Economic Outlook: Global recovery prospects still hinge on US economy

When the Bank of England (BoE) raised interest rates earlier this month by a quarter-point to 3.75 per cent, and the job market in the US showed upward development, politicians and economic officials began a thrust of statements about global economic recovery.

The BoE decision aims mainly at gauging inflation to below the government target of 2.5 per cent as consumers continue to spend with the huge cash-in on their equity. House prices are still rising, with more than 80 per cent of Britons owning their homes, and home-owners are borrowing to spend, tempted by the low interest on loans through re-mortgaging.

Of course, BoE forecasts a more strong growth in the fourth quarter and is revising its estimates of the economy upwards.

As for the American economy, third quarter growth of more then seven per cent in the gross domestic product (GDP) did not tempt the Federal Reserve to think of raising rates from its half century low of one per cent. This cautious approach is understood as not everybody is 100 per cent sure that the recovery in the largest economy is long-term.

Though economies in other parts of the world, in Europe and Asia, are growing and expected to grow through next year, it's still the health of the American economy that decides the prospects for global economic recovery. To sustain the pace of activity and growth in the American economy, a lot of factors to be kept under control are outside the hands of monetary policy officials.

Analogy

People tend to draw an analogy between the current recovery and the rise and fall of economic health in the 1980s. The economic policies of the Bush administration have been about as crude and destructive a cocktail of stimulants - lavish income and estate tax cuts for upper-income Americans, elimination of taxes on dividends, stepped-up military and homeland security spending - as we have ever seen.

Bush has pursued $2 trillion in callous tax cuts, and hundreds of billions of military spending on wars in Afghanistan and Iraq.

But the budget deficit may reach five per cent of the GDP in the fiscal year that began this October. (By contrast, the EU is currently up in arms because France's budget deficit exceeds the EU's three per cent threshold.) It is fitting that the 7.2 per cent rate of growth of America's GDP - in effect, its national income - is the fastest since the first quarter of 1984 under Ronald Reagan, when the annual rate reached 9 per cent.

Reagan's enormous tax cut of 1981 was of about equal size compared to the economy (properly adjusted for inflation and a couple of other factors), and he aggressively pumped up military spending.

We then embarked on a solid recovery, with 7.3 per cent growth reported for all of 1984, tapering off to under 4 per cent in succeeding years. The stock market set out on its long bull run as well, which Reagan enthusiasts hailed as the beginning of a new age.

But the federal budget deficit did not dissipate as promised with growth, capital investment did not rise as a proportion of GDP, and wages stagnated for most and fell for many even as jobs were created. Americans began borrowing at maddening, and mad, rates to support flattening incomes and the nation's savings rate just kept falling.

In the end, when you measured growth over a complete business cycle, both recession and expansion, the Reagan reforms produced no increase in the rate of growth over the 1970s.

The expected result is short-term growth and long-term damage. Even if the "Bush boom" hailed by some pundits temporarily takes hold, the administration's policies will weaken the economy over time, fall particularly harshly on its working middle- and low-income citizens, and fail to prepare the nation for a century of far more intense global competition.

With economies in Asia growing at a pace of six per cent, political pressures from Washington may not be enough to bring the virtues of this growth in China or India to boost the American economy.

The writer is based in Qatar