Download The World Economy on a Precipice

The World Economy on a Precipice
Uri Dadush
Carnegie Endowment for
International Peace
Beijing, March 2009
Main Points
1. Financial crisis has turned into a massive
global recession
2. US sub-prime was the crisis trigger, but
vulnerabilities run much deeper and wider
3. Despite improved fundamentals, developing
countries are being engulfed by the crisis
4. Depression scenarios are no longer
excludable, but most likely is an extended
global recession
5. Bold policy steps essential – including to
forestall protectionism
1. A MASSIVE, GLOBAL,
CRISIS
A massive, global, crisis [Y=f(K,L,E)]
 World output growth down from +3.5% p.a. in 20062007 to -5% (SAAR) estimated in the last six months
 Stock markets around the world fall about 60% from
their peak in Summer 2007
 In the U.S., unemployment set to rise from 4.5% in
2007 to 9% or higher in 2009
 Oil prices fall from $150 at the peak in Spring 2008, to
near $40; prices of metals also collapse
Global Impact: all countries affected by
financial turmoil since September
Most affected: Russia, Ukraine, Hungary, Greece
Least affected: China, United States, Philippines, Egypt
Based on change in exchange rate, spreads, and stock market.
2. CAUSES
Vulnerabilities and Triggers
 US vulnerabilities
 1. Monetary and Fiscal policies too loose too long
 2. Innovation and Regulatory Failure
 3. Excessive household debt and bank leverage
 Global vulnerabilities
 1. Demand Boom and Inflationary Pressures
 2. Housing and Asset price boom
 2. Large and widening external imbalances
 Triggers
 1. Subprime securities collapse
 2. Lehman failure
A major sustained world boom preceded
Percent change, year-on-year
10
75
Global IP
5
25
0
-25
Metal Prices
-5
-10
-75
Jan-91
Jan-93
Jan-95
Source: World Bank.
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Inflation surged
Median inflation rates: Jan 2000 to Dec 2008
12
Developing countries
9
6
3
High-income OECD
0
Jan00
Jan01
Jan02
Source: World Bank.
Jan03
Jan04
Jan05
Jan06
Jan07
Jan08
Jan09
3. EFFECTS ON DEVELOPING
COUNTRIES
Global industrial production plummets into 4th quarter of
2008...
manufacturing production, ch% (saar)
15
Developing
10
5
0
World
-5
-10
OECD
-15
-20
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Source: DEC Prospects Group.
Jul-08
Oct-08
Developing exports in decline
export volumes: ch% 3mma y/y
35
25
China
15
India
Mexico
5
-5
Jordan
-15
Jan-07 Apr-07
Jul-07
Oct-07 Jan-08 Apr-08
Jul-08
Oct-08
Source: National Agencies through Thomson/Datastream.
..and corporate bond spreads have
surged
Emerging-market corporate bond (CEMBI) spreads
Jan 2007 – Feb 2009
Basis points
900
800
700
600
500
400
300
200
100
Brazil
Source: JPMorgan
Philippines
Russia
Turkey
Ja
n09
Ju
l-0
8
Se
p08
No
v08
ay
-0
8
M
ar
-0
8
M
Ja
n08
Ju
l-0
7
Se
p07
No
v07
ay
-0
7
M
ar
-0
7
M
Ja
n07
0
4. FORECAST AND RISKS
World trade to contract in 2009 for the first since
the early 1980s (World Bank)
annual percent change in trade volumes
18
Developing country exports
15
12
9
6
3
0
World trade volume
-3
1981
1984
1987
Source: World Bank.
1990
1993
1996
1999
2002
2005
2008
Private capital flows set to decline more sharply
still in 2009
Net private capital flows to decline $165 bn in 2009(IIF).
Net private debt and equity flows
1990-2008, projected 2009
$ billions
Percent
1200
8
Percent of GDP
(right axis)
1000
6
800
600
4
400
2
200
0
0
1990
1993
1996
1999
Source: World Bank, Projections: IIF (adjusted)
2002
2005
2008
External Finance shortfall in developing
countries in 2009 ( World Bank)
 Private sector creditors shun emerging markets – net
private capital flows fall to $160bn from $1 tril. In 2007
 Higher borrowing costs as well as lower capital flows
 104 of 129 developing countries will have current
account surpluses inadequate to cover private debt
coming due; Eastern Europe most affected.
 Financial gap of about $268 bn in 98 of the 104
countries in the base case
 In a low-case scenario, financial gap could be $700
bn.
Global GDP to decline this year for the first time since World
War II( World Bank)
Sharp decline in GDP growth expected
Growth of real GDP, percent
Developing
8
6
4
2
0
High-income
-2
1981
1985
1989
1993
Source: Historical data: World
Bank. Projections: IMF, adjusted
1997
2001
2005
2009
The drivers of recovery
1. Fiscal stimulus (2.5-3% of GDP in ICs; less in DCs)
2. Lower interest rates (RIR near 0)
3. Bank recapitalization, guarantees, restructuring
4. Falling oil prices
5. Turn in the housing cycle/greed
BUT….will the state remain credible??
Did the financial crisis culminate in early
October?
Spread between 3-month US$ Libor and policy interest rate, basis points
350
300
250
200
150
100
50
0
-50
1/2/07
5/2/07
9/2/07
1/2/08
5/2/08
Spread
Today
9/2/08
1/2/09
Why the crisis could easily become
protracted and deeper
 The intensity of the downturn to date
 Financial crises lead to longer downturns (3-4 years)
and to bigger GDP declines (5% to 25% peak to
trough)
 This financial crisis is big (judging by bailout costs and
stock market decline to date)
 The size of debts in the US and UK is unprecedented
 Complexity of financial instruments
 Global spread of the crisis and coordination issues
Is a depression possible?
20
US GDP, annual growth
15
Price
10
5
0
-5
volume
-10
-15
1930
1941
1952
1963
Source: BEA
1974
1985
1996
2007
5. POLICIES
G-20 Crucial Policy: Mitigating Recession
1. Fiscal Stimulus
 Size and burden sharing
2. Monetary Policy
 Quantitative Easing (which assets?)
3. Bank Restructuring
 Asset Purchases (“Bad Bank”)
4. Support to most vulnerable countries (IMF resources)
5. Preempting Protectionism
Risk of Resurgent Protectionism
 The crisis has led to a large increase in uncertainty –
regarding jobs, livelihoods, and the viability of firms
 …and a massive expansion of states’ non-neutral
interventions into the economy creates room for the
politicization of economic decisions
 Protectionism has been modest so far, but the risks of
large deterioration are real
 Policymakers must take several steps to cement a joint
commitment to trade openness and collaborative
recovery
We have not been here before:
US economy is more trade dependent
1990 International dollars
Percent
35,000
16.00
30,000
14.00
25,000
12.00
10.00
20,000
8.00
15,000
6.00
10,000
4.00
5,000
2.00
0
0.00
1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004
GDP per capita (left axis)
Imports/GDP (right axis)
Sources: GDP per capita: Angus Maddison, "Historical Statistics for the World Economy: 1-2006 AD. Imports 1920-1947: US
Census. GDP 1920-1928: . GDP 1929-1948: US Bureau of Economic Analysis. 1948-2006: Imports as a percentage of
GDP: World Bank, Global Economic Monitor
Policy to Preempt Protectionism
 Visible and fair burden sharing on stimulus
 Moratorium on new trade restrictions through 2010
and formal monitoring and reporting in WTO
 Establish coordination councils on sensitive industries
 Reassert determination to conclude Doha by end
2009
 Form a working group on WTO reform