The Global Economy as a 747?

Making sense of the world economy is never easy. After all, world output — totaling $31 trillion in 2001 — represents the sum of more than 150 individual nations. Each of them produces various goods and services and finds itself at a different stage of industrial development.

At opposite ends of the spectrum, for instance, lie the United States — whose aggregate output totaled $10.5 trillion in 2001 — and tiny nations like Zimbabwe, whose output of $4.8 billion is just a tiny fraction of what the United States produces.

Understanding the individual parts of the world economy in relation to the whole has never been easy — but is ever more important. Why? To begin with, the United States is hardly the isolated entity as it is often portrayed in the U.S. press.

The global reach of corporate America is second to none. U.S. multinationals own and operate some 23,000 foreign affiliates sprinkled throughout the world. In fact, roughly 30% of the total earnings of the 500 U.S. companies in the S&P 500 Index are connected to global demand. For many of the largest U.S. companies, the dependence on global earnings is even greater.

Secondly, when and if economic growth accelerates in 2004 around the world, this should result in a redistribution of global economic growth — leading to “global rebalancing.”

Global economic growth has been dangerously lopsided and dependent on U.S. demand for the past eight years. The world needs other sources of demand, which I believe will emerge in 2004. To demystify the dynamics of the world economy, a frame of reference can help.

A good analogy is to think of the world economy as a Boeing 747 aircraft. Just as a 747 has four engines that enable it to lift off and gain altitude, so the world economy has four “engines” defined along geographic lines that power its GDP growth.

This engine accounts for only 23% of world output (based on purchasing power parity rates from the International Monetary Fund.) Yet, it has been the sole driver of global growth since 1995.

Four Engines of the Global Economy

Data Sources:Bloomberg; International Monetary Fund. Concept and copyright © 2003 by The Globalist

Led by Germany and France, which on a combined basis account for 40% of the region's output, the European Union represents Engine No. 2. In total, the EU is composed of 15 countries and accounts for roughly 20% of world GDP.

From Japan in the north to India in the south, this engine is home to roughly three billion people — or half of the world’s population. It accounts for 34% of world GDP. As a group, it is more heterogeneous than North America and Europe, where growth rates and level of development of the grouped countries are similar.

Including Latin America, Central Europe, Russia, the Middle East and Africa, this group has as its common denominator rich stores of commodities — and, more importantly, the dependence on commodities for export and public revenues.

Consequently, as world commodity prices go, so goes Engine No. 4, which accounts for 23% of world output.

Using this conceptual framework, the global business cycle comes into sharper focus. As 2003 winds down, the world economy continues to fire on just one engine — Engine No. 1. This is reflected in America's outsized current account deficit, which is the difference between what the United States produces each year and what it consumes.

America has kept the world economy from falling deeper into recession. At this juncture, other sources of demand (that is, other growth engines) are needed to push global growth back to its 3.7% annualized growth trend of the past 30 years.

The outlook for Engine No. 2 — Europe — is improving, albeit gradually.

Europe fell into recession in the first half of this year, but signs now point to a near-term rebound in economic activity. Hampering growth is the EU's Stability and Growth Pact, which effectively puts Engine No. 2 in a fiscal straightjacket.

Meanwhile, the strong euro has stunted export growth. Yet, the stronger currency has forced the pace of domestic reform — a trend that should help promote long-term growth.

Engine No. 3 — Asia — is showing more signs of vigor. It is a primary candidate to contribute to global demand in 2004.

Throughout the region, the negative SARS-related effects on growth have passed. China continues to grow at an annualized rate of 8% to 10%, serving as a growth catalyst for the rest of the region.

The other emerging giant, India, is now posting economic growth ranging from an annualized rate of 6% to 8%.

Japan also is showing signs of strength. As in the past, however, the durability of a Japanese rebound remains suspect given the nation's lingering problems in the banking sector.

If Japan — which accounts for roughly 75% of Asia's total output — somehow gains traction, Engine No. 3 could emerge in 2004 as a powerful growth engine for the world economy.

Thanks largely to soaring demand in Asia and particularly in China, prospects for Engine No. 4 — the rest of the developing world — have begun to improve. Strong global demand for oil, metals and other material resources has boosted the growth prospects in nations such as Russia, Chile, South Africa and Mexico.

In many of these countries, higher-than-expected commodity prices have bolstered the balance sheets of many governments. This has lowered the cost of borrowing — and improved the creditworthiness of many public and private sector entities. Indeed, Engine No. 4 is showing signs of life and could emerge as a key source of global demand in 2004.

It has been a long time since all four engines of the world economy have fired simultaneously. Indeed, not since 2000 has the world economy expanded at the 3.7% annualized rate that has been the long-term historical average for the past three decades.

2004 should be different, however, as the world economy appears poised to regain altitude — and a comfortable cruising speed.