Lecture: 01

The Changing Global Economic and Political

Landscape: Opportunities and Risks
MAJOR CHANGES IN GLOBALIZATION

RISE OF CHINA and INDIA

 More broadly, A half century after end of colonialism new role of
developing world
 New sources of economic growth
 New political power
 New patterns of trade
CHANGING GLOBAL FINANCIAL SYSTEM (IMF, WB, legal frameworks,
major private international banks and so on)
ENERGY
 Combination of scarcity and environmental concerns (global warming)
will force changes in production and consumption
The adjustment of Global Economy to these changes poses major risks and
opportunities
New opportunities
New markets
◦ Access to the global market place means that expansion
is not limited by the size of local markets
New sources of supplies of inputs
◦ Again, firms are not limited to inputs available locally
◦ Wider range of commodities, lower prices, higher quality, meeting specific
needs
◦ A global market place for talent
New opportunities
New sources of finance
◦ Increasing flow of funds to emerging markets
◦ From an ever expanding set of sources
◦ Most recently, growth of sovereign funds
◦ In a wide range of forms (debt, equity)

Access to global technology

◦ Means that “catching up” can occur quickly
New risks
Rapid changes in global comparative advantages
◦ New competitors
◦ New products, new technologies

Changes in global scarcities

◦ Reflected in volatility in commodity prices
◦ Especially in energy markets
◦ Linking of energy and agriculture
New risks
Financial market volatility
◦ Affecting even countries that manage their own markets
well
◦ Sub-prime mortgage crisis
◦ Large changes in risk premium

New rules of the game

◦ International rules (WTO, IMF, Basel)
◦ Domestic responses to the changing global landscape
◦ Backlash against globalization
I. The changing role of developing
countries

China and India, with 2.4 billion people have been

growing at historically unprecedented rates
Countries that were marginalized, excluded from global
economy are closing the gap between themselves and
advanced industrial countries
China at close to 10% growth for 30 years
India recently at more than 8% growth
Engine of global economic growth
 Global growth at 5% for past couple years has been almost
historically unprecedented
 Increased demand for commodities has helped developing
countries
Historical perspective
In 1820, China had 1/3 global GDP, India more than 15%
Between 1814-1828 Industrial Revolution and tariff barrier
knocked out Indian exports
◦ Indian textiles export to Britain fell by two-thirds
◦ British export of textiles to India rose five times
 China and India’s Share in World GDP
35%
30%
25%
20%
China
15% India
10%
5%
0%
1000
1000 1600 1820 1913 1973 1998
Angus Maddison, World Economy, 2001
US, China and India’s Share in
World GDP
Regions Share of World GDP
Globalization has played major role in their
success
 Access to markets
 Access to technology
 Lower communication and transportation costs
◦ 50 percent compounded annual decline in telecommunication cost in the 1990s
◦ Fiber optic glut during the Internet Bubble slashed telecom cost
◦ Scanners convert data to image file - 160 pages per minute.
While the global landscape has
changed, the world is still not flat…
Growing disparity between richest countries and poorest countries
Growing disparities within most countries of the world
 Threat of job loss in advanced industrial countries
 Even for well educated (outsourcing)
 Even if economy maintains full employment, wages can be depressed
Globalization has played an important role in these disparities
 Predictable effect on inequality within advanced industrial
economies
 Unfair trade treaties have compounded problems in developing
countries
 Problems compounded by asymmetric liberalization
Consequences of failures of globalization
Breakdown of Doha Round trade talks
 But it was a misnomer to call Doha Round a development
round
 Worries about consequences of Doha failure are overstated
No agreement is better than a bad agreement
 Many of today’s problems result from bad agreements of the past
 Possible that some obstacles, like agricultural subsidies, may be
resolved
Consequences of failures of globalization

The Doha Round is the latest round of trade negotiations among the WTO
membership. Its aim is to achieve major reform of the international trading
system through the introduction of lower trade barriers and revised trade rules.
Why Doha Round failed?
Agriculture a continuing problem
The proliferation of regional agreements
The US bilateral offensive and decline of commitment to the WTO
Strategic uncertainties in the developing world
Rise of the BRICS…Sinophobia
The financial crisis and efforts to revive Doha.
Consequences
Plethora of bilateral trade agreements
 Undermining multilateral trading system

Growing protectionist sentiments in advanced industrial

countries
 WTO created a rule of law
 Will prevent retreat behind protectionist walls
Further consequences
New geo-politics: new power of developing countries
and resolve to use
◦ Also evidenced, e.g. in China’s new role in Africa
◦ More assistance to infrastructure loans than African Development Bank
and World Bank combined
◦ Competition for resources will help developing countries—but drive up
prices for commodities
◦ And will impose new limitations on broader social agendas (Darfur,
global warming)
◦ G-8 will not work
Protectionism especially strong in areas of investment—
Sovereign Funds
◦ Shouldn’t be a problem in most areas if there is appropriate
regulatory framework in place
◦ But there is a risk of a backlash if West is seen as hypocritical
II. Lessons from successes and failures
in development and transition
No “magic bullet,” “secret recipe” to success
◦ Different countries have taken different routes
◦ Some opened themselves to FDI
◦ Some have not
◦ Some had large firms
◦ Some focused on small firms
◦ Successes requires a comprehensive agenda
◦ But a major mistake in a single dimension (like macro-policy)
can cause failure
Every country has a comparative
advantage
But discovering it may be difficult
China’s success was not based just on low wages of
unskilled labor
◦ There were other countries with lower labor costs
◦ Even in textiles, maintaining equipment requires skilled
workers
◦ China invested heavily in education
◦ China also invested heavily in technology, infrastructure
◦ And encouraged competition
◦ China’s success also based on “supply chain economics”
Trade liberalization no guarantee
NAFTA eliminated tariffs between Mexico and US
◦ Providing access to largest market in world—next door
◦ If ever a free trade agreement should have promoted growth,
this was it
◦ Large differences in wages

But gap between Mexico and US grew in first decade of

NAFTA
◦ And even jobs created in early days of NAFTA were lost
What Mexico did wrong
Weak infrastructure
Underinvestment in education and research
Monopolies (telecom, cement) raise prices of key
inputs
Important problems in governance
◦ Including physical security

Foreign banks took over banking

◦ Supply of credit to domestic small and medium sized
enterprises not engaged in international trade dried up
What Mexico did wrong
Mexico thought that NAFTA was its “magic bullet”—but was
wrong
Globalization is important, but globalization is not everything
◦ Its importance has often been exaggerated
◦ Local knowledge (e.g. in finance, marketing) still critical
◦ Countries must get their internal affairs in order
◦ India’s success began not with external liberalization, but with internal
liberalization
Mexico also believed that key to success was keeping tax rates
low
◦ But with low tax rates, country could not afford investments in
infrastructure and education required to attract FDI
Scandinavia: success in meeting
challenges of globalization
Rapid economic growth, penetration of new technologies
But even more important, outstanding performance in broad based
measures, like UNDP Human Development Indicators
Highest tax rates in world
Success because of high tax rates, not in spite of high tax rates
Finances first rate education, infrastructure, research, and strong
safety net
◦ Safety net important in responding to risk
◦ Risk taking critical for success in New Economy, Globalization
Protecting against volatility
Again, no magic bullet
In East Asia crisis, IMF talked about transparency
◦ But previous set of crises was in Scandinavia, region with greatest
transparency
◦ Transparency important, but not sufficient
◦ Large number of crises around world—including US S & L

Good regulation important

◦ Sub prime crisis and its global contagion illustrates problems that
arise with inadequate regulation and lack of transparency
◦ Problems more often caused by too little regulation, than too much
◦ Economic and social costs of crises can be huge
Transition economies
Success in early days of transition has not meant
success later on
Simple stories told by IMF early on have not been
borne out
◦ Shock therapy has not worked
◦ Countries that privatized and liberalized rapidly have not
outperformed other countries
◦ Good macro-policy is important
◦ But there can be rapid growth even with moderate inflation
Major advantages of countries of Eastern
and South-eastern Europe
Proximity, access to huge market
◦ Importance of supply chain economics

Standards of governance being set by EU

◦ Corporate governance
◦ Competition

But there is still scope for national policies

◦ Countries that have tried to conform to letter of corporate
governance rules, but not spirit, have not done as well
◦ Still scope for promoting access to credit—critical for success
Major advantages of countries of Eastern
and South-eastern Europe
Most countries have highly skilled labor force, with
very competitive wages
◦ Makes more sense to move jobs to where workers are, rather
than move workers to where jobs are
◦ Important to study why this hasn’t been happening more
◦ Lack of infrastructure?
◦ Domestic regulation?
◦ Lack of access to finance?
◦ Lack of access to non-traded inputs?
Long run prospects
Economic theory predicts rapid convergence
◦ If right policies, institutions are put into place

And there is some evidence that this is already

happening
Finance will facilitate this convergence
◦ And at the same time should reap high risk-adjusted returns
for providing a critical input
◦ More than just money
◦ Figuring out dynamic comparative advantage
Figuring out “dynamic comparative
advantage”

Requires combining local knowledge and global knowledge—local

knowledge of the strengths and weaknesses of the region, and how
these fit into the ever changing global landscape
Banks, and especially regional and local banks, and other financial
institutions, play an especially important role
◦ Securitization can play an important role in spreading risks
◦ But cannot replace the information-intensive role of banks
◦ Problems illustrated by the recent sub-prime crisis
III. The Global Financial System
Problems highlighted by persistent global imbalances,
high levels of instability
 Feb 27 episode, where a rumor in China led to largest declines
in stock markets since 9/11
Standard discussion involves shared blame
 U.S. fiscal and trade deficit
 European slow growth
 China’s undervalued currency
U.S. Shares Disproportionate Blame

U.S. deficit is more than $850 billion

 China’s multilateral surplus is only about $150 billion
 So even if eliminating China’s surplus fully translated into a
reduction in U.S. deficit, U.S. deficit would still be more than
$700 billion
 Likely would have no effect—U.S. just buys textiles from
Cambodia and Bangladesh
 But Cambodia and Bangladesh less likely to be willing to
finance U.S deficits
 So global instability might actually be increased if China
revalued its currency
China is trying to reduce multilateral trade
surplus
Through reducing savings
◦ Unique problem—too high savings
◦ One of key parts of 11th ¨five year plan¨
◦ Debate about best way to do this
◦ But so far has failed
More effective than through adjustment of exchange
rates
◦ Huge disruptive adjustments might be required
◦ Which could exacerbate some key problems, such as rural
poverty
Is this a problem?
“Normal” economics has some countries borrowing
from others. Why worry about U.S. borrowing?
 Something peculiar about richest country in the world not
being able to live within its means
 $500 billion last year flowed from poor countries to rich countries
 Deficits OK when money is being spent on investment to make
economy more productive
 Problematic in the U.S.
 Given demography, this is a period in which the U.S. should be
saving, not borrowing
Worry is that there will be a disorderly adjustment
Many reasons to worry
Fears of U.S. economic downturn
 Growth during last few years led by real estate
 Investment
 Taking money out of real estate through refinancing mortgages,
home equity loans
 US economy supported by low interest rates, consuming
beyond its income
◦ Household savings rate negative
◦ US economy spending $850 billion more than its income
With declining real estate prices and crisis in the
sub-prime mortgage market, this is all coming to
an end

 Problems not limited to sub-prime mortgage market

 Speculative real estate investment already stalled
 Matters likely to get worse as new regulations are put
into place to prevent abusive lending practices
 What will replace it?
Not consumption…
Real incomes of average Americans have not been doing
well
 Median income of male in 30s lower today than 30 years ago
 Problems exacerbated in last five years
 At the same time that real labor costs are increasing, we have:
 Slowing rate of productivity growth
 Increasing costs of health care
As America moves from -1% savings to more normal 3 to
4% savings, adjustment will depress aggregate demand
◦ Magnitude and duration of slowdown only question—short but deep
decline versus longer, but more limited one
Not investment…
Investment is weak
 And likely to remain so, as long as there remains uncertainty about
growth
 The problem, however, is not lack of funds
 Risk of increasing interest rates
 Fear of inflation
Anomalous juxtaposition
Period of high risk with low risk premium
 Added risk of return to more normal risk premium
 Effects would be felt in many markets
 Highly indebted developing countries
 Medium and long term bond markets
 Exacerbating problems in real estate
Underlying problems: (1)
U.S. Dollar as global reserve currency
 Risk of crises and IMF intervention has led countries to accumulate huge
amounts of reserves, mostly in dollars
 Basic economic identity
 Capital inflows = trade deficit
 U.S. exporting T-bills rather than automobiles
 But T-bills don’t create jobs— problem of aggregate demand
 Trade deficit has been increasing for a quarter century
Some in Europe aspire for the Euro to become global
reserve currency
 Europe would have same problem—high price to pay for
getting cheap loans
 Worse—because Europe’s hands are tied
 EU Growth and Stability Pact (SGP is a set of fiscal rules designed to prevent
countries in the EU from spending beyond their means. A state’s budget deficit
can not exceed 3% of GDP and national debt can not surpass 60% of GDP)
 Central bank focusing only on inflation
 Two-country reserve system may be even more unstable
What is needed
Global reserve system
 Keynes argued for this
 Basic idea contained in SDRs
 But U.S. has vetoed expansion
Current system is fraying
 Process may be unstable
 Growing lack of confidence in dollar
 Feeding on itself
 Asia major source of global savings
 Paying high price for re-circulating savings in West
 Beginning to explore alternatives
 Asian Bond Market
 Chiang Mai initiative (currency swap arrangement among ten members of
ASEAN)
Underlying problem (2)
Globalization has meant that the world is more interconnected; what
happens in one part of the world has impact on other parts
There is greater need for collective (cooperative) action
But economic globalization has outpaced political globalization
We do not have the international institutions and arrangements with
which to deal with these problems effectively and democratically
Sub-prime mortgage illustrates: inadequacies in regulation and
transparency of US financial markets has global consequences
Hard to imagine US without national regulation (only state regulation)
◦ So to in Europe
◦ But in an increasingly integrated world, that is what we are trying to do on a
global scale
IV. Global Warming
Increasing evidence— its real and its happening
faster than expected
Question is no longer whether we can afford to do
something about it, but whether we can afford to not
do something
 Kyoto is a major step forward
 Many countries put self-interest aside, to achieve a global
agreement
 But ¾ of sources of pollution are left out
 And Kyoto framework not likely to provide guide for future
Global warming is a global problem
requiring global action

Also a matter of global social justice

 Major polluters are in North

 Major costs are borne in South
Kyoto was a major step
forward
But left out three quarters of the sources of emissions
◦ US
◦ Developing countries
◦ Deforestation

And did not set ambitious enough goals, given what we now know
about the risks
Responding to climate
change
Almost certainly the world will respond to the challenges posed by
climate change
◦ New regulations/standards
◦ New taxes
◦ Elimination of old subsidies
Adjusting to climate change
Cost of responding to climate change—if we do it efficiently—is
relatively small, and much smaller than the cost of not responding
But certain sectors and firms will be hurt
◦ Coal
◦ Large car manufacturers
◦ There will be large changes in some prices
But new industries will also be created
◦ Firms that respond to new opportunities creatively will
do well…
Rising energy prices
Problems of global warming will compound problems
of energy insecurity and Mideast turbulence
◦ China and India have large coal deposits, few oil and natural
gas reserves
◦ Problems in some of alternatives
◦ U.S. corn based ethanol very inefficient
◦ Biofuels limited by water scarcity
◦ Carbon storage technology unproven
◦ Could dampen economic growth unless there is substantial
increase in energy efficiency and conservation—changes in
patterns of consumption and production
 Concluding Remarks:

Globalization presents new opportunities

But also new challenges…
 Both to the developed and developing world
There are many ways that globalization has not been working
well
 Increasing inequality, increasing disparities between richest and
poorest countries
 Globalization is only one of factors contributing
 Global instability
Globalization presents new risks
Changing comparative advantages due to rising
economic power of China and India
New protectionism
Global financial instability
 Disorderly adjustment of global imbalances
 New risks posed by financial innovation
 Re-pricing of risk
 U.S. economic downturn
 In globalized world, what happens in one country affects all others
Global warming
One of the objectives of banks and financial markets
is to manage risks
 But if that is to happen, there must be continued innovation
in financial markets and products, continued changes in
banking and banking regulations
 Some innovations will increase risks, reduce transparency
Globalization also presents new
opportunities…
One of objectives of banks and financial markets is not
only to manage these risks, but also to seize now
opportunities, in part by anticipating these changing trends
in the global landscape