Keynote Speech - Michael Spence
The G20, THE ADVANCED COUNTRIES AND THE INGREDIENTS IN IN A RECIPE FOR BALANCED GLOBAL GROWTH
I am honored to have the chance to be here to listen and to learn and it is a privilege to have a chance to say a few words this morning about the prospects and challenges for sustaining balanced global growth across the world and for maintaining an open global economy.
EMERGING ECONOMY GROWTH - ASIA AND LATIN AMERICA
The major developing countries have displayed remarkable resilience in the crisis and its aftermath. The crisis response was impressive, effective and fast. Growth is returning and is approaching and in some cases exceeding pre-crisis levels in Asia (east and south) and in Latin America, the latter helped in no small measure by the tailwind provided by Asian growth. I believe (and have argued) elsewhere that this growth is sustainable even in an environment of a slow recovery and slow medium term growth in the developed countries.
The reasons in summary are
1. the size of the emerging market economies take together is large and growing. We are probably about 10 years away from having developing economies pass the 50% of global GDP mark
2. Trade within the group is substantial and also growing
3. incomes are rising so that the composition of demand is better matched to the productive capabilities of these economies than it was when the incomes were lower and the dependence on advanced country demand higher.
4. macroeconomic management is sound and conservative, and the commitment to reform and structural change is deeply embedded.
5. Initial positioning was better going into the crisis and balance sheet damage coming out was less (in the financial and household sectors)
6. Therefore the fiscal capacity to sustain the public sector side of structural change is higher than in advanced countries
In short, the ingredients for sustained high growth are in place. The emerging economies prominently in Asia are able to support a multilateral effort to shift to balanced sustained growth in the global economy. In my view theses countries’ should play an increasingly active role in defining the G20 agenda and the manner of implementation.
What I just said would not have been true ten years ago. While the structural change was in place, the aggregate demand and the income levels would not have been sufficient to compensate for the shortfall on the developed country side.
One other caveat. While the emerging economies can probably sustain high growth in the context of an extended period of slow growth in the developed economies, a major second downturn or crisis in the latter or a major reversal of openness is a different story - the proposition about sustaining growth would not hold. Decoupling is not complete.
The G20 June Declaration says
• highest priority is to safeguard and strengthen the recovery and lay the foundation for strong, sustainable and balanced growth, and strengthen our financial system against risks.
On the growth part, it is fighting an uphill battle and probably losing. Not mainly, because there are deep disagreements about fiscal stimulus and consolidation and other issues, but rather because the basic growth oriented building blocks at the national level in the industrialized countries are not fully developed.
What are these building blocks? They are credible and reasonably comprehensive plans to support and guide the restructuring of these economies to restore and sustain growth beyond a secular horizon of 3 to 5 years.
Without these , policy coordination will be very difficult, The reason is that in the absence of a clear set of growth strategies at the national level, especially in the developed countries, none of the major players will know what the global economy will feed back in response to their own commitments.
Fiscal positioning is surely relevant to growth, but it is only part of the story. In all countries, developed and emerging, there are important structural changes with supporting investments and reforms that are needed to sustain growth. In the emerging economies, dealing with structural change is now deeply embedded in planning and in policy formation. That provides an important foundation for their sustained high growth. This is not true in the advanced economies.
THE US GROWTH CHALLENGE
The US is still the largest unified economy. It’s growth is important for the global economy and but also for its engagement in global coordination of policies designed to rebalance, restore momentum on openness and other global challenges. With a fragile recovery, sluggish growth and stubbornly high unemployment, the political agenda tends to be domestically focussed.
A period of low growth and high unemployment seems inevitable as de-leveraging and restoring fiscal balance are set to continue for some time.
But the problem is deeper and more long term. The US structural evolution over the past 15 years has been driven in large part by excess consumption enabled by debt-fueled asset inflation. The crisis put a stop to the excess consumption but the structural deficiencies and imbalances remain.
The export sector is too small and underdeveloped. The financial sector became outsized and is down-sizing. A systematic pattern of underinvestment in infrastructure has left competitive problems.
Energy prices have remained low causing vulnerabilities and underinvestment in shifting urban infrastructure and in intra and inter urban transportation . The education system has strengths but also persistent problems with efficiency and effectiveness in terms of output of cognitive skills that are matched to the labor market needs of high income advanced and open economy.
State budgets are in distress as a result of the crisis and insufficiently conservative initial positioning . Because balance is a requirement by constitution and convention, investment supporting structural change and growth will decline rather than increase.
The fiscal side requires long term balance and a transition involving a delicate balancing act between short run stimulus to achieve escape velocity on the one hand and sovereign debt risk (and its associated costs) on the other. This is the focus of much of the current debate.
But let’s suppose that a reasonable balance is found. The country still has to address the composition and size of expenditures, investments and revenues. To finance the growth supporting longer term investments, domestic private consumption has to shrink, meaning higher taxes, and government consumption probably has to shrink too in order to add further capacity for expanded public investment. Restoring long term growth will be painful. So will persistent underemployment and slow growth in the longer term.
Even this is not enough. The main long term challenge is productive employment. Not just the stubbornly high unemployment as a result of the crisis-induced lack of demand. But something that is deeper and more long term.
The challenge was addressed on a recent thoughtful article by Andy Grove, the long time CEO Intel. He argues that manufacturing is vanishing in the US economy and suggests that it should be an urgent priority to reverse this trend. He documented in some detail the data for technology sectors. He directly says that we have to keep more of these jobs at home.
I would describe the challenge slightly differently, not as manufacturing but as growth and competitiveness in the tradable sector. The obvious question is how to do that without resorting to protectionism.
This is a political as well as an economic issue. The social contract in America appears to be breaking down. An important part of that contract was a pact that on the one side had an open, flexible and dynamic system and the other the promise of employment opportunities and rising incomes for the motivated and diligent. It’s the second part of that contract is unravelling.
The set of goods and services that is tradable is expanding globally. But in the advanced countries significant parts of the tradable sector are shrinking, perhaps too much.
The employment effects of these trends over the past 15 years have been masked by excess consumption and the overdevelopment of sectors such as finance and real estate. The latter are now set to shrink.
Multinational companies have key roles in determining the location of economic activity. They can grow because they have access to high-growth emerging markets. MNC’S locate their operations where market and supply chain opportunities lie. Admittedly that generates useful domestic employment as a very good recent MGI study documents. In the tradable sector, in manufacturing and in a growing group of services, that means outside advanced countries.
Normally the incentive for labor saving technology or shifts toward capital intensity are driven by rising labor costs. The availability of low-cost, educated and disciplined labour forces in developing countries takes away the incentive for MNC’s to invest in capital and human capital intensive technologies that enhance labour productivity in the tradable sectors of the advanced economies. As a result, the evolving composition of advanced economies is increasingly weighted towards the non-tradable sector, combined with a set of high-end tradable services where both human capital and proximity matter. The underlying problem is a divergence (not a huge one) between market incentives and national needs and priorities.
There are several problems with these trends.
1. One is that the economy may become specialized (in the context of the global economy) in ways that are unwanted or dangerous in terms of independence and national security consequences.
2. Second as Grove points out, there are linkages between R&D, product development and manufacturing. Absence from the latter eventually can cause the others to lose competitiveness.
3. Third and most important, the the sectors that are left may not provide a powerful enough engine to create the productive employment these countries need to generate in magnitude and scope. Growth will be too slow. The export sector will be hard to revive. And the income distribution may move in the wrong direction.
Solutions to these problems are not easy to find. The maldistribution of income can be dealt with through the redistributive capacity of the tax system. But that addresses a symptom, not the underlying problem.
Out migration of manufacturing and other parts of the supply chain can be slowed by increasing protectionism. But that would impose costs on domestic consumers and would almost surely cause the beginning of a breakdown of the open global economy model, with very widespread damage throughout the world.
To avoid an outbreak of protectionism, there has to be an alternative. President Barack Obama’s new export council, announced last week, may address some of the problem. But it is not just exports - it’s a substantial portion of the whole tradable sector. A bolder move is needed: a broad public-private partnership to locate and invest in the development of technology in selected parts of the tradable sector where there are opportunities to make advanced countries competitive. The goal would be to create capital-intensive jobs that have labour productivity levels consistent with advanced country incomes. Public involvement and resources are needed to shift the market incentives at the margin. It won’t happen automatically. The technological base of the economy should not be taken as given, fixed and static and both public and private sectors have important roles in shifting it.
Would this damage developing countries in a significant way. Quite clearly not. The advanced countries altogether do not have several hundred million people to employ. A targeted program of this type would leave the vast majority of the labor intensive manufacturing where it is now: moving around the developing countries as the incomes and structures and comparative advantage shift. But it could add a significant and badly needed employment and growth engine to the US economy.
The other advanced countries have variants of these fiscal structural and growth challenges with some obvious differences.
REBALANCING AND RESTORING GLOBAL DEMAND
I think it is clear that the major emerging economies and the rest of the developing world have a large stake in the restoration of growth momentum in the advanced economies.
On this front the latter could use some external help on the demand side in the form of additional global demand. Armed with a fairly fully developed plans to restore growth without resorting to protectionism, the G20 could reasonably ask the surplus countries to help restore global demand by making the structural shifts that would lead over time to a maintenance of growth and openness and a reduction in the excess savings. The plans will differ across the surplus countries because of different initial conditions, stages of development and structural challenges. And they will have their own complexities.
China, as a result of an active internal debate with outside input and the benefit of the prior experience of a limited number of cases like Korea in which the middle income transition has been navigated at high speed, is well along in developing the policies that will shift the demand and supply sides of the economy, increase household income, reduce household and overall savings, and drive more growth from the domestic market. As in the USA, these structural changes are complex to implement in a way that sustains the growth momentum. They will take time. The challenge at this point is implementation.
THE G20 GROWTH AGENDA
If the G20 is able to agree that these concrete national growth strategies are needed useful as the building blocks of coordination, then it should say so and ask for them.
The supporting institutions (the IMF, the World Bank, the BIS and the FSB and the regional development banks) have deep knowledge of the structural dynamics and other ingredients that underpin growth across a wide array of countries. They would have the job of evaluating and determining whether they add up in terms of consistency. Adjustments will be needed.
This foundation may enable the G20 to address some of the important global priorities:
1. restoring global demand in way that is balanced, sustainable and fairly distributed across countries?
2. restarting the WTO with an agenda that is focussed on supporting the growth targets of various classes of countries. Completion of the DOHA round is important to developing countries substantively and symbolically and hence to G20 and WTO credibility and effectiveness.
3. Approval of the FTA’s by the US, the reinstatement of fast track authority and not reopening the largely settled issues in Doha would a step forward.
4. On the financial side, particularly important are a set up understandings about investment behavior on the part of the major holders of reserves and sovereign wealth assets. This needs to be consistent with the current account surplus and fiscal deficit reduction transitions that are part of the growth plan.
CURRENCIES AND EXCHANGE RATES
Currencies and exchange rates will also need to be addressed in a more systematic way, and not just on a contentious bilateral basis. The post Bretton Woods system is a hybrid. Developed countries by and large have had floating exchange rates, independent monetary policies open capital accounts and no significant reserve accumulation except Japan. The emerging economies adopted and evolved different policies more consistent with their growth strategies at various stages of development. Exchange rates were managed, capital controls were employed and post 97-98, significant reserves have been accumulated.
This hybrid system more or less worked until recently because it met the needs of diverse economies and importantly because the external impacts of emerging countries on overall balance and distributional factors were small enough to ignore. That time has passed.
The divergent needs are still present but the systemically important external effects of emerging country policies are now too large and important to ignore. The emerging countries need to understand and accept this.
The old hybrid won’t work because of these growing external effects and because floating exchange rates in a relatively volatile capital market environment won’t either at least for emerging economies. For the G20 core, we’ll need a new system that accommodates these diverse needs but balances them against system wide balance effects and fairness issues. It is a significant design challenge.
The non-G20 group countries, large in number and small in economic size (less than 15% of global GDP) can probably usefully function under the old hybrid model. Adding them in will probably only create unnecessary complexity.
The G20 Declaration from the recent meeting in Toronto is quite lengthy. Appropriate words (lots of them) verbally blanket the outstanding issues. There is nothing wrong with that as a beginning. What is missing thus far is not scope or intent, but rather a path or process to follow that gives some reasonable degree of confidence that each is contributing adequately according to his ability and to some extent receiving according to his need. In this respect, the November meeting in Korea is crucial.
This is a cooperative game on a giant scale that we are trying to learn how to play, a complex one because of asymmetries among the players. The chances that vagueness, asynchronous moves and separate agreements on distinct issues will probably produce a fully cooperative outcome are low.
One can hope that the mutual assessment processes that is underway under the auspices of the G20 will move things in the right direction. But right now there is no evidence that I can see that the MAP or any other set of forces is producing movement in the developed economies toward the kinds of structural change that would sustain growth, or even a broad based consensus that they are needed. Maybe they aren’t and I am wrong about this. Then we should at least have the debate.
In the developed economies, we are running short of dry powder to handle additional shocks. Arminio Fraga likens this driving in the desert without a spare tire. And we are on a lengthy and bumpy and somewhat risky road to a new normal. That seems inevitable. The problem is that on the present course, the destination may be as unattractive as the journey or worse and the global challenge is to try to make sure that doesn’t happen.
- Build a shared vision to support sustained economic growth in Asia, while drawing lessons from the past in a candid and constructive manner;
- Showcase Asia’s success in economic management, and highlight lessons for other regions;
- Examine Asia’s growth model, its prospects going forward, and the implications of change for the global economy;
- Discuss Asia’s role in the international community, including the IMF, in this process.
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