Will the world fall into recession?

Or is there a chance of an upturn in 2002?

By BBC News Online's Steve Schifferes

Just one year ago the prospects for the world economy seemed bright.

The world's largest economy, the United States, was growing at 4% annually after nearly a decade of economic growth.

And a huge trade imbalance meant that America was sucking in goods from the around the world, boosting exports from Asia in particular.

Growth was picking up in Europe and the UK as well, after a series of interest rate cuts and an attempt to stabilise the value of the euro.

Only in Japan was the news gloomy - and even there the government was claiming that the worst was over and recovery was on the way.

For the first time in decades you had employers chasing workers, rather than the other way around

Jared Bernstein, economist
Economic Policy Institute

Now the world may be sliding into a global recession.

The growth of the world economy is widely expected to slow dramatically, at least until the middle of next year.

The problem is that the three leading economies - the United States, Japan, and Germany - are slowing down at the same time.

And although growth may be positive in some parts of the developing world, except for China it is unlikely to keep up with the growth of population, so average income per head could actually fall.

US the key

The heart of the world slowdown is the dramatic turnaround of the US economy which has been accelerated but not created by the attacks of 11 September.

Most economists now believe that the US economy entered a recession as early as March, while in the third quarter (July-September) it was already down by more than 1%.

Flagging economy... engine for world growth is in trouble

The problem for the US economy was over-investment, particularly by the business sector, in new equipment such as computers and telecoms systems.

This was exacerbated by the huge boom in the stock market, which made it easy for companies to expand using their share price as collateral.

"We really had a capital investment bubble," said William Stavropoulos, the chairman of Dow Chemical. "The overhang is unbelievable."

By the middle of the year that investment had declined sharply, bringing down the tech stocks with it.

And the stock slowdown also affected consumer confidence which suffered another blow after 11 September.

Job cuts at big companies - especially electronic and telecoms giants like Lucent, Motorola, Hewlett-Packard, and AT&T - further weakened consumer spending.

Budget surplus

That quickly reversed the low unemployment environment which had led to the first real growth in family incomes in 20 years.

"For the first time in decades," said Jared Bernstein, an economist at the Economic Policy Institute, "you had employers chasing workers, rather than the other way around".

And the US Government's budget surplus was an early victim of the slowdown with the optimistic projections of a $3 trillion surplus disappearing after the tax cuts in the spring.

The US central bank, the Federal Reserve, has moved aggressively to try to contain the recession, cutting interest rates eleven times from 6.5% to 1.75% in the course of the year.

The Federal government has had less success in producing a further economic stimulus package, with negotiations mired in conflict between Democrats and Republicans as to who should be the main beneficiaries.

The behaviour of US consumers and businesses will be crucial to the future of the world economy in 2002.

The $10 trillion US economy is one-quarter of world output, and no other country looks like being in a position to become the new engine of economic growth.

Gloom in Japan

Indeed, the situation is even worse in the world's second-largest economy, Japan, where officials now expect the recession to worsen sharply in 2002.

Japan's economy has been weak for some time, and the loss of its export markets has helped push it deeper into recession.

Japan needs to increase consumer spending

Japan's companies have responded to the problems for the first time by massive lay-offs, and unemployment is now higher than in the United States, reaching 5.5% in November.

And prices in Japan are actually falling, encouraging consumers to delay spending in the hope that goods will get cheaper in the future.

The Japanese government also seems to be running out of policy options, with interest rates already at near zero for the past year, and a series of economic stimulus packages which have failed to boost the economy.

Indeed, although Prime Minister Junichiro Koizumi remains popular with the public, analysts and economists are worried that his plans for reform - however good they look on paper - will never make it to reality.

Japan's one hope is to revive its export sector, and the government has been quietly trying to devalue the yen to help companies sell more abroad, seeing it hit a record low against the dollar soon after Christmas.

Subdued Europe

The world's third largest economy, Germany, has also suffered from an economic slowdown which has been dragging the rest of the eurozone down with it.

Argentina remains deeply mired in crisis

Germany's growth rate also dipped into negative territory by the third quarter of 2001, and business confidence reached an all-time low.

From Germany's point of view, the European Central Bank (ECB) did not lower interest rates anywhere near far enough or fast enough to prevent a slowdown.

But the ECB was concerned about the economic boom on the eurozone's periphery, and has some fears that the launch of the euro as a cash currency will spur spending and inflationary pressures at the end of the year.

UK 'surviving'

The global slowdown is hurting countries most who are closely tied to the United States.

Canada and Mexico - the two biggest trading partners of the USA - are both recording near-zero growth this year.

And in the southern hemisphere, Argentina has failed in its attempt to tame inflation by tying its currency to the dollar and is in turmoil.

Surprisingly, it is the UK which so far has shown the strongest economic growth among the leading industrial countries.

Although the UK economy is expected to slow, it is not, as yet, near a recession, with strong consumer spending and a booming housing market compensating for a weak manufacturing sector.

Compared to Germany, Japan and the US, the UK has something to smile about

The fortuitous combination of seven rate cuts by the Bank of England, and big government spending plans for the next year, should ensure that the economy keeps growing.

And although unemployment has stopped falling, the UK still has the lowest rate among the G7 industrial countries.

If there is a recovery by the middle of next year, which many economists now deem likely, the UK may well escape the brunt of the world slowdown.

However, even Britain will not be immune if the world slowdown is prolonged.