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Global Economic Prospects, Risks and
Challenges for EuropeRobert F. Wescott, Ph.D.
SACEMilan
18 November 2005
2
Perceived Global Investment Risk
-80
-60
-40
-20
0
20
40
60
Canada UnitedStates
Japan WesternEurope
China EasternEurope
OtherAsia
LatinAmerica
Russia Africa MiddleEast
1998 2005
Source: UBS Index of Investor Optimism, August 2005
Percent rating the region “low risk”
minus percent rating it “high risk”
3
Economic Policy Floodgates Closing
-5
-4
-3
-2
-1
0
1
2
-5 -4 -3 -2 -1 0 1 2
2000-2004
2004-2005
US
Canada
Germany
US
Italy
Euro AreaGermanyFrance
UK
Euro Area
FranceItaly
JapanUK
Japan
Canada
Tighter Fiscal PolicyEasier Fiscal Policy
% change in real six month LIBOR
Change in structural f iscal balance as a % of GDP
China
China
Tighter Monetary Policy
Easier Monetary Policy
Source: IMF WEO, Author’s calculations for China
4
Oil: A Growing Burden on the World Economy
World Oil Expenditure as Percent of World GDP
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%Global Recession
Trigger Level?
Source: EIA, IMF WEO
5
Investors Concerned about Energy
0%
10%
20%
30%
40%
50%
60%
Great deal Moderateamount
Only a little Not at all
Percent giving each answer to the question, “how much are energy prices hurting the U.S. investment climate?”
Source: UBS Survey of Investor Optimism, Sept. 19, 2005
6
The Oil Price Pass-Through to Inflation is Falling
Percent change in CPI and core CPI divided by percent change in RAC of oil (during periods of 30%+ increases in oil prices)
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.1
1970s 2000s1990s1980s
CPI
Core CPI
CPICPI
CPI
Core CPI
Core CPI
Core CPI
Source: Bureau of Labor Statistics and Energy Information Agency
7
Why Isn’t the Dow at 12,800?(because of energy prices)
Change in DJIA when Corporate Profits are up 30% or More (Y/Y)
21.9
-3.3
0.8
31.1
-15.1
6.1
27.7
36.036.0
-20
-10
0
10
20
30
40
2000s1950s-1990s
Average:-4.5%
Average: 21.5%
Source: Bureau of Economic Analysis, Yahoo! Finance
8
Housing Prices Rising Worldwide
-75 0 75 150 225 300
Hong KongJapan
GermanySwitzerland
SwedenCanadaFrance
DenmarkBelgium
N. ZealandItalyU.S.
NetherlandsAustralia
BritainSpain
IrelandS. Africa
Percent Change, 1997-2005
Source: The Economist
9
Potential Impact of a Housing Crunch on GDPAssumed Price
DropAssumed Effect
on Real GDP
U.K. 9% -0.7%
Spain 8% -0.4%
Australia 7% -0.3%
France 6% -0.4%
Italy 5% -0.4%
U.S. 5% -0.3%
Canada 2.5% -0.4%
World N/A -0.3%
Source: Global Insight
10
Can Disequilibrium Continue? (China produces, the U.S. consumes?)
Current Account Balance (percent of GDP)
-8
-6
-4
-2
0
2
4
6
8
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Source: IMF WEO
11
Historically, Rising Interest Rates Add Financial Pressures
Monthly Fed Funds Rate
0
2
4
6
8
10
12
14
16
18
20
???
Black Monday
Continental Illinois Bank
Franklin National Bank
S&L Crisis
Penn Central Railroad
Latin American Crisis
High Tech Bubble
Mexican Crisis
Source: Federal Reserve
12
13
China’s Trend Has Been Sharply UpwardShare of World Economy, PPP Basis
0
5
10
15
20
25
30
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
pe
rce
nta
ge
Source: IMF
14
The Euro Area’s Unemployment Rate Exceeds
that of the Rest of the Industrialized World
Source: OECD, Standardized Unemployment Rates *South Korea 2000-2005
5.2%
9.5%
6.7%
3.8% 4.1%
0%1%2%3%4%5%6%7%8%9%
10%
U.S Euro Area U.K. SouthKorea*
Japan
Average Unemployment Rate, 1993-2005
15
Europe Lags the U.S. in Productivity
Eurozone 0.7%
Italy -0.3%
Germany 0.7%
France 1.3%
U.K. 1.8%
Japan 1.9%
Canada 0.7%
U.S. 3.5%
Average percent change in labor productivity, 2002-2004
Source: OECD
16
High Tech Manufactures: Asia Rising, Europe Declining
Source: National Science Foundation, “Science and Engineering Indicators 2004”
Share of World Production of High-Tech Goods
0%
5%
10%
15%
20%
25%
30%
35%
US Germany France U.K. Italy Japan China SouthKorea
India
1980 1990 2001
17
Greenspan’s Medicine Would Help Europe(Real short-term interest rates)
-2
-1
0
1
2
3
4
5
6
7
I 1
990
I 1
991
I 1
992
I 1
993
I 1
994
I 1
995
I 1
996
I 1
997
I 1
998
I 1
999
I 2
000
I 200
1
I 200
2
I 200
3
I 200
4
I 200
5
Fed funds / ECB policy rate deflated by “core” CPI inflation
EU real interest rate
US real interest rate
EU real interest rate
Sources: Federal Reserve, Bureau of Labor Statistics, European Central Bank, European Commission
18
Cross Country R & D Spending
0%
1%
2%
3%
Japan U.S
.
S. Kor
ea
Germ
any
OECD
Franc
eE.U
.U.K
.Ita
ly
Source: National Science Foundation, Science and Engineering Indicators 2004
Percent of GDP, 2000 (latest available year)
19
Percentage of 18-24 Year Olds in Science and Engineering Programs
0%
1%2%
3%4%
5%6%
7%8%
9%10%
U.K.
S. Kor
ea
France
Japan
Germ
any
U.S.
Italy
China
Source: National Science Foundation, Science and Engineering Indicators 2002