Growing, At Last

Ah, the sweet smell of economic recovery. Stock markets around the globe are resurgent, corporate spending looks set to rise, and optimists are even talking about a return to the golden years of noninflationary growth in the mid-1990s. But how strong is this upturn, really and is it sustainable?

That may depend on where you stand. When TIME's Board of Economists met during the World Economic Forum in Davos, Switzerland, late last month, the perspectives varied according to geography. "The U.S. economy is on steroids," said a worried Pascal Blanque, chief economist at the French bank Credit Agricole. Blanque fears an America bulking up on dangerous deficits, a lax monetary policy and the falling dollar. "The European economy is on tranquilizers," retorted Laura D'Andrea Tyson, dean of the London Business School and former chair of the Council of Economic Advisers in the Clinton Administration. She argues that Europe is both too complacent about its weak growth and strong common currency, and too slow to boost its international competitiveness in response to surging U.S. and Chinese productivity.

The face-off between Blanque and Tyson highlights a sharp divergence in risk perceptions at the board session, which also included Moises Naim, formerly Venezuela's Trade and Industry Minister, who is editor of the Washington-based journal Foreign Policy; Fang Xinghai, the deputy chief executive of the Shanghai Stock Exchange; and Slawomir Sikora, president of Poland's Bank Handlowy w Warszawie now part of Citigroup.

All five economists seemed upbeat about the resumption of growth worldwide and relieved that investment is picking up and confidence appears to be returning to both consumers and business. But while the U.S. focuses on jobs and obsesses about the emergence of China as a low-cost economic colossus, European Union nations have turned inward. They are preoccupied by the addition of 10 new E.U. members this year, by the tussle over a new European Constitution and by the collapse of the Growth and Stability Pact, which imposed rigid discipline overly rigid, critics say on governments to curb deficits. Europeans are concerned about the impact of the falling dollar on their exports, but they have yet to take action to stem the tide. "Be patient with Europe," pleaded Blanque. After all, he said, economic-reform efforts in France, Germany and elsewhere are under way, but they will take time to yield tangible results.

Too much time, said Tyson and Naim. "Europe has a tsunami coming its way this year," warned Naim. He predicted that as the weak dollar undermines European companies, European countries will be paralyzed by a clash between businesses urging far greater flexibility and unions and other groups seeking protectionist barriers. "This is the clash we're going to see emerging powerfully in Europe in the next 24 months," Naim said.

For all such sparring, the sentiment this year is far better than it was 12 months ago. Then, as the Iraq war loomed, the board was worried that a "culture of caution" had taken root among consumers and businesses alike. Today world trade is up; oil prices didn't spike, as was feared; mergers and acquisitions are back in fashion; and U.S. consumers, boosted by President Bush's tax cut, are buying the whole world out of the doldrums. Even Japan's economy, mired in recession for much of the past decade, is growing at a healthy pace again. "There's a remarkable degree of consensus" among forecasters for U.S. growth between 3.5% and 4% this year, Tyson said. If they're right, that could be the fastest growth in four years (and a big boost to Bush's reelection prospects).

Not everyone is buying that opinion. "I have some doubts" about those growth predictions, said Blanque. "Recovery is a bet on investment, and investment is running out of steam." He believed the U.S. still suffers from overcapacity not to mention consumer indebtedness. Tyson agreed that the American consumer's ability to keep on spending will prove decisive.

There are other risks, none greater over the long term than the estimated $521 billion budget deficit. That's the biggest ever in dollar terms and, at about 5% of gross domestic product (GDP), the largest in more than a decade. The U.S. current-account deficit, which measures the combined balances on trade in goods and services, income and currency transfers, is also at a record high: about $550 billion for 2003. Last month the International Monetary Fund warned that these deficits pose "significant risks" for the U.S. and the world economy. Why? Because they are so large, they could inflate interest rates worldwide and potentially destabilize foreign-exchange markets.

The critical issue, Tyson said, is this: At what point does a growing structural federal budget deficit undermine international confidence in the U.S. economy? For the moment, Asian central banks are helping fund the deficit by buying dollars. That's keeping their trade with America on track and U.S. interest rates low, and effectively financing the worldwide expansion. But, Tyson asked, "how long can they keep doing this?" The U.S. Federal Reserve gave a partial answer recently when it abandoned a five-month-old commitment to keeping rates low "for a considerable period"--a statement widely interpreted to mean that rates are headed upward later this year. That's a growth brake.