THE GLOBAL ECONOMY: Perspectives and Trends

JOSEPH STIGLITZ

September 2003

BACKGROUND

• THE GLOBAL ECONOMY HAS BEEN WEAK FOR SEVERAL YEARS– FIRST GLOBAL RECESSION OF NEW ERA

OF GLOBALIZATION• WITH SIMULTANEOUS

RECESSIONS/SLOWDOWNS IN EUROPE, AMERICA, AND JAPAN

• AND EMERGING MARKETS FEELING THE CONSEQUENCES

Marked change in perspective in the last five years

• From euphoria of New Economy to worries about global slowdown,

• From the Roaring 90s to the malaise of the new millennium

• From triumphant globalization to a distrust of globalization

DISCONTENT WITH GLOBALIZAITON

• FROM TRIUMPHANT GLOBALIZATION (AMERICAN STYLE) TO DEEP DISTRUST OF GLOBALIZATION

• Demonstrations at Seattle, Washington, Prague—every major meeting

• East Asia crisis, Russian crisis, Latin American crises

• September 11: Concerns about terrorism, secret bank accounts

• Global dissatisfaction with trade agreements

NEW ECONOMY DID NOT ELIMINATE THE BUSINESS CYCLE

• BUT EXCESSES OF DEREGULATION, CORPORATE AND ACCOUNTING SCANDALS LET TO IMBALANCES

• “BAD INFORMATION” LEADS TO BAD INVESTMENT DECISIONS

• GRADUALLY BEING WORKED OFF

IRAQ WAR DID NOT CAUSE RECESSION

• THE RUN-UP TO THE WAR WEAKENED ECONOMY FURTHER

• BUT THE RESOLUTION OF THE WAR DID NOT RESOLVE THE UNDERLYING WEAKNESSES

• THE RUN-UP TO THE WAR EXPOSED FURTHER WEAKNESSES IN THE GLOBAL GEO-POLITICAL SYSTEM

• WEAKNESSES EVIDENCED EARLIER• AS ECONOMIC GLOBALIZATION HAD

OUTPACED POLITICAL GLOBALIZATION

• THE END OF THE WAR HAS NOT RESOLVED TENSIONS IN THE MIDDLE EAST AND HAS BROUGHT TO THE FORE CERTAIN LONG STANDING PROBLEMS– CREDIBILITY OF POLITICAL LEADERSHIP– PROBLEMS OF DEBT

MILD NOTES OF OPTIMISM

• A WEAK RECOVERY IS IN MOTION IN THE U.S.

• EUROPE IS BREAKING THE SHACKLES WHICH HAS TIED IT DOWN

• PROSPECTS IN CHINA AND INDIA ARE PARTICULARLY GOOD

• WHILE LATIN AMERICA WILL DO BETTER THAN LAST YEAR, THERE REMAIN DEEP CONCERNS

OUTLINE

• US

• EUROPE

• CHINA

• LATIN AMERICA

• OTHER EMERGING MARKETS

– US WENT INTO RECESSION IN MARCH 2001

– STILL A LARGE, AND GROWING, GAP BETWEEN ACTUAL PERFORMANCE AND POTENTIAL

PROSPECTS FOR THE U.S. ECONOMY WEAK

Economic mismanagement in U.S• Anemic response to corporate, accounting,

banking scandals– Continuing revelations of problems

• Problems in private pension programs– Will be a drain on profits– Trying to bury problem may only make it worse

• A tax cut that failed to provide adequate stimulus

– Almost three million job losses

Weak recovery is in offing

• Military expenditures combined with massive tax cuts did provide some stimulus

• Especially with provisions inserted at last minute– Aid to states– Cuts for low income individuals

BUT RECOVERY WILL BE WEAK

• AND LEAVE CONTINUING GAP BETWEEN U.S. ACTUAL PERFORMANCE AND POTENTIAL

• IMPLYING WEAK RECOVERY OF JOB MARKET

SOURCES OF WEAKNESS

• HUGE DEFICITS• PRIVATE SECTOR DEBT OVERHANG

– ONLY MORTGAGE REFINANCING SUSTAINED CONSUMPTION OVER LAST THREE YEARS

• FISCAL STRINGENCY AT STATE AND LOCAL LEVELS– FORCING EXPENDITURE CUTS AND TAX

INCREASES

• WEAKNESSES ELSE IN GLOBAL ECONOMY—PULLING US ECONOMY DOWN RATHER THAN HELPING RECOVERY

PRIVATE SECTOR DEBT OVERHANG

• MEANS THAT WHEN INTEREST RATES START TO RISE (AS THEY NORMALLY DO IN RECOVERY) INCREASED BURDEN OF DEBT SERVICE WILL FORCE CUTBACKS IN CONSUMPTION

• WEAKENING OF REAL ESTATE MARKET—DECLINING HOUSEHOLD WEALTH ALSO CONTRIBUTING TO CUTBACKS IN CONSUMPTION

HUGE DEFICITS PRESENT PROBLEM IN SHORT RUN AND

LONG• ALREADY LEADING TO INCREASE

SPREAD BETWEEN t BILL INTEREST RATE AND MEDIUM TERM RATES

• LIKELY TO HAVE ADVERSE EFFECTS ON HOUSING MARKETS AND EMERGING MARKETS

• GROWING LACK OF CONFIDENCE IN U.S. MACRO-MANAGEMENT

FISCAL DEFICITS HAVE MAJOR CONSEQUENCES

• TWIN DEFICITS– FISCAL DEFICITS LEAD TO TRADE

DEFICITS– WEAKENING AGGREGATE

DEMAND/SLOWING US ECONOMIC– TRADE DEFICITS LEAD TO

PROTECTIONIST SENTIMENTS AT HOME

•Return of soaring fiscal deficits—put strong demands on global capital markets

–Massive borrowing from abroad

– Potential changes in sentiments could have major effects on exchange rates

• Only weaknesses in Europe, elsewhere have prevented further decline in dollar

– Will the world be willing to continue to finance these deficits?

– Large changes in exchange rates can be negative sum:

• U.S. gains on exports• But weaknesses in financial markets may more

than offset these gains• Europe hurt doubly: stronger exchange rate,

weaker American, global economy

EUROPE’S HANDS HAVE BEEN TIED

• Stability pact limits scope for fiscal stimulus• ECB has difficult task balancing different

economic situations in different parts of the continent

• But narrow focus on inflation, problems of earlier decades, has meant that it has failed to respond to current situation, contributing to weakness in Europe

EUROPE FACING AN INSTITUTONAL CRISIS

• FRAYING OF STABILITY PACT– WHAT WILL REPLACE IT?

• WAINING CONFIDENCE IN EURO– REJECTION BY UK– LIKELY REJECTION BY SWEDEN

Emerging markets mixed picture

• Major recessions, depressions in Latin America– Brazil weathered storm, but at what cost?

And how stable?• IN RECESSION• “HOPE” IS THAT REESTABLISHED

CONFIDENCE WILL ALLOW INTEREST RATES TO BE LOWERED, AND LOWERED INTEREST RATES WILL RESTORE GROWTH

• BUT EVEN LOWER INTEREST RATES WILL BE HIGH—8% OR MORE REAL

• GROWING CONCERN ABOUT LACK OF GROWTH STRATEGY

• AND FAILURE TO ADDRESS SOCIAL PROBLEMS

• WEAK ECONOMY WILL CONTINUE TO FORCE FISCAL STRINGENCY, GIVEN IMF PROGRAM

• WORSENED BY PECULIAR IMF ACCOUNTING DEFINITIONS, WHICH INHIBIT INVESTMENT IN STATE OWNED ENTERPRISES AND LAND REFORM

Burden of Debt

• While previous government did a great deal to consolidate the fiscal position—getting debts of states and localities under control—and made major strides in education—it left a major legacy of debt

• With debt GDP ratio of 60%, 8% real interest rates represents a huge redistribution of almost 5% of GDP from taxpayers to creditors, markedly reducing resources that can be spent on other government programs

Argentina on road to recovery, without the IMF

• Driven by exchange rate adjustments

• Leading to import substitution

• And some increases in exports

• Increasing interest by foreign investors

• IMF money would not, in any case, go to provide finance for real economy, only to repay IMF

Mexico also weak

• Reflected in Fox’s poor performance in election• Stalling of “reform program”• Which was not politically astute, and did not

address some of major problems– “Symbolic” reforms

• Growing disillusionment with NAFTA– Jobs lost as a result of competition from China and

weak U.S. economy– While subsidized U.S. agriculture hurting poorest

Mexicans

Free Trade of America’s

• Strong opposition in Latin America• Based on U.S. refusal to do anything about

agriculture• U.S. steel tariffs had large negative symbolic

effect– American hypocrisy– If US, richest country, with strong safety net, near full

employment, needs to resort to safeguards, argument for protectionism in developing countries even more compelling

• Even with free trade area, America uses non-tariff barriers (dumping, countervailing duties)– Principles of “fair trade” differ depending on

whether good is produced at home or abroad– If dumping laws were applied to American

firms, most would be judged to be dumping– Charges are made that if government lends

money at less than the usurious IMF interest rates (25%) it is subsidy.

Emerging Consensus

• No agreement is better than a bad agreement• Democratic processes tying hands of Brazil, India, and

others against signing an unfair agreement• But special interests in North will make it difficult for a fair

agreement to be agreed upon• And will try to continue to impose non-tariff issues into

trade agreement (TRIPS)• U.S. pursuing strategy of bilateral agreements, extracting

concessions from countries one-by-one– Growing worry that it undermines multilateral system– Growing concern about long term consequences for a fair global

trading regime

Latin America is Rootless

• Strategy of last dozen years has failed– Best student of Washington Consensus

policies– Growth just over half of what it was in pre-

reform decades of 50s, 60s, and 70s– With labor flexibility leading to more

unemployment and more informality (no job protections)

– And greater poverty

• Privatization record mixed• Opening up markets to short term capital

flows destabilizing—benefits in earlier period more than offset by costs later

• Would like to forge a new “social democratic model”

• But the past mistakes have left them without the resources and freedom to do so

China

• China has had robust growth

• Even through period of global financial crisis

• Based on use of sound macro-policies:

• Deficit spending to finance long term investment projects

• Remarkably successful efforts at restructuring SOE’s

Gaining confidence in new leadership

• Managed SARS epidemic– Will it return next winter?

• Initiated more intensive look at problems of the Northeast

• Continued concerns with Western provinces• Building on broad successes of previous

regimes—housing reforms, creation of securities markets, move to create competitive markets, address bad loan programs

• Has maintained confidence of the international financial community

• Even though it has not fully liberalized capital markets

• Access to WTO is seen as providing new opportunities

Continuing Worries

• Will there be excessively rapid growth—overheating– So far, little sign, at least as reflected in inflationary

pressures

• Massive problems associated with social insurance system– Can they be funded with proceeds from privatization

• Can bad debt problems really be managed?– Rapid growth makes handling such problems far

easier; reason that country has to maintain high growth

CHINA’S SUCCESS POSES PROBLEMS FOR THE GLOBAL

ECONOMY• CHINA HAS BECOME

MANUFACTURING POWERHOUSE

• WILL UNDERCUT MANY OTHER DEVELOPING COUNTRIES– PROBLEMS FACING MEXICO TODAY– THEY CAN FIND NICHES, ESPECIALLY IN

SERVICE SECTORS– BUT IT MAY NOT BE EASY

TENSIONS WITH AMERICA ALREADY ON THE RISE

• Exchange rate has contributed to China’s competitive advantage

• Widespread blame on China for U.S. trade deficit (as in earlier disputes with Japan)

• Real problem not China’s trade or exchange rate policy but U.S. macro-mismanagement

Will China’s position be sustainable?

• China concerned about its own stability

• low (competitive) exchange has been important for China’s growth and employment creation—important for political stability

• China is likely to use other instruments (e.g. VAT export rebates), as it did before

Could pressure against China and other Asian countries backfire

• Now they hold vast reserves in dollars, reflecting their trade surpluses

• But they are thinking of holding their reserves increasing in each others’ currencies

• Pace of change might accelerate with undue pressure

Korea

• Most impressive recovery from East Asia crisis

• Largely because they did not follow the directions of the IMF, e.g. bank and real restructuring

• But diversified their economy, both in structure and trade

Korea

• Increasing important trade relations with China– Figured out symbiotic relationship

• Shift from exclusive focus on exports to domestic market– Problems created by excessive issue of

domestic consumer credit

Russia

• Robust recovery after ruble devaluation– Showed IMF policies had restrained

growth potential– Based on import substitution– And luck of higher oil prices

• slower growth as effect of earlier devaluation wears off

Continuing Debate

• Optimists—newly established “rules of law” provide basis of new market economy

• Broader consensus—– Aftermath of mismanaged transition likely to

impede growth for some time• Lack of effective rule of law, good institutions• Manifested in Mafia capitalism• Huge inequality

Further Grounds of Pessimism

Country still mostly an oil (natural resource) country—deindustrialized

If oil prices fall, government’s budgetary position will be precarious

If oil prices rise, Dutch disease problems get worse, difficulties of creating jobs and broad based growth

INDIA

• Has had now almost twenty years of impressive growth (even before reforms of early 90s)

• Growth still somewhat dependent on the vagaries of the weather (agriculture)

• But increasingly strong service/IT sector• Most significant worry: high public deficits

(federal, state and local) 10% of GDP• Will more stringent immigration conditions in US

prove to be a boom for India?

Weak state of global economy

Consequences

• High level of global uncertainty

• Marked slowdown in capital flows to emerging markets

• And even in FDI

• There are normal restorative forces, they move slowly, government is not doing as much as it could

Economic globalization outpaced political globalization

• Rules, institutions governing globalization largely set by advanced industrial countries, special interests in those countries, for their own advantage– Inequitable: developing countries not only

have not reaped “fair share” of benefits, in some cases worse off

Economic globalization outpaced political globalization

Failure to address problems of global financial architecture– Still succession of crises, one after

another– Developing countries still have to bear risk– Bankruptcy reform moved into deep freeze

Economic globalization outpaced political globalization

• And new worries about those that countries that have been left by the side– In Africa, middle east– Bypassed by globalization– Growing poverty, despair– In Africa—devastation of AIDS

Economic globalization outpaced political globalization

• American unilateralism– Evidenced earlier in response to global

warming, strategic arms, international criminal court

• Yet to manage globalization well will require a multilateral approach

Economic globalization outpaced political globalization

• Impending breakdown of Doha round of trade negotiations?– Key role of agriculture for developing

countries– Intellectual property—drugs, biopiracy– New issues—competition, investment

Economic globalization outpaced political globalization

• New impediments to globalization– Iraq War did not solve problem of global

terrorism– New visa requirements and security

precautions– Backlash against globalization?

PROBLEMS POST WAR

• Iraq Reconstruction

• Challenge: Creating a viable market economy with – Large debt overhang– War destruction– Movement from socialism to a market

economy

PROBLEMS POST WAR

• Movement from socialism to a market economy– Badly managed elsewhere– Major advantage over Russia: existence of

entrepreneurial class– Major disadvantage: lack of human capital– Risks: American ideological approach, rapid

privatization• Low receipts to government• Asset stripping• Viewed as illegitimate

PROBLEMS POST WAR

• Debt overhang– U.S. position:

• Russia and France should foregive debts• Earlier contracts not “legitimate,” can be

abrogated• America has made its “contribution”: $80

Billion spent on war• But U.S.

– opposes systematic procedure for bank restructuring

– Elsewhere has insisted on contracts being honored

Debt overhang

– Fundamental questions raised• Should there be an international “rule of law”—

or should such questions be decided on an ad hoc basis?

• Odiose debts and illegitimate contracts: Are there principles which should guide such judgments, or should such questions be decided on an ad hoc basis?

• Lack of clear answers contributes to market uncertainty

NEW OPTIMISM

• Growing recognition of the importance of, need for, international rule of law

NEW OPTIMISM

• Growing recognition of the importance of, need for, international rule of law

NEW OPTIMISM

• Growing recognition of special problems confronting Africa

NEW OPTIMISM

• In many emerging markets, new popular leadership, trying to avoid extremes of earlier generations, a balance between government and the market