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The World Economy on a Precipice
Uri Dadush
Carnegie Endowment for
International Peace
Beijing, March 2009
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Main Points
1. Financial crisis has turned into a massiveglobal recession
2. US sub-prime was the crisis trigger, butvulnerabilities run much deeper and wider
3. Despite improved fundamentals, developingcountries are being engulfed by the crisis
4. Depression scenarios are no longerexcludable, but most likely is an extendedglobal recession
5. Bold policy steps essential including to
forestall protectionism
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1. A MASSIVE, GLOBAL,CRISIS
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A massive, global, crisis [Y=f(K,L,E)]
World output growth down from +3.5% p.a. in 2006-2007 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
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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.
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2. CAUSES
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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
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A major sustained world boom precededA major sustained world boom preceded
Metal Prices
Global IP
Percent change, year-on-year
Source: World Bank.
-10
-5
0
5
10
Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-0
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3. EFFECTS ON DEVELOPINGCOUNTRIES
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Global industrial production plummets into 4th quarter of2008...manufacturing production, ch% (saar)
-20
-15
-10
-5
0
5
10
15
Jan -07 A pr-07 Ju l-07 Oct-07 Jan-08 A pr-08 Jul-08 Oct-08Source: DEC
OECD
Developing
World
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Developing exports in declineexport volumes: ch% 3mma y/y
-15
-5
5
15
25
35
J a n-0 7 Apr-0 7 J ul-0 7 Oct-0 7 J a n-0 8 Apr-0 8 J ul-0 8 Oct-0 8Source: National Agencies through
China
India
Jordan
Mexico
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..and corporate bond spreads havesurged
Basis pointsBasis points
Emerging-market corporate bond (CEMBI) spreads
Jan 2007 Feb 2009
Source: JPMorganSource: JPMorgan
0
100
200
300
400
500
600
700
800
900
Jan-07
Mar
-07
May
-07
Jul-0
7
Sep-07
Nov-07
Jan-08
Mar
-08
May
-08
Jul-0
8
Sep-08
Nov-0
8
Jan-09
Brazil Philippines Russia Turkey
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4. FORECAST AND RISKS
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World trade to contract in 2009 for the first since
the early 1980s (World Bank)
Source: World Bank.
annual percent change in trade volumes
World trade volume
Developing country exports
-3
0
3
6
9
12
15
18
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
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$ billions$ billionsNet private debt and equity flows
1990-2008, projected 2009 PercentPercent
Percent of GDP
(right axis)
Private capital flows set to decline more sharply
still in 2009
Source: World Bank, Projections: IIF (adjusted)
0
200
400
600
800
1000
1200
1990 1993 1996 1999 2002 2005 2008
0
2
4
6
8
Net private capital flows to decline $165 bn in 2009(IIF).
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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 surplusesinadequate 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.
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Global GDP to decline this year for the first time since WorldGlobal GDP to decline this year for the first time since World
War II( World Bank)War II( World Bank)
Sharp decline in GDP growth expectedSharp decline in GDP growth expected
High-income
Developing
Source: Historical data: WorldBank. Projections: IMF, adjusted
Growth of real GDP, percent
-2
0
2
4
6
8
1981 1985 1989 1993 1997 2001 2005 2009
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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??
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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 andstock 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
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Is a depression possible?
-15
-10
-5
0
5
10
15
20
1930 1941 1952 1963 1974 1985 1996 2007
US GDP, annual growth
Source: BEA
volume
Price
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5. POLICIES
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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
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G-20 Policy Issues: Avoiding a Repeat
Macro-Policies and Asset Price Bubbles
Regulation of all Systematically Important Financial Institutions (Non-Banks)
Transparency and Market-Making in Credit Default Swaps
Rules on capital adequacy, extent of securitization, mortgage issuance
Regulation of Credit Rating Agencies
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How the world will change: some longer
term implications
Fiscal burden
Monetary overhang
Moral Hazard
Nationalized Banks (and other firms?)
Large reserve accumulation encouraged
Retreat from globalization and the market paradigm?
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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 thepoliticization of economic decisions
Protectionism has been modest so far, but the risks oflarge deterioration are real
Policymakers must take several steps to cement a jointcommitment to trade openness and collaborativerecovery
W h t b h b f
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We have not been here before:
US economy is more trade dependent
1990 International dollars
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 ofGDP: World Bank, Global Economic Monitor
Percent
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
1929 1934 1939 19441949 19541959 19641969 19741979 19841989 19941999 2004
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
GDP per capita (left axis) Imports/GDP (right axis)
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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
