Prof. Ángel Pascual-RamsayDirector, Global Risks, ESADEgeo

Department of Strategy and General Management, ESADE Business SchoolNon-Resident Senior Fellow, The Brookings Institution

Global Economic Risks and Geoeconomics:Applications to Europe and its Businesses

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Why Do Economies Grow Rapidly?

• New VUCA (volatility, uncertainty, complexity, and ambiguity) context

• 12 Key global economic and geoeconomic trends

• Rodrik’s Trilemma

• Global economic and geoeconomic risks

• Recommendations for EU businesses

• Writing exercise on today’s lesson

• Conclusion

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Lesson Road Map

VolatilityUncertaintyComplexityAmbiguity

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New VUCA Context

Source: Bennett and Lemoine

• Global growth– 2015 (projected): 3.1% (IMF WEO Oct 2015)

– 2000-2010: 3.7%

• Now, mainly up to the BRICS

• Deteriorating outlook for emerging economies

• Improved outlook for developed economies– Benefiting from low oil prices– But, still vulnerable (quantitative easing, low

quality employment, etc.) 5

Context: Global Economic Landscape

1. Economic axis shifting back to the Pacific

2. Slowdown in emerging economies

3. Increasing role of emerging and frontier markets

4. Secular stagnation

5. Deflation

6. Drop in oil prices

7. Quantitative easing and possible risk of price effects

8. World financial system remains vulnerable

9. On-going euro crisis

10. Structural unemployment

11. Rise of state capitalism

12. Retrenching globalization

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12 Key Global Economic and Geoeconomic Trends

The world economy’s center of gravity is shifting back to the Pacific at the fastest rate in history (“Return to 1820”)

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1. Economic axis shifting back to the Pacific

World's largest economy (PPP) 1000: India 1500: China 1600: China 1700: India 1820: China 1870: China 1913: US 2003: US 2014: China

It’s all about China…

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2. Slowdown in emerging economies (1/2)

• Decreasing growth– 7% first three months of 2015

• Transition to a new economic model– Consumption vs. investment– Services vs. manufacturing– Domestic demand vs. exports

• Risks – Real estate bubble– Credit boom and bad loans– Unemployment– Social unrest

2. Slowdown in emerging economies (2/2)

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…and China is slowing down

3. Increasing role of emerging and frontier markets (1/3)

• Tapering: gradual withdrawal of Fed injections of liquidity

• Less capital available to finance investment & growth

• Risk of sudden stoppage

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3. Increasing role of emerging and frontier markets (2/3)

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• Currency & price volatility

• Slow-down in convergence

• End to the factors fueling emerging economies’ growth:– High prices of raw materials – Low interest rates – External funding

3. Increasing role of emerging and frontier markets (3/3)

• Brazil facing serious slowdown

• Domestic factors also behind slowdown in Chile, Colombia and others

• Venezuela and Argentina are particularly vulnerable

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Example: Latin America

– Venezuela: • Hyperinflation• Price controls• Consumer supplies drying up• Drop in GDP

– Argentina: • 26% inflation• Weak national

currency and dollar convertibility

• Low currency reserves Source: The Economist

• “Secular stagnation hypothesis”—sustained lower levels of output

• The new abnormal: EU & Japan

• High public/private debt

• Adverse demography

• Decreasing productivity

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4. Secular stagnation

Source: Eurostat

• Deflationary tendencies

• Structural unemployment in Southern Europe

• Deflationary spirals are very dangerous; they lead to postponement of investments, and make debt-servicing harder.

• Prices are falling or flat in Greece, Spain, UK, Ireland, and Portugal

• ECB task: keep prices stable ("inflation rates below but close to 2%”), not stimulate growth (in theory…)

• Inflation in “Euro Land” is around 0.7% but little political support for higher

• Clashing interests– Core: wants low inflation and strong Euro– Periphery: wants higher inflation and weak

Euro

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5. Deflation

Source: Financial Times

• Structural or cyclical?– Excess supply: fracking, but also Iraq, Iran, etc.

– Weak demand: China slowdown

– Geopolitics: Saudi Arabia vs. Iran, US vs. Venezuela, etc.

– Competitive dynamics

– Trading & speculation

• Good or bad?– Growth stimulus vs. deflation

– Excessive supply vs. weak demand

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6. Drop in oil prices

• German 10-year bond yield below ZERO

• Eurozone economy grew 0.4% in Q1 2015

• Asset price bubbles; EU stocks at 15-year high

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7. Quantitative easing and possible risk of price effects

Source: BBC

• Shadow banking• Credit boom and asset price

bubbles • Regulatory uncertainty• International liquidity crises:

sudden stops and capital outflows• Systemic financial crises• Stock market volatility and crashes

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8. World financial system remains vulnerable

• Unsustainable debt & meager growth prospects in Southern Europe

• EMU design flaws: Monetary union, but no fiscal union, no lender of last resort

• Risk of disorganized Grexit and contagion

• Austerity programs socially untenable. Democratic deficit of EU institutions. ‘Emptying’ of democracy. Return of nationalism.

• Risk of EMU fracturing, through capital flight, unorderly sovereign defaults (Grexit), voluntary/forced Eurozone exit, etc.

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9. On-going euro crisis (1/2)

• Two key geopolitical events behind the Euro’s current predicament:

• Beginning of reforms in China• Growth and amassing of savings in emerging economies

• Fall of Berlin wall• German re-unification, D-mark parity, recession, low interest rates in

Eurozone19

9. On-going euro crisis (2/2)

Why geopolitics matters

Employment in US manufacturing industry (blue) vs Production (red)

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10. Structural unemployment (1/2)

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10. Structural unemployment (2/2)

Source: The Economist

Market Value of State-owned Enterprises as a % of GDP (2011)

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11. Rise of state capitalism

Source: OECD

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12. Retrenching globalization

• Fragmentation in international trade and finance

• Dysfunctional global governance (UN, G20, WTO)

• Greater difficulty in reaching truly global agreements– Regional trade agreements (TPP, TTIP), new regional institutions (AIIB, etc.)– Alternative institutions and mediums of exchange (Yuan)– Increasing diversity in economic models

EU-US and BRICS share of world economy

2014 2019

EU+US 33.3% 30.7%

BRICS 30.1% 32.7%

EU and Developing Asia share of world economy

1980 2014

EU 30.9% 18.4%

Developing Asia 7.54% 26.8%

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Group Reactions to Key Global EconomicAnd Geoeconomic Trends

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Rodrik’s Trilemma

Deep economic integration

Nation state Democratic politics

Global FederalismGolden Straitjacket

Bretton Woods compromise

Choose any two…but only two

Source: Dani Rodrik. ‘The Globalization Paradox’

1. Macroeconomic risks

2. Financial risks

3. Governance risks

4. Geoeconomic risks

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Global Economic and Geoeconomic Risks

• Global macroeconomic imbalances

• Global growth slowdown

• Global economic and regional recessions and crises

• Contagion of national imbalances: recessions, fiscal deficits, inflation, deflation, etc.

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1. Macroeconomic Risks

Source: voxukraine

• System financial crises

• Shadow banking

• Credit bubble contagion

• International liquidity crisis: sudden stops and capital outflows

• Stock market volatility and crashes

• Currency wars28

2. Financial Risks

• Global economic governance shortcomings. Lack of institutional capacity.

• Divergence between US, Japanese, and EU policies

• Excessive dependence on Central Banks

• International competition and new technologies lead to low tax-gathering capabilities

• Incorporation of emerging markets in global institutions

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3. Governance Risks

• Companies aligned with the interests of their states: diplomatic ambitions, supply of raw materials, local job-creation, infrastructure, positioning on key trade routes, etc.

• Sovereign wealth funds buying critical infrastructures in foreign countries (ex. Huawey)

• Use of SWFs investment as a tool of foreign policy interference

• Companies faced with “unfair” competition by state-sponsored rivals

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4. Geoeconomic Risks

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Recommendations for EU Businesses

3. Rethink human resource strategies to attract multicultural, flexible, and adaptable human capital

1. Boost the internationalization of European businesses

2. Promote multi-localization (combining outsourcing and market access) and SME collaboration

4. Focus on emerging social groups and new consumption patterns

Two-minute Paper

Please write for 2 minutes about what you have learned in today’s session and why the information is important for EU businesses.

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Conclusion

Questions?

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This powerpoint presentation and the matching teaching plan were developed as a part of the Jean Monnet project MEKBiz (Mainstreaming EU Knowledge in Business Studies and Strategy), hosted by ESADEgeo – Center for Global Economy and Geopolitics and partially funded by the European Commission.

“The European Commission support for the production of this publication does not constitute an endorsement of the contents which reflects the views only of the authors, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”