NCPA - National Center for Policy Analysis

What's Ahead for the Global Economy?

May 14, 1999

Rudi Dornbusch, professor of economics and international business at the Massachusetts Institute of Technology, sees some rocky spots ahead in the world economy. But his views are far from totally pessimistic.

Here is a brief outline of some of his observations:

  • U.S. stocks are overpriced, but any adjustment will probably be soft in the long run -- thanks to confidence in the economy and a variety of available policy tools.
  • Given the level of federal budget surpluses, one such tool would be tax cuts -- which would support consumer spending and avoid a serious downturn here.
  • As the world economy gathers strength, commodity prices will rise prompting a small increase in inflation -- which the Federal Reserve would probably meet with a measured and prudent hike in interest rates.
  • Potentially much more serious is the prospect for Japan -- with its huge public debt and massive unfunded pension liabilities.

Japan's public finances are in disastrous condition and the problem is out of control, Dornbusch contends. According to the International Monetary Fund, Japan's public debt is now 130 percent of gross domestic product. Moreover, the Organization for Economic Cooperation and Development puts the net present value of pension liabilities at 107 percent of GDP.

Deep deregulation is desperately needed there. But Japan's political system is dysfunctional and its politicians are deeply confused as to the depth of the deterioration that has already taken place.

If a financial meltdown were to take place in Japan, neither the I.M.F. nor the U.S. could stage a bailout because the numbers would be staggeringly large. In that event, much of Asia would join in capital export controls and that would spell the end of an increasingly open world economy.

Source: Rudi Dornbusch (M.I.T.), "The Global Economy's Trouble Spots," Wall Street Journal, May 14, 1999.


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