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

Global Policy Dialogue

23rd January

London School of Economics

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The shift and the shocks

• Shift

• Shocks

• Prospects

4

1. The shift

• In the 19th century, there occurred the “great divergence”

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

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

• Divergent growth is mirror image of converging incomes

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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 Emerging and developing economies China India

Source: IMF, WEO database

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1. The shift

DEVELOPED COUNTRIES FALL, ASIA RISES

SHARES IN WORLD OUTPUT(at PPP, per cent)

29 25 20 18

2524

20 18

47

14 18

0%10%20%30%40%50%60%70%80%90%

100%

1990 2000 2010 2016

European Union United States Other advanced economies ChinaIndia Other developing Asia Other emerging economies

Source: IMF WEO database, October 2011

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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;

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

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

– Ongoing shift in global economic activity

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2. The shocks

• The economic collapse was large and enduring

• The rescue was also dramatic:

– Liabilities of the core financial system were nationalised;

– Monetary policy is unprecedented; and

– Fiscal policy has been put on a war-time footing.

• 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”. Given the scale of affected economies, it could be longer.

• Conventional fiscal and monetary firepower is used up.

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2. The shocks: global

THE LEGACY OF THE DEBT EXPLOSION

HOUSEHOLD DEBT TO INCOME RATIO

60

80

100

120

140

160

180

2000

Q120

00Q3

2001

Q120

01Q3

2002

Q120

02Q3

2003

Q120

03Q3

2004

Q120

04Q3

2005

Q120

05Q3

2006

Q120

06Q3

2007

Q120

07Q3

2008

Q120

08Q3

2009

Q120

09Q3

2010

Q120

10Q3

2011

Q1

United States Euro area United Kingdom Japan

Source: IMF WEO, September 2011

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2. The shocks: global

A LONG DEPRESSIONGDP 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

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2. The shocks: global

THE SOVEREIGN DEBT CRISIS

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

2006200920122015

Source: IMF WEO, October 2011

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2. The shocks: global

STRUCTURAL FISCAL DEFICIT(as per cent of GDP)

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

Canada France Germany Italy Japan United Kingdom United States

2008 2009 2010 2011 2012

THE AGE OF PREMATURE RETRENCHMENT

13 2. The shocks: global

FISC

AL

RO

OM

? YE

S

TE

N-Y

EA

R G

OV

ER

NM

EN

T B

ON

D Y

IEL

DS

0 1 2 3 4 5 6 7 8

30/10/2009

30/11/2009

30/12/2009

30/01/2010

28/02/2010

30/03/2010

30/04/2010

30/05/2010

30/06/2010

30/07/2010

30/08/2010

30/09/2010

30/10/2010

30/11/2010

30/12/2010

30/01/2011

28/02/2011

30/03/2011

30/04/2011

30/05/2011

30/06/2011

30/07/2011

30/08/2011

30/09/2011

30/10/2011

US

UK

JapanG

erman

yF

rance

ItalyC

anada

Sp

ain

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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

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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

• Too little, too confused and too late

• The crisis is potentially terminal for the eurozone

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2. The shocks - eurozone

CURRENT ACCOUNT BALANCES(per cent of GDP)

-12.0-10.0

-8.0-6.0-4.0-2.00.02.04.06.08.0

10.0

Finlan

dNet

herla

nds

Belgium

Germ

any

Austri

a

Franc

e

Italy

Irelan

d

Spain

Greec

e

Portug

al

Estonia

1999-2007 Average 2012

EUROZONE IMBALANCES

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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

200220032004200520062007200820092010201120122015

Source: World Economic Outlook database April 2011

18 2. The shocks -

eurozone

RO

AD

TO

TH

E E

UR

OZ

ON

E F

ISCA

L C

RISE

SS

PR

EA

DS

OV

ER

BU

ND

S

0

100

200

300

400

500

600

01/01/2007

01/03/2007

01/05/2007

01/07/2007

01/09/2007

01/11/2007

01/01/2008

01/03/2008

01/05/2008

01/07/2008

01/09/2008

01/11/2008

01/01/2009

01/03/2009

01/05/2009

01/07/2009

01/09/2009

01/11/2009

01/01/2010

01/03/2010

01/05/2010

01/07/2010

01/09/2010

01/11/2010

01/01/2011

01/03/2011

01/05/2011

01/07/2011

01/09/2011

01/11/2011

Be

lgiumS

painF

ranceItaly

Netherlands

19 2. The shocks -

eurozone

RO

AD

TO

TH

E E

UR

OZ

ON

E F

ISCA

L C

RISE

SS

PR

EA

DS

OV

ER

BU

ND

S

-500 0

500

1000

1500

2000

2500

3000

3500

4000

01/01/2007

01/03/2007

01/05/2007

01/07/2007

01/09/2007

01/11/2007

01/01/2008

01/03/2008

01/05/2008

01/07/2008

01/09/2008

01/11/2008

01/01/2009

01/03/2009

01/05/2009

01/07/2009

01/09/2009

01/11/2009

01/01/2010

01/03/2010

01/05/2010

01/07/2010

01/09/2010

01/11/2010

01/01/2011

01/03/2011

01/05/2011

01/07/2011

01/09/2011

01/11/2011

Greece

Ireland

Portu

gal

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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

– “Imbalances” are a vital symptom of economic stress

• So how might it all play out?

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

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2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012GROWTH FORECASTS FOR 2012

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

US

UK

Japan

Eurozone

Germany

France

Italy

Spain

Jun-11 Jan-12

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2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012GROWTH 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 (withoutJapan)

Russia

Eastern Europe

Brazil

Latin America

World

Jun-11 Jan-12

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3. Prospects: global

• Here are salient elements of global challenges:

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

– Rebalancing the world economy, to give over-leveraged economies to enjoy export-led growth, 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.

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3. Prospects: eurozone

• What is needed now in the eurozone are:

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

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

– The big risk is a combination of premature fiscal tightening in the periphery and the absence of adjustment in the core;

– That will lead to further deep recessions;

– And a possible break-up.

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3. Prospects

• Some guesses:– Growth in high countries will remain weak for many years,

with a significant chance of a true depression;

– Headline inflation rates will fall;

– Short-term official interest rates will remain low;

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

– Eurozone break-up risk remains;

– The US will be the fastest growing of big economies;

– Emerging countries will grow quickly, but there is some chance of crises there, too.

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