Finance and Investment

The Global Economy in 2011: A Rocky Ride or Smoother Sailing Ahead?

In the United States, most experts are betting that the economy will grow stronger this year, but they warn that high unemployment, a depressed housing industry and other problems could dampen growth. Meanwhile, the fate of the euro is still in question, and the specter of inflation looms large in China, Latin America and India despite their resilience to the recent global downturn. In the Middle East, observers expect renewed growth, but they note that resource constraints will become an increasing problem for the region. Knowledge@Wharton spoke with Wharton faculty and other experts to get their views on what's ahead for the world economy in 2011.

The United States: Housing Risks

In the U.S., "the threat of a double dip [recession] has passed," says Wharton finance professor Richard Marston. The congressional compromise to extend the Bush-era tax cuts for two years should help the country's recovery, he predicts. "With the added stimulus of the tax bill, we will have continued growth in 2011."

Still, "there are some very severe downside risks," says Wharton finance professor Franklin Allen. One main concern is housing: Allen, Marston and other experts agree that the uncertain housing market will continue to be a drag on the economy.

"In the housing market, the data is going in different directions," Wharton real estate professor Susan M. Wachter notes. Some reports show sales picking up, while others show prices continuing to stagnate. "The bottom line is that we're bouncing along the bottom.... We're likely to be in a holding pattern." Fortunately, Wachter says, the weak housing market probably will not do too much additional damage to the economy, as most of the harm has already been done. New-home construction is not likely to go lower, for example.

According to Wachter, the housing market has enjoyed some stability because many lenders have been reluctant to foreclose and sell homes at fire-sale prices. A lender is typically willing to sell when a foreclosed property can fetch as much as the appraisers say it is worth, she says, but appraisers rely on backward-looking data that is quickly out of date in a volatile market, making it hard for the lender to know what a property is really worth.

U.S. economic growth also could be hampered by ripple effects from the continuing debt problems in a number of European countries, Allen notes. In addition, economies are starting to overheat in some developing countries, especially China, he says. China has started to raise interest rates to curb inflation, but that could draw more foreign money into China, possibly depriving other countries of capital they need to speed growth while worsening China's inflation problems.

Europe: Are Two Heads Better Than One?

In Europe this year, whoever takes over from Jean-Claude Trichet as head of the European Central Bank (ECB) in October will inherit a different set of issues than the French banker did when he began his term back in 2003, according to Allen. Back then, the euro zone's single currency was still in its infancy, and most Europeans were happy to give fiscal and monetary union the benefit of the doubt. But the European Union's big macroeconomic imbalances and debt crises that began with Greece's near-default last year and spilled over to Ireland, Spain, Portugal -- and potentially could affect Italy and Belgium -- have left plenty of skepticism over the lack of policy flexibility granted to members of the 17-nation euro zone (with Estonia the latest to join as of January 1).

The Frankfurt-based institution is expected to announce Trichet's successor this spring, and the appointment "will really matter a lot," says Allen. A frontrunner is Axel Weber, head of Germany's central bank who is seen as a close ally of German Chancellor and major euro proponent Angela Merkel. Another strong candidate is Mario Draghi, governor of the Bank of Italia, "who is extremely talented," notes Allen, "but I can't see the Germans allowing a southern European to head the bank."

All that will unfold as euro zone countries tumble through recovery at different speeds, depending on the range of austerity measures undertaken. But collectively, according to a recent report from Guillaume Menuet and Silvia Ardagna, analysts at Bank of America Merrill Lynch, "while the pace of recovery [in Europe] post the 2008 recession looks to be quite reasonable, overall levels of GDP have a long way to go before recouping output lost in the downturn."

China Grapples With the 'I' Word

China watchers are beginning 2011 much as they did 2010 -- concerned about inflation. Though still low by international standards, consumer price inflation early last year was hovering at less than 2%. But since the massive monetary expansion of late 2008, liquidity continued to flood in, putting upward pressure on prices. Housing and food prices surged during the year, and a growing wave of discontent among workers seeking long overdue pay raises swept across the country. By November, consumer prices were up 5.1% year on year.

In a December report, London-based Economist Intelligence Unit (EIU) predicted that average year-on-year consumer price inflation will be 3.9% in 2011, helped largely by intense price competition among goods manufacturers. But this could change if, for example, wages increase and push up the cost of manufacturing, causing price hikes. Agriculture, which accounts for a sizable portion of the country's consumer price index, is arguably a greater concern. Local newspapers are reporting that blue-collar workers in cities like Shanghai are unable to stretch their meager paychecks to cover the rising costs of staples, such as milk and vegetables.

"Having stimulated the economy tremendously, the government now has to deal with the consequences of it," says Wharton management professor Marshall W. Meyer. He and others note that the country's enviable growth -- the EIU estimates that real GDP growth in 2010 will average 10.2% -- has been fueled by a massive expansion of money supply. The inflationary consequences have been largely hidden in the form of rising asset prices, he says.

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