade shares, and to neglect the effects on international financial indicators, with feedbacks of much amplified magnitude on many supposed safe harbors.

By summer, 1998, the full effects were appearing in places that had disregarded further implications of events that were taking place in several developing country areas.

Sign posts. What can be seen at the present time that should cause reflection about the seriousness of the state of the world economy?

1. unusual volatility, especially in financial markets

2. capital flight toward quality investments for a safe haven

3. the sheer size and speed of financial transactions

4. the prevalence of bankruptcies

5. growth slowdown in growth of gross world product, world trade volume

6. commodity price deflation

7. political instability

8. a general world crisis?

i.  On a daily (intradaily) basis, financial markets swing violently. Also basic fiscal and trade balances move swiftly. For example,, the USA has wiped out a decades-old public deficit but enlarged the foreign trade deficit. The error balance (known as the statistical discrepancy) has swung, in the USA from large positive values to large negative values in little more than 5 years. While the US has had prosperity for many months with good macroeconomic balance, in recent years, the foreign trade deficit has widened perceptibly.

ii.  The early reaction to the financial crisis in East Asia was for investors to shift their funds into very safe (such as treasury securities) instruments, mainly in the form of treasury notes or bonds. This has brought down US interest rates by more than 100 basis points in 1998, alone.

This makes for a very uneven distribution of capital supply and slows much needed investment activity in developing countries. As far as the US economy is concerned, this has been a welcome event at the beginning (summer, 1997), and it is just beginning to be present in Germany or other highly stable economies of Western Europe.

iii.  Capital markets have undergone important technical change so that it encourages very rapid and very large transaction turnover. Financial authorities have admitted that they do not fully understand the full working of such market systems, and they can readily get out of control. This contributes to turbulence and is operative in both advanced industrial economies and developing economies. It is very unsatisfactory for such activity to be taking place when few people, if any, understand the details fully.

iv.  One result of the present situation in financial markets is that many firms and also many private individuals are going bankrupt - failing on a large scale.

Korean bankruptcies started early - in steel, motor cars, and other sectors. These were developing in 1996 and broke out in early 1997, followed by Thailand's foreign exchange depreciation and bankruptcies, especially in finance and real estate. The wave of bankruptcies in East Asia has been well publicized. These are all important cases, but the most serious bankruptcy problems, as far as world recovery is concerned, are those of Japan. Japanese banks, security dealers, and more general businesses have been surprisingly weak and prone to bankruptcy problems. This means that Japan is not performing positively in the solution and eventual recovery process, but is an ongoing contributor to the basic problem.

v.  Two of the most important aggregative measures for the total world economy are Gross World Product (GWP) and World Trade (WT), both adjusted for inflation, i.e. real magnitudes. They are listed in the accompanying world summary table as annual percentage changes. It can be seen that the world economy slowed considerably, in growth terms, in 1998. Neither GWP nor WT fell from 1997 to 1998, but the growth rates were positive and not negative. It can be seen that this projection looks for larger production growth in 1999 and 2000, but slightly falling or nearly level growth rates in WT.

Developing-world growth exceeds industrial-country growth in this forecast, through 2000, but there are noteworthy cases in each grouping. Japan is expected to register negative growth in 1998 and to recover very modestly in 1999/2000. In East Asia overall growth is dominated by seriously troubled economies in Indonesia, Thailand, Malaysia and South Korea, where production is declining in 1998. The Asian total is also falling, but a turn for the better is expected in 1999, and the year 2000 looks even better.

A strong exception in Asia is China. Foreign exchange markets are not fully liberalized, and China has fortunately been able to provide some stability to Asia. The request from the USA and other main investing countries in Asia has been to hold the reminbi steady and not try to promote Chinese competitiveness through exchange depreciation. China has not only responded in a supportive way for upholding currency stability but is on track for their goal of 8% real growth. There was some slippage early in 1998 and also a set-back as a result of summer floods, but the prevailing forecast remains for the stated target. Some economists think that growth may fall to 7.0-7.5% or lower, as in the table, but the figure of 8% remains attainable. Domestic policy expansion is the main tool. An area of erosion has been export growth.

Among developing countries, Latin America has been experiencing some trouble, after there had been years of recovery in Mexico and Argentina. Now, Brazil, the largest economy in Latin America, and Chile, the most dynamic and liberal market economy in the region are experiencing trouble. In both cases, there are forecasts of slower, but positive growth. Venezuela, however, is still in a serious recession. Brazil has just completed an election campaign, with the expected re-election of President Cardoso, who brought down hyperinflation and an orchestrated support package of financial credits should enable Brazil to come through this difficult period without a deep recession. There may well be some more currency depreciation.

Another troubled economic area, where production has declined or fallen to very low positive levels is Russia. In that case, severe currency depreciation, political instability, disorderly markets, and banking problems have combined to keep production falling, at a time when reformers were expecting a turnaround. Russia is the most important country in Eastern Europe and the former Soviet Union. Not all economies in this grouping are in such dire straits, but the situation is mixed, and some countries that were thought to be progressing well have slipped in the past two years.

vi.  For the greater part of the last half century, concern has been with restraining inflation. By and large the anti-inflation fight has been successful, but an entirely new situation has developed, namely, falling or weak commodity prices. There is not general deflation in the world economy, but in some sectors, particularly in the marketing of primary products, there have been very significant price declines.

It should be noted that in countries where devaluation or depreciation of currencies takes place, imports become very expensive and can lead to increases in general price indexes. This has happened in Mexico, East Asia, and could happen in Brazil. Price rises have occurred in some east Asian economies.

Commodity markets present a different picture. The most dramatic and important case has been the market for crude oil. The price hovered near $20/barrel for some time after the Gulf War and caused some fear that another round of price increases was in store, but last winter some special factors brought the price near $12, and it is now at about $15. This weak price has caused serious income loss for Venezuela, Mexico, and Ecuador in Latin America. In East Asia, Indonesia has encountered significant income shortfall in trying to rebuild its external position.

Other oil-exporting countries in Africa, Asia, and the Middle East are experiencing similar difficulties but not necessarily fresh crises.

The weakness of commodity prices has further repercussions. In Latin America, where a second economic shock is being anticipated, basic raw materials are very important - e.g. copper for Chile, agricultural products for Brazil and Argentina - grain prices and non-ferrous metal prices have been quite low in 1998. The reasons have been excess supply, relative to demand, as a result of a mild winter in areas of significant fuel consumption for heating, less demand for energy at both the enterprise and household levels in depressed economies (especially East Asia), and allowances for increased oil deliveries by Iraq. In addition, many OPEC producers are thought to have been exceeding quota allotments.

Commodity prices move in cycles, not always synchronized, however, and we can look for some future increases. Higher input costs for raw materials will not contribute to better performance in the major industrial countries, but will be helpful for producing and exporting countries.

vii.  In Russia, political instability occurred together with economic instability. Cause and effect are difficult to establish,, but the fact that little was done (or wrong things were done) to get the Russian economy off to a reasonable start in 1990 undoubtedly contributed to the political instability. This situation then deteriorated, as the country's valuable resources were exploited for the benefit of a small minority. Russia went through a recession comparable to the decline in the USA after the 1929 stock market crash, and positive growth has not yet been realized.

Governments fell in Thailand, Korea, Indonesia and other East Asia countries. In these cases poor economic performance was certainly one of the factors in causing political change and instability.

Mexico has been ripe for political reform. Had the PRI been able to deliver sound economic conditions, it is possible that they would have retained power, but new forces challenged the PRI and are gradually gaining strength on a reform program. Other Latin American countries are undergoing political change too, but a large scale political change is not yet taking place in many of the other countries. The Brazilian test for President Cardoso has yet to take definitive shape.

Political change occurred in Western Europe (UK, Germany, France, in particular) but it has not been disorderly. It is not wholly divorced from the states of the respective economies, but it cannot be called a case of instability.

viii.  Will the economic adjustments taking place in many countries now erupt suddenly into a world economic crisis? This is the big question that is on the minds of many thoughtful people. The forecast table of Project LINK does not give a warning of world collapse into a deep crisis. There are some recessions observable and some severe economic adjustments, but the overall averages do not reach bottom or become explosive. A gradual and modest recovery is expected for 1999 and 2000. The world economic situation is perilous but not at all hopeless. Authorities have unused policy instruments at hand, and a coordinated easing of credit would be a strong possibility, were there continuing signs of deeper crises in the main trouble spots or outbreaks in new areas.

A general world recession cannot be ruled out, but the forecast presented is not in this category.