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U.S. Slowdown Going Global

Connectivity in World Economy Hurting Many Nations

By Steven Pearlstein

Washington Post Staff Writer

Wednesday, July 18, 2001; Page A01

It's official: The economic slowdown that began last year in the manufacturing and tech sectors of the United States has now spread around the world, creating a synchronized downturn for the first time in a decade.

After a decade-long slump, Japan is slipping back into recession while the export "tigers" of Southeast Asia find they have few places to export to. Another currency and credit crisis has gripped South America. Even Europe, which only months ago boasted that it would avoid the contagion, is showing all the early symptoms. Only China, in the midst of reforming its vast domestic economy, seems to be immune.

Now, business executives and economic policymakers around the world are concerned that economic weakness could boomerang back to where it began, knocking out any chance of a quick rebound in the United States and dragging the global economy into recession.

"The principal risks to the U.S. economy are now global," said Jerry Jasinowski, president of the National Association of Manufacturers.

"This is a serious contagion that, left to its own dynamics, could become a vicious cycle that feeds on itself," warned economic forecaster Allen Sinai of Decision Economics Inc., who puts the odds of a global recession at 40 percent.

"There's serious weakness at the center of the world economy," said Caroline Atkinson, a former Treasury official now at the Council of Foreign Relations.

Federal Reserve Chairman Alan Greenspan is expected to address the issue today when he goes to Capitol Hill to present his semiannual report on the U.S. economy. On Friday, President Bush will meet with the heads of the other leading industrial nations in Genoa, Italy, at their annual meeting on economic issues.

Globally, the latest crop of economic indicators show most of the arrows pointing down. Singapore's economy is now officially in recession while France reported last week that its free-spending consumers had suddenly become tightfisted. And manufacturing orders are so weak in Germany, Europe's largest economy, that the leading business group there forecasts an anemic growth rate of just 1 percent. In the United States, the Federal Reserve reported yesterday that industrial production fell 0.7 percent in June, the ninth consecutive monthly decline. [Story, Page E1.]

Putting the best gloss on the situation, finance ministers from the industrial countries meeting in Rome last weekend predicted that a resurgent American economy, bolstered by tax cuts, lower interest rates and falling energy prices, would be enough to pull the global economy out of its slide.

That's what happened the last time, after the Asian economic crisis in 1998, when a booming U.S. economy became the world's consumer of last resort. And with American consumers still spending and the housing market still robust, it could happen again if U.S. economic growth picks up to 3 percent by early next year, as some forecasters now predict.

"I'm pretty confident now about the U.S. pulling the rest of the world out of the doldrums," said C. Fred Bergsten, director of the Institute for International Economics.

But pessimists in this debate say this time may be different. In the face of falling profits and rampant overcapacity, U.S. businesses are still pulling back rapidly on their capital spending, they argue, and are unlikely to respond to the Fed's interest rate medicine. In addition, with unemployment rising and household wealth falling, they fear that the heavily indebted American consumer will finally stop spending.

"There's no growth locomotive to turn this around," said David Hale, chief economist at Zurich Securities.

One reason economists and policymakers are so nervous about the global economy is that they have already been unpleasantly surprised by the speed and degree to which the slowdown has spread.

"We don't yet fully understand all the elements in the international area which are affecting the industrial countries," Greenspan acknowledged in congressional testimony last month. Whatever happens in the U.S. economy "tends to have a significantly larger impact on our trading partners" than in the past, he said. "And what is happening among our trading partners has a greater effect on the U.S. than we can readily understand."

Analysts have identified three factors that may be driving the contagion effect.

The most obvious has been the explosive growth of world trade, which now accounts for 25 percent of the world's economic output, double the percentage in 1970. Much of it involves the United States. Last year, according to Morgan Stanley economist Stephen Roach, exports to the United States accounted for 25 percent of Mexico's economy, 32 percent of Canada's and 40 percent of the growth in Asian countries outside of Japan. Not surprisingly, those are the countries that have been most directly affected by the U.S. slowdown.

"The world has simply become too dependent on the U.S.," Roach said.

Now Roach fears that the impact of an overly strong dollar and weak economies abroad will combine to cut U.S. exports this year by 5 percent to 10 percent -- enough, he calculates, to call into question those growth forecasts of 3 percent.

Globalization of finance and investment are also part of the story. The same investors now participate in all the major stock and bond markets, just as the same global banking firms make loans in all the major economies. And what happens in one place affects the way investors and lenders behave everywhere else.

In the 1980s, for example, Japan's speculative bubbles in stocks and real estate eventually pushed over into the United States. Similarly, the gyrations of the Nasdaq Stock Market in the 1990s triggered sympathetic booms and busts on European and Asian exchanges. Now, the specter of a default in recession-ridden Argentina has raised interest rates in Brazil, Mexico and South Africa, dampening growth prospects in those countries as well.

"These financial linkages are not all that well captured by the economic models, which is one reason why we underestimated the potential for contagion," explained Peter Hooper, a former Fed economist now with Deutsche Banc Alex. Brown in New York.

The rise of the multinational corporation has also contributed to the connectivity in the global economy. When a multinational corporation is doing well, according to executives, it tends to boost investment and employment everywhere -- even in regions and product lines that may be lagging. But the reverse is also true: When a multinational firm begins to feel beleaguered because several divisions are in trouble, there is a tendency to pull back across the board.

"What we probably underestimated was the impact of having more big companies operating worldwide," Christian Noyer, vice president of the European Central Bank, said in explaining why European growth rates are falling well short of official projections. "No matter where they are based, a sudden weakening of the U.S. economy prompts them to cut investment elsewhere. So the spread goes more rapidly than before."

The recent experience of cell-phone maker Nokia Corp. offers a case study in the new economic contagion.

Last year, a 66 percent increase in its phone sales gave the Finnish company a dramatic lead over rivals LM Ericsson AB and Motorola Inc. and transformed Nokia into a darling of investors worldwide. The company made plans to increase investments and expand its worldwide production network. And even as the U.S. economy slowed and cash-strapped European phone companies delayed introduction of new-generation cellular systems, Nokia headed into 2001 expecting sales to grow by an additional 35 percent.

Today, with the market seemingly saturated with phones, prices falling and the world economy sputtering, Nokia has acknowledged that it will be lucky to eke out anything more than "modest" increases in its sales. More than 3,000 employees have been laid off, including at least 1,800 near Fort Worth, 200 in Finland and 300 in Germany. The company's stock, which was trading above $60 a share last year, closed yesterday at $17.46 -- a paper loss of nearly $200 billion.

But the economic impact extends well beyond Nokia.

In part, responding to the drop in orders from Nokia and other mobile-phone makers, Texas Instruments Inc. announced in April that it would lay off 2,500 workers, 60 percent of them in Texas, at its chipmaking plants and slash its capital spending by $1 billion. Describing the falloff in orders as the sharpest the industry had ever seen, Chairman Tom Engibous predicted revenue in the second quarter would fall 20 percent.

Also hit by Nokia's fall was Europe's second-largest chipmaker, Munich-based Infineon Technologies AG, which said late last month that it will post a second-quarter loss of more than $500 million because of sales declines and a write-off of unsold inventory.

"In the last three to four weeks, it was like some kind of avalanche. There was a wave of order cancellations in a way we hadn't seen before," chief executive Ulrich Schumacher told analysts. With no recovery in demand for mobile phones expected, the company also imposed a hiring freeze and said it will cut its capital spending plans by more than $1 billion over the next 18 months.

Also hit hard was a small Greensboro, N.C., company that relies on Nokia for more than half its revenue. R.F. Micro Devices Inc. had explosive growth in its sales of radio frequency integrated circuits before hitting the wall earlier this year. Yesterday it reported that its second-quarter sales were down 29 percent, as the handsome profits of last year gave way to red ink.

Also reporting disappointing results yesterday was Philips Electronics NV, which makes most of the display screens and speakers for Nokia phones in factories in Shanghai, Beijing and Vienna. During the second quarter, sales at the company's component division fell 40 percent because of volume and price declines, resulting in a quarterly operating loss of about $280 million.

Division President Matt Madieros said yesterday that he has cut capital spending in half and reduced his payroll by 7,000. And four new assembly lines Philips has just built in China, he said, will remain idle until cell-phone orders pick up.

Two Japanese companies have also felt the chill winds from Helsinki.

Hitachi Ltd. announced last week that it was temporarily shutting down the Japanese production line that makes power amplification modules for many Nokia phones. The company has already warned investors that sales will be flat this year and profits will decline because of continued softness in the Japanese economy, as well as "the global impact of the slowdown in the U.S. economy."

And in Monterrey, Mexico, Sanyo Electric Co. opened a $10 million plant to make rechargeable batteries for Nokia phones just as orders were beginning to drop off. Nokia's business was so significant to it that Sanyo set up a separate subsidiary last year just to deal with that one customer. A company spokesman refused to say how many workers in Monterrey and three other Mexican plants were laid off as a result of the "realignment" of Nokia's production.

It is that degree of cross-border interdependence, analysts say, that now raises the risk of global contagion -- and makes it more difficult for economic policymakers to stop it after it gets going.

"At this point, the formula for global recovery has got to be more complex than simply providing modest tax and interest rate cuts to the U.S. economy," said Jeffrey E. Garten, dean of Yale University's School of Management. "The complacency shown by the political leaders I find really dangerous."

© 2001 The Washington Post Company

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