Academic journal article National Institute Economic Review

Chapter II. the World Economy

Academic journal article National Institute Economic Review

Chapter II. the World Economy

Article excerpt


Longer-term prospects and the implications of

developments in Eastern Europe

The most important factor affecting our view of long-term prospects is the potential effect of developments in Eastern Europe. Since our last forecast, which was completed three months ago on 9th November 1989 the political map of Europe has changed. The Czechs, Rumanians and Bulgarians appear to have joined the Poles and the Hungarians in the drive for democracy and more open markets. The collapse of the East German regime, and the gathering pace of the drive for unification with the FDR has been even more remarkable. Almost any possible outcome will change the prospects for growth and economic developments in the whole of the non-Communist world. We would argue that these effects will not just be confined to Continental Europe.

Model-based economic forecasts always contain some elements of judgement, but they are generally based on the structure of the model, which is in turn based on a perceived structure of the world. The momentous events in Eastern Europe are likely to change the structure of the world economy in at least two ways. Firstly, the pattern of trading blocks is likely to change. Exports and imports from the East are likely to rise very markedly. As we commented in the November issue of the Review, the Baltic states could very easily emulate the smaller countries on the Pacific rim, and Czechoslovakia and Hungary could easily become major players in European trade in the next ten years. Secondly, a reunited Germany would be an extremely difficult structural change for us to handle. Our model is econometrically based, and we like to have up to 25 years of data available when we are crafting each of our country models. We will not have this for a united Germany. We could expect that a united Germany would produce a very different baseline forecast than that which we are presenting here. Our tools are not well suited to the task of analysing such structural changes. Our main forecast does not allow for German reunification, in part because we feel it will be some years before the process of economic integration is likely to be completed but it does attempt to take on board the implications of other changes in Eastern Europe for the rest of the world. We feel that this should give a good picture of potential developments at least in the short to medium term.

We have allowed three effects to feed through to our main case forecast. The influx of economic migrants into West Germany is already having effects on the economic development of Europe, and we have attempted to allow for this. Our assumptions and their implications are set out in box 8. The Eastern Bloc economies have been running a current account surplus for most of the 1980s. We do not expect this to continue. We have recently recast our database for the Centrally Planned Economies (CPEs) and have consequentially produced a new set of equations for this bloc on our model. We expect these new equations to break down very soon as the underlying structure changes, but they do allow us a basis from which to work. We anticipate that the CPEs will move into deficit in the 1990s. This is the mirror image of saying that we are anticipating a major change in the existing pattern of capital flows, with an increase in flows to Eastern Europe.

There are also likely to be major effects on the US economy as it diverts resources from military expenditure toward more consumer goods production. These effects are discussed below. The effects of government expenditures cuts in Europe are likely to be less marked. Prospects for the world economy in the 1990s look good. In the 1970s and 1980s growth was relatively cyclical, partly because of monetary and fiscal policy shocks in various countries such as the US, but also because of the effects of commodity price shocks. The risks in our forecast, at least over the longer term, all appear to be on the positive side. …

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