Global Economic Cooperation or Bust

According to estimates by the United Nations, the global economy expanded by 3.8% last year, continuing the strong performance recorded since 2003. Led by China and India, developing countries were prominent among the best performing economies, expanding by 6.5% on average in 2006. But can this apparently benign pattern of global growth be sustained, particularly since growth has been accompanied by ever-widening global financial imbalances?

Average annual growth in the least developed countries, many in Africa, reached almost 7% last year. The world’s largest economy, the United States, expanded by 3.2 %, and growth also recovered in previously sluggish Japan and Europe. These trends are remarkable in light of the shocks from the surge in oil prices, the wars in Afghanistan and Iraq, international terrorism, and the breakdown of multilateral trade negotiations.

Strong economic performance reflects strong domestic demand in the US, owing to low borrowing costs and rising asset prices. This lifted manufactured exports around the world and kept inflation down, which in turn boosted demand for energy and raw materials from the developing world, pushing up commodity prices and benefiting many poor countries. The savings generated in East Asia and the major oil exporters have increased global liquidity, helping to finance the US current account deficit, which has now reached unprecedented levels.

But the outlook for 2007 is for weakening global economic growth. The UN’s World Economic Situation and Prospects 2007 cautions that a weaker housing market will undermine US growth. Consequently, global economic expansion will slow, as no other major country is set to take over as the main engine of growth. With slowing world economic growth, US financing needs could cause a drop in investors’ confidence in the future of US-based assets, precipitating a sharp dollar depreciation.