The shift and the shocks: prospects for the world economyMartin Wolf, Associate Editor & Chief Economics Commentator, Financial Times

Oxonia

15th February 2012

Oxford

2

The shift and the shocks

3

The shift and the shocks

• Shift

• Shocks

• Prospects

4

1. The shift

• In the 19th century, there occurred what Kenneth Pomeranz called the “great divergence”

• In the second half of the 20th century, convergence began, with Japan and the east Asian “tiger economies”

• In the late 20th and early 21st centuries convergence spread to Asian giants

• Today’s divergent growth is a mirror image of converging incomes

5

1. The shift

EMERGING COUNTRIES OUTPERFORM HUGELY

GDP SINCE THE CRISIS

90

100

110

120

130

140

150

160

170

2007 2008 2009 2010 2011 2012

Advanced economies Latin America and the CaribbeanSub-Saharan Africa ChinaIndia Central and eastern EuropeDeveloping Asia

Source: IMF, WEO database

6

1. The shift

EMERGING COUNTRIES OUTPERFORM HUGELY

GDP GROWTH RATES IN THE WORLD ECONOMY(10-year moving average, end year)

012345

678

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

World Advanced economies Emerging and developing economies

Source: IMF WEO, September 2011

7

1. The shift

UNEVEN PACE OF CATCH-UP GROWTH

GDP PER HEAD AS A SHARE OF US GDP PER HEAD (at PPP)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

Brazil China India Indonesia Mexico Russia Turkey

ForecastSource: IMF, WEO database, October 2011

8

1. The shift

• Risks to the great convergence:

– In the long run, it is hard to believe that the catch-up process will not continue, provided the world avoids huge shocks;

– But it is not going to be smooth, as we can see from past performance;

– China is exposed to excessive reliance on investment, high dependence on exports and property bubbles;

– If China slowed substantially, the impact on commodity exporters could be substantial;

– But China still has a big catch-up potential

9

1. The shift

• The “great convergence” has had powerful consequences:

– An ongoing “labour-supply shock”, which lowered relative wages of the relatively unskilled in high-income countries;

– Initially, a dis-inflationary shock, as China lowered world prices for manufactures;

– Then an inflationary shock, as demand for raw materials soared;

– An increase in the surplus of desired savings and so the rise of the global imbalances;

– and throughout, an ongoing shift in global economic activity

10

2. The shift

REAL INTEREST RATES

-1

0

1

2

3

4

5

6

Jan-1985 Jan-1987 Jan-1989 Jan-1991 Jan-1993 Jan-1995 Jan-1997 Jan-1999 Jan-2001 Jan-2003 Jan-2005 Jan-2007 Jan-2009 Jan-2011

UK INDEX-LINKED US TIPS

Asian financial crisis

Western financial crisis

THE SAVINGS GLUT?

11

1. The shift

RISE OF IMBALANCES

GLOBAL CURRENT ACCOUNT IMBALANCES(as per cent of world GDP)

-3

-2

-1

0

1

2

3

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Germany and Japan China and emerging Asia Peripheral Europe Rest of World Oil Exporters US

Source: WEO, October 2011

12

1. The shift

RISE OF FOREIGN CURRENCY RESERVES

GLOBAL FOREIGN CURRENCY RESERVES ($bn)

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

China Rest of developing Asia Rest of developing countries Industrial countries

13

2. The shocks

• The economic collapse was large and enduring

• The rescue was also dramatic:

– Liabilities of the core financial system were nationalised;

– Fiscal policy was put on a war-time footing; and

– Monetary policy has remained unprecedented;

• This then is a “contained depression”.

• According to Carmen Reinhart and Kenneth Rogoff, This Time is Different, it could take three years, to return to “normality”. But, given the scale of affected economies, it could be longer.

14

2. The shocks: global

THE LEVERAGE CYCLE

HOUSEHOLD DEBT(over disposable income)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

UK Canada US Japan Germany France Italy

2000 2007 2009 2010

Source: OECD

15

2. The shocks: global

THE US LEVERAGE CYCLE

SECTORAL RATIOS OF US DEBT TO GDP

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Households Non-financial Business All Government Financial Sectors

16

2. The shocks: global

THE LONG SLUMPGDP IN THE GREAT RECESSION

90.0

92.0

94.0

96.0

98.0

100.0

102.0

104.0

Q12008

Q22008

Q32008

Q42008

Q12009

Q22009

Q32009

Q42009

Q12010

Q22010

Q32010

Q42010

Q12011

Q22011

Q32011

US UK CANADA JAPAN ITALY FRANCE GERMANY

17

2. The shocks: global

THE SOVEREIGN DEBT IMPACT

NET PUBLIC DEBT OVER GDP (per cent)

0

20

40

60

80

100

120

140

160

180

Japan Italy United States France United Kingdom Germany Canada

2006

2009

2012

2015

Source: IMF WEO, October 2011

18

2. The shocks: global

FISCAL ROOM? YES, FOR SOME, NOT ALL10-YEAR GOVERNMENT BOND YIELDS

(percentage points)

0

1

2

3

4

5

6

7

8

01

/01

/20

08

01

/03

/20

08

01

/05

/20

08

01

/07

/20

08

01

/09

/20

08

01

/11

/20

08

01

/01

/20

09

01

/03

/20

09

01

/05

/20

09

01

/07

/20

09

01

/09

/20

09

01

/11

/20

09

01

/01

/20

10

01

/03

/20

10

01

/05

/20

10

01

/07

/20

10

01

/09

/20

10

01

/11

/20

10

01

/01

/20

11

01

/03

/20

11

01

/05

/20

11

01

/07

/20

11

01

/09

/20

11

01

/11

/20

11

01

/01

/20

12

Germany France UK US Japan Canada Italy Spain

19

2. The shocks - eurozone

• The eurozone crisis is the world, in miniature

• The core of the eurozone financial crisis is not a fiscal crisis

• It is the interaction of balance of payments with financial crises, though huge debt stocks played a part in creating liquidity problems for sovereigns

20

2. The shocks - eurozone

• The difficulty is largely the result of the divergences accumulated in the years of excess: what made everything seem so good was creating an acute long-term crisis

• The failure of a true union stands revealed: neither financing in a crisis nor workable adjustment mechanisms

• Everything invented on the fly – too little, too confused, too late

• The crisis is possibly terminal

21

2. The shocks - eurozone

THE GOOD, THE BAD AND THE UGLY

CURRENT ACCOUNT IMBALANCES IN THE EUROZONE(per cent of Eurozone GDP)

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Germany Netherlands France Italy Spain Portugal & Greece Rest Eurozone

Source: IMF, World Economic Outlook database, April 2011

22

2. The shocks - eurozone

LOST COMPETITIVENESSUNIT LABOUR COSTS IN MANUFACTURING

RELATIVE TO GERMANY

60

80

100

120

140

160

180

200

Q1-1999

Q1-2000

Q1-2001

Q1-2002

Q1-2003

Q1-2004

Q1-2005

Q1-2006

Q1-2007

Q1-2008

Q1-2009

Q1-2010

Q1-2011

Portugal Italy Ireland Greece Spain

Source: OECD

23

2. The shocks - eurozone

ROAD TO THE EUROZONE FISCAL CRISES

NET PUBLIC DEBT(relative to GDP)

0

20

40

60

80

100

120

140

160

180

Greece Italy Portugal Ireland Spain

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2015

Source: World Economic Outlook database April 2011

24

2. The shocks - eurozone

ROAD TO THE EUROZONE FISCAL CRISES

10-YEAR GOVERNMENT BOND SPREADS OVER BUNDS(percentage points)

-5

0

5

10

15

20

25

30

35

40

01

/01

/20

07

01

/03

/20

07

01

/05

/20

07

01

/07

/20

07

01

/09

/20

07

01

/11

/20

07

01

/01

/20

08

01

/03

/20

08

01

/05

/20

08

01

/07

/20

08

01

/09

/20

08

01

/11

/20

08

01

/01

/20

09

01

/03

/20

09

01

/05

/20

09

01

/07

/20

09

01

/09

/20

09

01

/11

/20

09

01

/01

/20

10

01

/03

/20

10

01

/05

/20

10

01

/07

/20

10

01

/09

/20

10

01

/11

/20

10

01

/01

/20

11

01

/03

/20

11

01

/05

/20

11

01

/07

/20

11

01

/09

/20

11

01

/11

/20

11

01

/01

/20

12

Portugal Ireland Greece

25

3. Prospects

• At the broadest level, we are watching the interaction of two huge events:

– A secular shift in the location of economic activity; and

– The collapse of a generational expansion in private and, to a lesser extent, public sector leverage in high-income countries

– The eurozone crisis falls at the intersection of these processes

• So how might it all play out?

• We do not know. There are too many unknowns.

26

2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012

GROWTH FORECASTS FOR 2012

-2.0 -1.0 0.0 1.0 2.0 3.0 4.0

US

UK

Japan

Eurozone

Germany

France

Italy

Spain

Jun-11 Jan-12

27

2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012

GROWTH FORECASTS FOR 2012

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

China

India

Asia Pacific (NB excluding Japan)

Russia

Eastern Europe

Brazil

Latin America

World

Jun-11 Jan-12

28

3. Prospects: global

• Here are salient elements of immediate global challenges:

– Accelerating de-leveraging in the private sectors of overleveraged countries;

– Rebalancing the world economy, to give over-leveraged economies export-led growth, which is necessary when their private sectors run huge financial surpluses;

– Reducing fiscal deficits in high-income countries, without killing the recovery; and

– Avoiding excesses in emerging countries, despite easy financial and monetary conditions.

29

3. Prospects: eurozone

• What is needed now in the eurozone are:

– Financing with adjustment, which will take at least 5 years and possibly 10 years, or more;

– Adjustment means structural reforms and divergent inflation across the eurozone, with high inflation in core countries and low inflation in vulnerable countries;

– The big danger would be premature fiscal tightening in the periphery together with absence of adjustment in the core;

– That would lead to deeper recessions;

– And a possible break-up.

30

3. Prospects

• Some guesses:

– The US will be the most dynamic of big economies;

– Growth in high countries will remain weak, with some possibility of still worse;

– Headline inflation rates will fall;

– Short-term official interest rates will remain low, for a long time;

– Countries with their own central banks will have low long-term bond rates; many eurozone countries will not;

– Eurozone break-up risk is significant;

– Emerging countries should grow quickly, but there is a chance of crises there, too.