World economic and financial conditions remain generally encouraging, notwithstanding a disappointing performance recently in continental western Europe, and the global economic expansion is expected to continue at a satisfactory pace in 1996–97 and over the medium term (Table 1 and Chart 1). The strength of economic activity is particularly impressive in the emerging market countries of the developing world, with an increasing number of them reaping the benefits of structural reforms and strong macroeconomic fundamentals. In a number of such countries in Asia, concerns about overheating have been alleviated to some extent by a moderation of growth. And in most of the transition countries, the private sector is increasingly responding to the progress that has been made toward macroeconomic stability, the growing reliance on market forces, and these countries' integration into the world economy.

Among the industrial countries, there has generally been continuing success in containing inflation, but growth and labor market performance have remained uneven. A number of countries—most notably the United States—are experiencing robust growth of output and employment; these economies tend to be characterized by relatively flexible and dynamic labor and product markets and significant progress toward fiscal consolidation. In Japan, supportive monetary and fiscal policies and a correction of the earlier overvaluation of the yen have finally put the economy on the path of recovery after a protracted economic slowdown. But financial sector problems remain a downside risk and the authorities will soon have to confront the task of restoring balance in the public finances.

Many industrial countries, however, are yet to share fully in the current expansion, and continue to face the important policy challenges of addressing the deep-seated structural and macroeconomic weaknesses in their economies. Some countries are also experiencing difficulties in their banking systems with attendant downside risks to confidence and economic activity. In much of continental Europe, in response to the faltering of growth in the second half of 1995 and in view of the approaching deadline for Economic and Monetary Union (EMU), the policy mix has shifted toward tighter budgetary policies and easier monetary conditions. Together with a correction of earlier exchange rate misalignments this has improved prospects for a resumption of stronger growth in the latter part of 1996. The projected strengthening of growth will facilitate fiscal consolidation and lessen uncertainties about the EMU timetable and the associated risk of tensions in financial markets. In addition to stronger efforts to reduce the growth of public expenditures and contain fiscal imbalances, fundamental labor market reforms and deregulation of product markets remain essential if Europe is to achieve greater economic dynamism and be able to meet future challenges.

In the developing world, despite the growing number of success stories, many countries continue to struggle with macroeconomic imbalances and structural impediments that keep their living standards well below what they are potentially capable of achieving. The role of market forces is generally increasing, but high degrees of government intervention in the economy and large claims on financial resources by the public sector and quasi-public entities continue to hamper the development of the private sector in many countries. These problems also often limit countries' ability to take advantage of their improving access to foreign markets. Reforming the public sector, removing price distortions, liberalizing foreign trade and payments, opening up to foreign direct investment, and strengthening the capacity of the financial system to mobilize domestic saving and allocate financial resources to productive uses are all essential elements of a comprehensive growth strategy. Such reforms need to be supported by prudent macroeconomic policies aimed at containing fiscal deficits, controlling inflation, and maintaining external viability.

In the transition countries, where there have been considerable improvements in inflation performance, there is still a need to continue the reform process and to achieve and safeguard greater macroeconomic stability. In many countries, including some that are relatively advanced in the transition process, fiscal deficits remain excessive and contribute to continued price pressures. Transformation of the enterprise sector is often being impeded by acquiescence to tax and wage arrears and by growing portfolios of nonperforming bank loans, which undermine the ability of price mechanisms and of the financial system to allocate resources more efficiently. The inadequacy of social safety nets also hampers the needed restructuring of loss-making enterprises. Without adequate progress in these areas the economic and social costs of the transition will be considerably higher, the benefits will be smaller and slower to materialize, and the risks of reversal of the economic and political reform process will remain.

The achievements of recent years underscore the validity of the cooperative strategy to strengthen the global expansion set out by the Interim Committee in 1993 and reaffirmed in its October 1994 Madrid Declaration. At the same time, the continuing problems affecting many countries suggest a need to broaden the strategy in several areas and to strengthen its implementation. Experience in recent years has confirmed that economic success requires sustained efforts at both structural reform and macroeconomic stabilization and that efforts over a broad range of policies are mutually reinforcing. It has become particularly apparent that a failure to tackle serious weaknesses in some areas may increase the short-term costs, and delay the positive effects, of those policies that go in the right direction. More comprehensive and better balanced policy approaches are necessary if a greater number of countries are to realize their full growth potential.