Annual Economic ReportIntroduction  World economic activity expanded at a faster pace than expected in 1999 and the first half of 2000. As a consequence, recovery from the setbacks suffered domestically in 1998 was considerably quicker than initially anticipated. In addition, the outlook for future export-led growth in developing countries strengthened further during 1999, prompting both the International Monetary Fund and the Organisation for Economic Co-operation and Development to revise upwards their forecasts of world economic activity over the next two years. The outlook for demand, especially in the euro area, South Africa's most important export market, has improved substantially since 1998. The pace of economic activity in Southeast Asia, another prominent destination for South African exports, is also accelerating. While economic activity picked up on a worldwide scale, inflation remained low in most industrial and emerging-market economies. The evidence of strong growth in most countries focused the attention of monetary policy-makers on the possible overheating of economies. Due to official monetary policy intervention, interest rates generally rose throughout 1999 and the first half of 2000, keeping inflation pressures at bay. Technological progress and disciplined fiscal policies helped to contain consumer price inflation in most of the countries that have established trade links with South Africa. Global inflationary pressures remained muted, even in the face of strongly rising international prices for crude oil.The South African economy responded quickly to the recovery in the international economy — growth accelerated progressively from quarter to quarter during 1999. Contrary to general expectations, the synchronisation of the domestic economy with the international economy broke down in the first half of 2000. At an annualised average rate of just more than 1½ per cent in the first half of 2000, South Africa's economic growth fell behind that of the international economy. For 2000 as a whole, global economic growth is expected to be in the region of 4 per cent and in developing countries it may go as high as 5½ per cent. The slowdown in the domestic economy in the first half of 2000 was mostly concentrated in the goods-producing sectors of the economy. It was not caused by weak aggregate domestic demand or a fall-off in foreign demand for exports from South Africa. In fact, strong aggregate domestic demand caused import volumes to rise from the first quarter of 1999 and export volumes also grew vigorously over the same period. The slowdown should rather be blamed on a phenomenon that has become typical of the modern South African economy: aggregate supply is invariably lethargic in its response to demand stimuli. Prospects for longer-term high production growth have also waned because of a steep decline in the fixed investment ratio. Fixed capital formation of about 14½ per cent of gross domestic product is not enough to sustain a high rate of output growth and job creation. Since capital formation adds to the stock of productive capital and therefore determines the rate at which aggregate demand can grow without inducing inflation, the low investment ratio is effectively constraining the growth capacity of the economy and increasing the underlying inflationary potential. However, over the past eighteen months or so, real gross domestic expenditure grew broadly in tandem with gross domestic product so that there is little reason to expect any additional pressure on end-product prices from this source. Although capital formation fell to a low level during 1999 and the first half of 2000, the share of total factor rewards allocated to capital increased somewhat at the expense of labour's share. With output volumes growing at a fairly modest pace, the growing share of the value of output accruing to employers may seem to indicate that end-product prices were rising faster than unit labour costs and that producers were widening their operating margins. The improvement in gross operating surpluses neverthel