U.S. Will Lead the World’s Economic Recovery

The year just ending saw changes in the world--starting well before the terror attacks of Sept. 11--that will direct the course of economies, nations and industries in 2002 and beyond.

The terror attacks, of course, have had a profound effect, altering relations among nations and military priorities. Economically, however, Sept. 11 accelerated a U.S. and global recession that already was underway.

In the new year, the U.S. economy will have to lead the world out of that recession. No other economy or group of economies can do it, because the U.S. economy is now so large relative to others.

At more than $10 trillion in annual output of goods and services, the U.S. economy is larger than those of Japan, Germany, France and Britain combined. The magnitude reflects the rapid growth of the “new economy� in the late 1990s as information technology exploded. Five years ago, the U.S. economy was 50% larger than that of Japan. Today it is more than double the size of Japan’s.

So the No. 1 question as 2002 begins is: How strong will the U.S.-led recovery be, and what form will it take?

There are other important questions, and emerging trends.

* What will be the centerpiece of U.S. industry, reflecting trends both positive and negative? Answer: Health care.

* What will pose the greatest threat to the world economy? Answer: Japan’s economic weakness and the possibility of yen devaluation. What will offer benefits? The euro and the World Trade Organization.

* Trends the world will see in 2002 include more prominent roles for Russia and Central Asia in the world economy, particularly on questions of energy; a new focus on the economies of Pakistan and India; and changes to the economies of the Middle East.

The U.S. economy will recover gradually, picking up speed in the second half of 2002 but advancing about 3% for the full year. That happens to be the growth rate that was considered normal for the U.S. back in the early ‘90s, before the technology boom spurred faster growth.

A healthy economy is in prospect, with strong home building and home sales. The stock market lately has been anticipating that, boosting stock prices of homebuilders such as Ryland Group Inc., Centex Corp. and Lennar Corp.

Long-term interest rates could fall from today’s levels of 5% to 6% on 10-year Treasury bonds, because “there is no threat of near-term inflation,� says economist Albert Wojnilower of MonitorClipper Partners, a New York investment firm.

Basic industries, from automotive to chemicals to travel and tourism, should return to pre-Sept. 11 patterns. Energy costs, which rose unexpectedly and hurt the economy in early 2001, will return to a familiar pattern--oil prices at $20 to $25 a barrel, even if there is disruption in the Middle East. Natural gas will remain at about $3 per thousand cubic feet, half of what it cost last winter.

The entertainment industry, a hallmark of Southern California business, will return to normal after this year’s slump in TV advertising but a record year of movie revenues. The industry will build on its new products, too. Digital video discs (DVDs) will give movies and TV shows new life in a different format, notes analyst Jeffrey Logsdon of Gerard Klauer Mattison, a New York investment bank. Also, video games, driven by the success of machines such as Microsoft Corp.’s Xbox, will continue rapid growth.

Economic recovery also will increase foreign trade, another mainstay of Southern California industry.

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Use of the Internet

Continues to Expand

Technology is not taking a back seat. Internet-related industry, combining electronics, fiber-optic communications links and computing, will be a growth business again, for both home and business use.

Use of the Internet continued to grow 20% a year, even in 2001 as dot-com firms failed and computer sales slumped. More than 100 million people in the U.S. and even larger numbers worldwide send and receive e-mail, shop online and research subjects of interest. Demand is there for increased capabilities and broadband services.

For business the Net has opened new vistas. Jack Welch, the just-retired chairman of General Electric Co., says the technology investment “bubble� was not a mistake but a major advance for U.S. industry. “That ‘bubble’ left us with real business abilities to get closer to suppliers and customers,� Welch says. “We cut $1 billion out of GE’s costs, and we’ll cut more next year.�

Watch for U.S. business, which saw profits reduced by more than $100 billion in 2001, increase investments in cost-saving technology.

Investment didn’t really fall that far in this recession year. At the peak, U.S. business poured $792billion into technology equipment and services in 2000. Investment fell to $750 billion in 2001, according to Giga Information Group, but could rise to $780 billion in the coming year.

Defense spending will rise to about $320 billion next year and reflect lessons of the war in Afghanistan. Because the U.S. wants access to troubled areas of the world, such as the Middle East and Central Asia, and cannot count on having permanent bases there, defense spending will focus on long-range naval and air power. The idea, explains Loren Thompson, director of the Lexington Institute, a military think tank in Arlington, Va., will be to use ships and planes as vehicles for advanced electronic and radar gear capable of surveillance, targeting and firing of programmed missiles.

Such “network-centric� warfare will mean business for the former Litton Industries, Avondale and Newport News shipyards that now are owned by Northrop Grumman Corp., and for long-range cargo planes such as those made by Boeing Co. and Lockheed Martin Corp.

But defense is no longer the centerpiece industry of the U.S. economy. Health care is.

Health care will be the largest activity in the economy, accounting for more than $1.5 trillion in expenditures on products and services, from the drugstore counter to the hospital bed to advanced biotechnology laboratories. Health care in 2002 will account for almost $1 of every $7 spent.

The mapping of the 30,000 genes and 3 billion chemical pairs in the human genome has opened up the prospect of biomedicine as the next great wave of technology and industry.

And it has opened visions of unprecedented medical achievements. Merck & Co. is investing $400 million in research on drugs aimed at diseases of the brain and central nervous system--Alzheimer’s, stroke and others.

Biotechnology companies are growing and evolving. Amgen Inc.’s proposed acquisition of Immunex Corp. is a bid to become a biotech firm with a broad and varied product line. Other companies, such as Biogen Inc. and Chiron Corp., are studying Amgen’s move.

The biomedical device industry will continue to grow, thanks to constant improvements in heart valves and related implants and to baby boomers’ demands for devices and surgical procedures that will stave off the effects of aging.

Medical costs are rising 8% to 12% a year, sparking political debates about drug costs and drug company profits and about who will pay the bills. In employer-provided health insurance plans, the coming pattern will be to pass on more of the costs to employees.

“The annual cost of covering a family of four is about $7,000. In the future, employers will allow workers to choose how to spend that money,� says analyst Kenneth Abramowitz of Carlyle Group, a New York investment firm. As individuals pay more out of their own pockets, health care will be forced to offer more choice and flexibility to consumers.

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Trouble in Asia,

Change in Europe

The weakness of the Japanese economy threatens all of Asia and the global economy. Japan’s banks have bad debts of $600 billion, a sum equal to 18% of the country’s gross domestic product.

Prices are falling 4% a year, estimates Kenneth Courtis, chief Asia economist at Goldman, Sachs & Co. Such deflation decreases housing prices, eliminating home equity behind 46% of the mortgages in Japan.

The fear is that Japan will solve its debt problems by printing money, which would depreciate the yen to 160 or 200 to the dollar. The yen already has fallen 10% in two weeks to 131 to the dollar.

Steep devaluation would cause competitive devaluations in Thailand, South Korea, Taiwan, Singapore and China, because those countries are linked to Japan through investment and trade. Japan remains the economic leader of Asia, with some of the world’s most skilled companies--think Toyota, Honda, Sony--and production facilities in all the Asian countries.

Devaluations in Asia would cause a great flood of low-priced goods onto world markets, hurting Latin America and other regions as well as industrial and farm producers in the United States.

Pressure on Japan to reform its economy by restructuring its companies and banks could lessen the severity of a devaluation. Such pressure already is coming from China, which is threatening to appeal Japan’s policies to the WTO, the international body set up to hear just such disputes.

But expect global trouble from Japan in 2002. Says Courtis: “It would be naive to think that the greatest financial and economic crisis in a major economy since the 1930s could go to climax without an international upheaval.�

Meanwhile, 12 of the 15 members of the European Union start using the euro as a single currency Tuesday. The euro currently trades at about 88 U.S. cents, down 24% from 1999, when it was introduced in government accounts. Many U.S. economists say the euro will never amount to much, because Europe is less a union than 15 countries with separate budget authorities.

But Tommaso Padoa-Schioppa, a member of the European Central Bank and an architect of the euro, is not worried. He points out that the single currency allowed the central bank to more easily expand money supplies across Europe in the wake of the Sept. 11 terror attacks. And Padoa-Schioppa also notes that when the U.S. was in its infancy, the fledgling dollar united the economies of the separate states.

So the euro is helping Europe’s struggling economies, which will pick up next year in the wake of the U.S. recovery, says economist Robert Levine of Rand Corp., a Santa Monica research firm.

Russia stepped forward as a supplier of energy to Western economies on Sept. 11 and will become a more active participant in the world economy in 2002. Russia, with its Caspian Sea region, and the neighboring countries of Central Asia are known to contain untapped deposits of oil and even greater supplies of natural gas. Development of these resources is important to Asia as well as to Europe.

Russia’s entry to the WTO, which requires members to observe rules of trade among nations, is a certainty for 2002.

So are new negotiations for gas supplies to Europe. Central Asia’s energy reserves are expected to give the world an alternative to supplies from the unstable Middle East, but only a partial one. World oil demand, which rose even in recession-bound 2001, is too great to contemplate without supplies from Saudi Arabia, Iraq and other member countries of OPEC.

As the new year dawns, there is speculation in Washington and other capitals about possible military actions in Iraq. But whatever happens on that score, economic actions are necessary to foster development in the paradoxically rich-yet-poor Middle East. Oil-rich Arab countries sent more than $600 billion in investments to world capital markets in 2001, yet invested little at home. Arab countries took in only $7 billion in foreign investment, according to the Washington-based Middle East Economic Research Institute. More investment at home could help alleviate the region’s instability.

Investment to help develop the unstable economies of Pakistan and India is a certainty for 2002. U.S. aid will go to Pakistan as a reward for its support in the war on terrorism. Investment in India will increase also as the turbulent area of South Asia steps forward to assume a place in our changed world economy.

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James Flanigan can be reached at [email protected].