On the Road to Global Recovery, Are We There Yet?

Dr Anthony Stokes, Senior Lecturer in Economics

Australian Catholic University, Strathfield.

While the term 'Globalisation' has found common usage in recent years, only in the last four years has the term ‘Global Financial Crisis’ or ‘GFC’ become a common area of discussion in the news and the global economy. In the USA the downturn and subsequent problems became known as the ‘Great Recession’, a term that did not apply in Australia’s case. The aim of this paper is to look at the main aspects of Globalisation and the impacts of changes in the global economy in recent times and the challenges that they bring.

The Global Economy

The Global economy is the world economy. It is the economic activity going on in the world. It is the combined economic activity that takes place in each individual economy plus the activity between countries. It includes all production, trade, financial flows, investment, technology, labour and economic behaviour in nations and between nations.

Economists try to predict trends in the world economy by applying models that demonstrate how changes in certain economic variables or factors have affected the domestic or global economy previously. In our current economic environment these tools are becoming more limited. In the 21st Century the states of the domestic and global economy have been largely influenced by non-economic factors. These are factors that economists could not predict. These include terrorist attacks or the fear of such attacks, the outbreak and spread of the Severe Acute Respiratory Syndrome (SARS) virus, the bird flu and instability in the Middle East. These factors have had great influence on the state of the global economy in the last decade, and these, and similar events, will continue to do so into the future. In the last 5 years the main factors to impact on the global economy have been the GFC and even more recently the problems facing Greece and other members of the European Union with their National Debt. In the future these issues will probably be overcome and then the main issues that may impact on global growth will include the aging population in many industrial nations and the environmental consequences of rapid growth.

Since 2001 the global economy had steady growth until the onset of the Global Financial Crisis in the second half of 2008. While the global economy still managed to expand by 3.2% in 2008, it contracted by 0.5% in 2009. The situation was even worse in advanced economies with GDP growth falling to negative 3.4% in 2009. The Global Financial Crisis (GFC) developed into the worst global recession since the great depression of the 1930’s. There is however some light at the end of the tunnel. Despite high levels of unemployment in many countries and sovereign debt problems, especially in Europe, levels of economic growth increased in 2010 before economic uncertainty returned in 2011 (Figure 1). The IMF (2013) considers that the worst is over but risks still remain especially in Europe. The IMF (2013) reports that World GDP grew by 5.3% in 2010 but slowed to 4.0% in 2011. Projections by the IMF for 2012 and 2013 suggest that global growth will continue at 3.2%

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and 3.3% respectively. Growth in advanced economies recovered to 3.2% in 2010 but slowed to 1.6% in 2011. In 2012 growth in the advanced economies slowed to 1.2% and is expected to continue at that rate in 2013. The big improvers have been the emerging and developing economies with growth rates of 5.1% in 2012, headed by China and the ASEAN nations with growth rates of 7.8% and 6.1% respectively. However, as can be seen in Figure 2, the levels of Real GDP growth do vary considerably been countries. It is also important to remember that nations with growth rates below 2% are likely to have no improvement in their unemployment rates or face worsening levels of unemployment.

Figure 1 – Industrial Production, World Trade and Unemployment Levels (%)

Note: US = United States; EA = euro area; CIS = Commonwealth of Independent States; DA = developing Asia; EE = emerging Europe; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa.Source: IMF, World Economic Outlook, 2013.

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Figure 2 - Global Average Projected Real GDP Growth during 2013

Source: IMF, World Economic Outlook, 2013.

What sovereign debt issues are threatening the global recovery?

In many advanced economies, the public sector has high funding needs because of persistent budget deficits and the increased reliance on short-term debt financing in the early stages of the financial crisis. For 2011, Japan and the United States face the largest public debt rollovers of any advanced economy at 56% and 29% of GDP, respectively (Figure 3). The Euro area governments currently facing the highest market pressures need to cope with rollover rates above 15% of GDP. There are growing fears especially among a number of European Union members that certain countries have debt problems that may lead to defaulting of these loans. There is an estimated $3.9 trillion worth of debt owed by Portugal, Ireland, Italy, Greece and Spain to other European nations.

One of the main areas of concern is Greece. Greece has a large funding requirement for its National Debt, reflecting both its sizeable budget deficit (12.7% of GDP in 2012) and a need to refinance large volumes of maturing debt (outstanding net debt in 2012 was 160% of GDP). Ireland and Portugal are in a similar situation and this has heightened the fear of a nation or nations defaulting on their debt payments. The issue facing these European nations is that the growth in debt and the level of funds required to finance the debt is much larger as a percentage of GDP than the USA or Japan (Figure 4). On 2 May 2010, the Euro zone countries and the International Monetary Fund agreed to a €110 billion1 loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a €85 billion rescue package for Ireland in November, and a €78 billion bail-out for Portugal in May 2011. In 2012 Cyprus joined the list of European nations creating concerns for global growth and financial stability.

1 There is approximately $1.28 US to 1 Euro (2013).

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Figure 3 – Government Funding Needs as a Percentage of 2011 GDP

Source: IMF, Global Financial Stability Report, 2011.

Figure 4 - The Higher Costs of Funding the Governments’ Debts (in percent)

Source: IMF, Global Financial Stability Report, 2011.

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At the start of 2012, Greece was facing sovereign default and in need of more funds from the IMF and EU. On 10th February 2012, the Greek cabinet approved the draft bill of a new austerity plan, which has been calculated to improve the 2012 budget deficit by €3.3 billion (with a further €10 billion improvement scheduled for 2013 and 2014). The austerity plan includes:

22% cut in minimum wage from the current €750 per month. Holiday wage bonuses (two extra months of full wage being paid each year) are

permanently cancelled. 150,000 jobs cut from state sector by 2015, of which 15,000 shall be cut by the end

of 2012. Pension cuts worth €300 million in 2012. Changes to laws to make it easier to lay off workers. Health and defence spending cuts. Industry sectors are given the right to negotiate lower wages depending on

economic development. Opening up closed professions to allow for more competition, particularly in the

health, tourism, and real estate sectors. Privatisations worth €15 billion by 2015, including Greek gas companies DEPA and

DESFA. In the medium term, the goal remains at €50 billion.

The uncertainty of a Greek default still remains. Despite these rescue packages there is still no guarantee that these nations or other nations in Europe will not renege on their debt and send the global economy back into recession.

The Fiscal Cliff and Sequester in the USA

In 2012 another concern rose in the USA in regards to their fiscal policies and plans to reduce the budget deficit. This became known as the ‘Fiscal Cliff’. The ‘Fiscal Cliff’ was the sharp decline in the budget deficit, which could have occurred at the start of 2013, due to increased taxes and reduced spending as required by previously enacted laws in the USA. The US Government had agreed to temporary tax cuts and increases in spending that were designed to stimulate the economy during the GFC. Among the changes that were set to take place at midnight on December 31, 2012 were the end of temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would increase taxes, a rollback of the ‘Bush tax cuts’ from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 - a total of $1.2 trillion over ten years - were scheduled to take effect (Kenny 2013).

The impact of abiding by the previous decisions made during the GFC would have been higher unemployment and a likely recession. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the Congressional Budget Office also estimated that the policy would have reduced Gross Domestic Product (GDP) by 4 percentage points in 2013, sending the economy into a recession. At the same

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time, it predicted that unemployment would rise by almost a full percentage point, with a loss of about two million jobs.

The USA has a sovereign debt of $16.4 trillion. Both the large debt and the possibility of the ‘Fiscal Cliff’ pushing the USA and the global economy back into recession created low confidence and economic uncertainty. While the decision to not go ahead with many of the tax increases and cuts to spending temporarily averted the ‘Fiscal Cliff’ at the beginning of 2013 the underlying problem remains.

The new term that will consider the level of spending cuts that will take place in the USA is known as the ‘Sequester’. The ‘Sequester’ is the $1.2 trillion in spending cuts that Congress agreed to in the Budget Control Act of August 2011 in order to limit excessive spending by the Obama Government. The Republicans required the scheduled cuts in exchange for raising the debt ceiling. These cuts involve $600 billion each in both defense and discretionary spending, and are scheduled to last from this year through to 2021. This year, the impact would be about $1.2 billion if the entire sequestration kicks in. Now, Congress can let the ‘Sequester’ go into effect as scheduled or come up with a new budget deal to address the deficit via more targeted spending cuts (Kenny 2013). Either way, this again creates economic uncertainty in both the US and global economies. The impact of this ongoing uncertainty has been a decline in the value of the US dollar in comparison to many nations, including Australia.

How well is the global economy recovering from the Global Financial Crisis and dealing with the sovereign debt problems?

In examining the recovery from the Global Financial Crisis, three key areas will be considered:

Trade Investment, and Finance.

1. The State of Global Trade

The growth in global trade is generally more than double the level of world GDP growth. The growth in export volumes in advanced economies averaged 5.2% per annum from 2000-2008 compared to 9.3% for emerging and developing economies. The impact of the Global Financial Crisis was to reduce export volumes in advanced economies by 12.2% and emerging and developing countries by 8.3% in 2009. While this may suggest that the poorer countries were not as adversely affected by the Global Financial Crisis, they are actually less able to deal with such a crisis because of their poor financial positions. It also reflects the fact that world trade is dominated by the advanced economies. The IMF (2006) found that the richest 15% of nations had 70% of the goods and services exported in the world in 2005. This compared to less than 4% for the poorest 30% of nations. This dominance by the richer industrial nations also tells us that if demand in the industrial economies is slow, so will be the level of world trade growth. There is some evidence that the direction of trade is changing. Higher prices for primary commodities and the

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extraordinary growth of trade in developing Asia helped boost the combined share of developing economies and the Commonwealth of Independent States (CIS) in world exports to 45% in 2010 (IMF 2011). However the poorest nations are still missing out with the Least Developed Countries having only 1% of world exports.

In 2010 world trade did recover with a growth in trade volumes of 13.8% and an increase in commodity prices of 26% (Figure 1). In 2012, world trade slowed with exports from advanced economies growing just 1% while the emerging and developing economies increased 3.7%. The outlook for world trade worsened in the period 2011-12 as the Euro sovereign debt crisis undermined global growth. There are signs, however, of improvement as world trade volumes are expected to grow 3.6% in 2013 (WTO, 2013).

2. International Investment

This relates to investment by Transnational Corporations (TNCs). This is also known as International Direct Investment (IDI) or Foreign Direct Investment (FDI). Now there are approximately 82,000 transnational corporations (TNCs) throughout the world with over 810,000 foreign affiliates. The global TNCs are dominated by firms from the USA, Japan and the European Union, the home bases of 85% of the top 100 TNCs.

The level of FDI flows rose from 44 billion dollars US in 1985 to over 1941 billion dollars US in 2008. Up till 2008, the areas of greatest new investment have been into the emerging markets in Asia, South America and the countries of the former USSR. In 2007, FDI grew by 70% in Russia and by 50% in the Latin American Countries. This has occurred due to their relatively low wage rates and growing economies.

In 2008, as a result of the Global Financial Crisis, there was a turnaround in this trend with Global Foreign Direct Investment falling 15% (Figure 5.) Despite two years of downturn, by the end of 2011, FDI inflows increased in all major economic groupings − developed, developing and transition economies (Figure 6). Developing and transition economies continued to account for half of global FDI in 2011 as their inflows reached a new record high, at an estimated US$755 billion.

Unfortunately the improvement did not continue. Global Foreign Direct Investment (FDI) inflows declined by 18% in 2012, to an estimated US$1.3 trillion (Figure 5) – a level close to the trough reached in 2009 – due mainly to macroeconomic fragility and policy uncertainty for investors.

The decline in FDI in 2012 mainly impacted the advanced economies (Figure 6). FDI flows to developing economies remained relatively resilient in 2012, reaching US$680 billion, the second highest level ever recorded. Developing economies absorbed an unprecedented US$130 billion more than developed countries (UNCTAD 2013).

Figure 5 - Investment Trends in the Global Economy

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Figure 6 - Global FDI Inflows 2000-12

Figure 7 – FDI Inflows to Developing and Transition Economies 2008-12

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3. International Financial Flows

International financial flows have grown most rapidly of all, at 10 times the rate of World GDP. Since the phasing out of controls on foreign exchange trading in the 1970’s, international financial flows have grown exponentially. In 1980 global foreign exchange trading was 10 times the value of world trade. Foreign exchange trading is now estimated to be more than 100 times the value of world trade and growing. The level and direction of international financial flows are now the main determinants of the value of most nations' exchange rates. Trade in goods and services has little impact on the exchange rate today, except perhaps as a psychological influence on the behaviour of international financial traders.

Financial flows take many forms. The fastest growing area has involved interest rate, credit, currency, equity, and commodity derivatives. Interest rate, credit and currency derivatives make up over 90% of the total value of derivatives traded, see Figure 8. The turnover in the derivatives markets is now much larger than the cash markets. Only 1% of the foreign exchange market involves payments for trade. Most of it involves forms of derivatives trading.

What are Derivatives?

Derivates are simple financial contracts whose value is linked to or derived from an underlying asset, such as stocks, bonds, commodities, loans, and exchange rates. They are international financial instruments for spreading risk or hedging.

They include: futures, options,

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swaps, forward rate agreements and other hedging instruments, include issuing debt securities and undertaking

repurchases.

An important point to note is the amount of foreign exchange traded in one day is greater than all the reserves of the world’s Central Banks. This severely limits the ability of Central Banks to influence the flow of finance in the global economy and thus the impact these flows can have on a nation's exchange rate, as was seen in the Asian currency crisis in 1997. The amazing rate of growth in the financial flows, and as a result their ability to impact on the global economy, can be seen in Figure 8. The total estimated notional amount of outstanding derivative contracts stood at $595 trillion at the end of December 2007, a rise of over 40% during the year. The Global Financial Crisis led to a decline in the volume of derivatives traded and for the first time there was actually a decline in the annual volume of trading so that contracts fell to $593 trillion at the end of 2008. This fell further in 2009 to be only $444 trillion in the middle of the year but recovered to $603 trillion by the end of the year. In 2011 derivative trading increased in the first half of the year to reach $707 trillion but slumped to $648 trillion by the end of 2011, as a result of falling consumer and investment confidence as a consequence of the EURO Zone sovereign debt issues. In 2012 derivative trading declined further to $632 trillion in the second half of the year.

Figure 8 - The Growth of Derivatives ($ Billions)

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2011 20120

100000

200000

300000

400000

500000

600000

700000

Source: BIS, Annual Reports (various)

Trading in interest rate, equity and foreign exchange contracts all declined during the GFC but recovered to the previous levels and remained stable during 2009-2010 (Figure 9). The experience of the GFC has shown that the markets are less inclined to take risks in the face of unstable and declining financial and economic conditions and that they limit their trading activities as a result. Concerns about sovereign debt in 2011 and 2012 have again taken

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confidence from the market. In 2012 the main forms of derivatives traded were interest rate contracts (77%), foreign exchange contracts (12%) and credit default swaps (CDS) (4%).

Figure 9 - Global Derivatives Traded

Source: BIS, Annual Reports (2013)

Conclusion

The Global Financial Crisis in the period 2008-09 led to falling share markets, and instability in financial and foreign exchange markets. This uncertainty discouraged investment and spending leading to falling economic growth rates and rising unemployment levels. Foreign Direct Investment declined and finance was more difficult to get for consumers and businesses.

There are signs however that the stimulus packages put in place by most governments and the low levels of interest rates are encouraging spending and most economies are recovering from the GFC. Recovery has been slow in some regions especially the European Union and economic growth levels are unlikely to contribute to improvements in unemployment in many of the most affected countries till 2014. However, concerns about sovereign debt in Europe, accompanied by political instability, may further slow the recovery.

While the market driven nature of globalisation does tend to provide benefits in the long term, it also has its flaws. There will always tend to be periods of financial instability and in these periods there is a need for greater government intervention in the economy. In

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between these periods there may also be a need to look at the current operation of financial markets to prevent or reduce the likelihood or magnitude of such occurrences in the future.

References

Bank for International Settlement (BIS) (various years), Annual Report, various, Basle, Switzerland, BIS.

International Monetary Fund (2011), Global Financial Stability Report, available at http://www.imf.org/

International Monetary Fund (2011-13), World Economic Outlook, available at http://www.imf.org/

Kenny, T. (2013), About.com, available at http://bonds.about.com/b/2013/01/29/the-sequester-explained.htm and http://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htm

Reserve Bank of Australia (various years), Reserve Bank of Australia Bulletin, Sydney, RBA.

Stokes, A. (2012), Where is the Global Economy Heading? available athttp://homepages.ihug.com.au/~gep/The%20global%20economy(2012).pdf

The United Nations Conference on Trade and Development (UNCTAD) (2013), Global Investment Trends Monitor January, 2013, available at http://unctad.org/en/PublicationsLibrary/webdiaeia2013d1_en.pdf

The United Nations Conference on Trade and Development (UNCTAD) (2010), World Investment Report 2010, available at http://www.unctad.org/templates/webflyer.asp?docid=13423&intItemID=5539&lang=1&mode=downloads

The United Nations Conference on Trade and Development (UNCTAD) (2010), Assessing the Impact of the Current Financial and Economic Crisis on Global FDI Flows, available at http://www.unctad.org/en/docs//diaeia20093_en.pdf

Internet Resources

Bank for International Settlement (BIS), http://www.bis.org

Greenacre Educational Publications, http://homepages.ihug.com.au/~gep/economics.htm

International Monetary Fund, http://www.imf.org/

Organisation for Economic Co-operation and Development, http://www.oecd.org/

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The Human Development Report, http://www.undp.org/hdro/

The World Bank Group, http://www.worldbank.org/

The World Trade Organisation, http://www.wto.org/

The United Nations Conference on Trade and Development (UNCTAD), http://www.unctad.org/

FREE HSC REVISION DAY

ACU’s Economics lecturers at Strathfield are providing a FREE revision program for HSC Economics students on Tuesday 9 July.

Students do need to register on line at www.acu.edu.au and click on University Experience or go to

www.acu.edu.au/universityexperience

You will receive:

A lecture on : The Current State of the Australian Economy

Question and answer revision of HSC economics topics

Information on ACU’s Bachelor of Arts and Economics degree

There are limited spaces so book early.

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