World Economic Forum at Davos - World Economic Growth in 2005 and 2006

Based on 'The Goldilocks Economy' from Time Magazine, February 2006

Oil prices soared, central banks across the world hiked up interest rates – sounds like an economic disaster. But last year, the global economy defied the gloom and continued to grow robustly. High US consumer spending mixed with a booming China that feeds the Western plate with low cost products resulted in a second year running growth by about 4%. The good news is not over – the world in 2006 is yet to see another year of economic growth as the twin American-Chinese engine continues to go full steam ahead.

This wonderful forecast was cooked up by the TIME’s Board of Economists at the World Economic Forum in Davos. The US economy is expected to grow while China notches up another 9% growth. Laura D. Tyson, dean of the London Business School said that the “outlook is basically for another Goldilocks kind of year”. There are also signs of Japan and Germany of breaking out from their torpor, which has strapped them down.

But still, a few threats lie around waiting to strike. The supply of oil is struggling to keep up the surge in demand with the confessed “addiction to oil” by President Bush and the guzzling of oil by the thirsty economies of China and India, sending prices up to $60 a barrel. It is being disrupted by politically instable areas of the world from Russia to the Middle East.

Concern was also expressed on the US’s borrowing and consumption binge which could soon come to an end, bringing down with it the value of the dollar. Even if the dollar remains strong, Stephen Roach, chief economist of Morgan Stanley, warned of a “dangerous degree of complacency” among investors. He argues that the weakest link in 2006 will be the American consumer, but it is unfortunately the most important factor.

The dire predictions from last year did not seem to come true as the dollar rose in value and inflation seemed to have been curbed despite soaring oil prices. This act of resilience from the global economy reveals how capable the world is of absorbing shocks like this. On Ben Bernanke, the new Fed chairman, Jacob Fenkel, a former governor of the Bank of Israel, said “He’s the world greatest inflation-targeter with no inflation to target”.

Japan also seems more buoyant after cutting down on red tape, which have helped to restore confidence: exports rose by 17.5% and imports surged by 27%, reflecting healthy domestic demand. Despite a hefty budget deficit, it is expected for Japan to grow 2.2% this year.

In Germany, business confidence is at its highest since May 2000, according to a survey, looking well for the Chancellor, Angela Merkel. In a speech at Davos, she vowed to increase German flexibility and attack bureaucracy.

But China’s boom and the uneasy relationship with the US was a major talking point. US officials had called to China to revalue the renminbi in an effort to reduce the $800 billion trade deficit by making their goods more expensive and thus reducing consumer demand. China obliged, but with little change.

China’s growth is also boosting Asia as it is exporting goods wroth about $300 billion to the US and Europe but is also importing about $100 billion worth of raw materials and goods from elsewhere. While China only accounts for 5% of the world economy, it is responsible for 30% of the world’s economic growth. This is all being fuelled by foreign investment, which is why economists have argued that China needs to increase its own domestic demand.

Many people feel that they are being harmed by globalization. Many see China as a power threat rather than an effective economic ally, as a threat to jobs rather than a source of jobs.

Nevertheless, these long term worries are not likely to harm another year of flourishing economic growth. But as Goldilocks discovered, even if the porridge is just right, it can still lead to problems when the bears return.